What happens when public debt stops buying progress?

FOR much of the post-war era, rising public debt was associated with infrastructure expansion, educational progress and stronger public institutions. Governments borrowed, but citizens could see improvements in public services and living standards. Today, that relationship appears increasingly broken.

Across the advanced democracies, public debt has risen to levels not seen outside major wars. Yet, productivity growth has slowed, educational outcomes have weakened, and public trust in institutions has declined.

The central challenge is not simply the level of debt. It is whether governments are generating sufficient returns from their resources.

Paradox of rising public debt

In many advanced economies, public debt now exceeds 100 per cent of gross domestic product; Japan’s debt remains around 240 per cent. Fiscal deficits remain elevated even outside recessions, and debt-servicing costs are rising as interest rates normalise.

At the same time, productivity growth across much of the Organisation for Economic Co-operation and Development (OECD) has slowed sharply.

Europe illustrates the challenge. International Monetary Fund managing director Kristalina Georgieva recently argued that Europe possesses enormous untapped potential, but remains constrained by fragmented markets, regulatory barriers and incomplete integration. Europe’s problem, in other words, is not a lack of spending but insufficient reform.

Educational outcomes tell a similar story. The OECD’s Programme for International Student Assessment results have stagnated or declined across many advanced economies, particularly after the pandemic. Despite rising expenditure, learning outcomes have weakened and human-capital gains have slowed.

Economic inequality adds another dimension. While governments have devoted enormous resources to social protection and redistribution, outcomes have often disappointed. Politically influential groups have been more successful in protecting benefits than younger and lower-income households have been in securing new opportunities.

As fiscal pressures rise, governments increasingly rely on ad hoc measures that do little to improve long-term distributional outcomes.

The result is a widening gap between what citizens expect and what governments are fiscally capable of delivering. For many younger households, affordable housing, secure employment and upward mobility appear increasingly difficult to attain. At the same time, governments face growing constraints from debt service, ageing populations and entitlement commitments.

These pressures are especially visible in the US. Federal debt exceeds 100 per cent of GDP for the first time since the World War II, while interest payments are now the third-largest category of spending, exceeding defence. Despite relatively strong growth and technological leadership, concerns about affordability and economic security have contributed to declining public trust.

New spending pressures

The challenge is becoming more acute because advanced economies are entering a period of powerful new spending pressures. Defence spending is rising sharply in response to geopolitical tensions. Governments are committing substantial resources to industrial policy and strategic technologies, while ageing populations are increasing pressure on pension and healthcare systems.

Much of any fiscal space created through spending cuts or higher taxes may therefore be absorbed by age-related expenditures rather than new investments in growth or opportunity.

The issue extends beyond fiscal sustainability. As debt rises, governments become increasingly dependent on stable financing conditions and are left less prepared to respond to future crises.

Fiscal space that was deployed aggressively during the global financial crisis and the pandemic may be much more limited when the next major shock arrives. Resources that could otherwise support investment in education, research, infrastructure and innovation are increasingly absorbed by interest payments.

Lessons for emerging economies

The experience of advanced economies offers important lessons for Asia and other emerging economies.

While much of the region emerged from the 1997 Asian financial crisis with a strong commitment to fiscal prudence, debt sustainability and policy buffers, fiscal pressures are now increasing across the board owing to ageing, climate spending needs, industrial policy and geopolitical pressures. In some economies, rising public debt and debt-servicing costs are already beginning to constrain fiscal flexibility.

For emerging economies in Asia, the lesson is not that governments should avoid public investment or active fiscal policy. Rather, it is that sustained increases in public debt can gradually erode both economic performance and policy flexibility if they are not accompanied by stronger productivity growth, institutional reform and improvements in public-sector effectiveness.

Preserving fiscal space may prove particularly important in a world of greater geopolitical uncertainty, financial volatility and more frequent shocks. It may also determine which economies retain the capacity to invest in the productivity gains associated with artificial intelligence.

Ultimately, the paradox facing many countries today is that governments are larger, more indebted and more interventionist than ever, yet many citizens feel less secure, less prosperous and less confident in public institutions.

Historically, public debt often financed investments that expanded productive capacity and strengthened the middle class. Today, more public resources are absorbed by debt service, age-related spending and strategic expenditures – at the expense of future growth.

The defining challenge is no longer simply managing high debt. It is restoring the link between public resources and public performance. Without stronger productivity, better institutions and more effective public spending, rising debt risks becoming not a source of national renewal, but a symptom of institutional decline.

The writer is a distinguished fellow at the Centre for Social and Economic Progress and former director at the International Monetary Fund