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Debt is on the rise. Recently, global debt has reached unprecedented levels. It is reported that in the third quarter of 2023, global surged to a near-record $307 trillion, representing 335% of world GDP (Institute of International Finance (IIF)). Historically, we’ve looked to developed economies as explanations for rising debt levels. However, developing economies have recently been borrowing more and more, often at very high-interest rates.
You can check out this great article by the World Economic Forum on why developing economies are taking on more and more debt.
Several different factors have contributed to the ballooning global debt, but one stands out above them all; increased government spending. In response to significant economic disruptions such as the 2008 financial crisis, the recent COVID-19 pandemic and the Russia-Ukraine war, governments worldwide have pumped trillions of dollars into their economies to stimulate growth, maintain employment, and support their healthcare systems. As governments don’t have endless resources, they resort to taking on debt to fund such expenditures, especially when the economy isn’t performing well. Periods in which economic growth is low and the government is forced to borrow can be damaging the government is taking in less tax which is often used to fund such spending.
Simultaneously, private sector indebtedness has also risen in the last few years which has been driven by record low-interest rates (Which decrease the cost of taking on debt) that have encouraged increased levels of borrowing. According to a report by the International Monetary Fund (IMF), corporate debt has seen a significant uptick, in the funding of operations and/or the taking on of new investment opportunities with the borrowed financial capital.
The consequences of such unprecedented levels of global debt are far-reaching, as a high debt burden can limit a government's fiscal space due to its commitment to pay debt servicing fees on existing debt. In turn, this reduces its ability to respond to future crises or invest in growth-enhancing areas such as infrastructure and education, without perpetuating the issue by taking on more debt.
Moreover, excessive debt can increase a country's susceptibility to economic shocks, heightening the risk of a full-blown debt crisis which is particularly concerning for emerging markets and low-income countries. This is because lower-income economies traditionally have higher debt servicing costs as they are a less trustworthy debtor, meaning they may face challenges servicing their debts if global financial conditions tighten and they aren’t able to access additional capital.
If you've got a spare 30 minutes, I would highly recommend checking out this all-time great video on how our capitalist economies actually operate by Ray Dalio and the inevitable nature of debt crises:
However, despite the looming danger, the global debt dilemma can be addressed through a combination of domestic and international efforts. Internally, countries can undertake fiscal consolidation measures, such as broadening the tax base (increasing the numbers of tax levied) or decreasing levels of public expenditure. However, these measures must be taken with caution, as too much austerity can reduce the performance of the economy, which will have an inverse effect. Tax revenue might fall and higher spending might be required, thus increasing debt levels again.
Debt restructuring also emerges as another avenue to reduce global debt levels. Debt restructuring is the changing of terms in an existing borrowing agreement to make the terms more favourable for either party. The decreasing of interest rates in a debt agreement could be very beneficial for the borrower as it would reduce the cost of their existing debt, and perhaps put them in a better position to pay off that debt. This strategy has been used successfully in the past, with a prominent example being during the Latin American debt crisis in the 1980s and the Heavily Indebted Poor Countries (HIPC) Initiative by the World Bank and IMF in the late 1990s and early 2000s.
Here again is another fantastic video showing the effect of the IMF's HIPC initiative ave in practice and how it supported the Somalian economy:
However, despite the array of different possible policies and initiatives, economic growth, on an economy-to-economy basis, prevails as the most sustainable from an independent perspective. There are many different ways in which economic growth can be achieved without excessive government spending. Supply-side policies might enhance productivity and international competitiveness. This can be through the encouragement of research and development by reducing bureaucracy and red tape, for example. The stimulation of economic activity boosts the levels of tax revenue in an economy, increasing the capacity to service the existing debt without incurring more to pay it off. Perhaps more importantly, a thriving economy helps to increase the view of the said economy being seen as a trustworthy borrower, which would lead to lower and more sustainable interest rates on any debt taken out in the future to fund economic activity.
The global debt crisis is a challenge but is certainly not insurmountable. With disciplined fiscal management, strategic debt restructuring, and robust economic growth policies, countries can navigate through it. However, while there is plenty that individual economies can do themselves, international cooperation is vital to ensure that developing economies do not suffer too much and face a disproportionate amount of the burden. Multilateral institutions and creditor countries play a significant role when it comes to reducing this burden on developing economies and supporting their ambitions.
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