Transcript | 2. lecture: Debt crisis - University for modern Slovakia

In the second trimester of our university, we explained how and why the world global financial crisis occurred that erupted in full at the autumn of 2008 and subsequently changed to the global economic crisis that hit the world in 2009. The world economy has seen this year an absolute decrease of 0.6%, which was the first time in decades. The growth of world economy, however, quickly recovered and by the International Monetary Fund (IMF) the world economy in 2010 grew by 4.8%, which is admittedly a bit less than in 2007 (5.3%), but significantly more than in 2008 (2.8%). According to estimates by the IMF similar growth should endure in the years 2011 to 2015 (from 4.2% to 4.6%).

But these are global figures; they represent the average value of very different development in different parts of the world. How else, the best are China and India; the worst are Western Europe, Japan and USA.

Source: World Economic Outlook, IMF, Oct. 2010

From the data in the table it is evident that in the coming years China and India will be growing twice as fast as the world, while U.S. growth will be about half of the world average, one-third growth will be in the euro area and Japan, and Central and Eastern Europe could grow a little faster than the world in average. At least according to IMF forecasts.

The fact that the poorer countries (with proper economic policy) grow faster than rich ones, is normal and natural. Nevertheless, there is a big problem here. It lies in the fact that the richest countries (USA, Western Europe and Japan) have enormous debt, which has greatly increased during the global financial and economic crisis. It is related to the fact that the global financial and economic crisis in all these countries was dealt with robust and very expensive rescue projects, particularly through the pouring liquidity into banks, saving large companies (automotive companies in the U.S.), pouring money into the economy through the operation of central banks and through the government stimulus packages. I.e. it was just in the spirit of the recommendations of Keynesian school of economics and just like in Japan throughout the past twenty years (see lecture from second trimester: Japanese crisis).

The result is increase of public debts.

Source: WEO, IMF, Oct. 2010

The plight of public debt in developed countries is probably the best illustrated by the fact that 60% of the debt limit, which is considered acceptable (and therefore was chosen in the so-called Maastricht criteria), is now exceeded in almost all developed European countries, USA, and Japan.

The most recent data even suggest that the development was even worse than predicted by the above IMF forecast, and in 2011 100% debt limit was exceeded besides Japan also in Greece, Italy, USA, UK, France, Ireland, and Portugal.

This development very aptly illustrates where the Keynesian policy of aggregate demand stimulation is leading during the crisis. This is best seen in the figures for Japan, which in 1997 exceeded the 100% limit and with its stubborn insisting on the Keynesian stimulation and prevention of markets from clean-up drove its debt to astronomical heights.

A high public debt is of course a problem for the country. The growth of public debt starts a vicious cycle of increasing public spending, higher taxes, lower growth, higher unemployment and then re-expanding public debt, increasing government expenditure and thus again and again. Public expenditures are growing because of rising debt service, which increases the growth of the debt itself, but also because of the increase of the risk premiums, which are usually growing at indebted countries. The need for higher taxes then leads to greater tax avoidance and lower growth and more unemployment, which again leads to lower revenues and higher public spending and thus increase the deficit and debt, and thus still around. And that was not enough, there are objective reasons that the situation will get worse and make it more complex.

This is particularly the aging of the population, occurring in all developed, but also in majority of middle-income countries, including Slovakia. Just to illustrate that we know what we talk about. In 2010, in Slovakia there were 5.4 people in active economic age per pensioner; in 2050 that will be 1.8. This is prognosticated by demographic forecasts that are relatively accurate unlike other forecasts for such a long period. This means that if we have only ongoing schemes (first pillar) in Slovakia, and if in 2050 we would like to keep today's pension rate (ratio of average pension to average salary, now about 50%), we would have to increase the contribution burden three times compared to today's level. Or the pensions would be one-third of today's level with the current levy burden. Or public debt should climb to 350% of GDP. I think it is clear that these alternatives are unsustainable and we need reform. The similar problem is healthcare, because a higher proportion of older people significantly increases healthcare costs. In addition, the growing demand for health services, as well as the natural human desire to live longer with the new, but still more expensive options to extend the length and quality of life.

Indebted welfare states with generous public pension and health systems in this respect are quite similar to the time bomb that is ticking quietly, slowly, but inexorably. How relentlessly and when they explode if no significant changes are undertaken in the way of their operation, we will discuss in the next lecture.