The ways out that aren’t
Economic growth is unlikely to prevent fiscal crisis
Immigration only defers the problem. Higher productivity means higher interest rates
Illustration: Ben WisemanIt is a favourite trick of politicians to promise economic growth to flatter their budget forecasts.
Debt is only one-half of the debt-to-GDP ratio; increasing output can be as good as shrinking what you owe.
In the mid-20th century, the catch-up of wartorn economies, a baby boom, women’s entry into the workforce and the expansion of secondary education meant growth contributed to the rich world paying off its debts from the second world war).
Emerging economies enjoying catch-up or commodities windfalls have at times grown their way out of debt rather than restructuring it or inflating it away.
Today, the low-hanging fruit has largely been picked.
But politicians of left and right still pin hopes on growth to shore up the public finances.
The left tends to favour more immigration, which is seen as a natural response to the problem of an ageing society.
The right emphasises productivity, brought about by tax cuts, deregulation and technological advances.
Unfortunately, neither population nor productivity is likely to rescue today’s budgets.
Start with increasing the size of the workforce.
“Immigration [is] one of the answers to Europe’s demographic ageing,” declared the Council of Europe’s parliamentary assembly this year.
At an annual central-bank jamboree in Jackson Hole, Wyoming, both Ueda Kazuo, governor of the Bank of Japan, and Christine Lagarde, president of the European Central Bank, suggested that foreign workers were the natural solution to the problem of demographic drag.
The appeal is obvious.
Immigration mechanically boosts GDP, spreading existing debt over more people.
In the near term, deficits fall because tax receipts rise.
More migrants can also look better (fiscally speaking) than more babies, who do not arrive ready to work.
Youthful in discretion
The trouble is that the young get old.
The baby boomers have gone from being budget boons to budget-busters.
Life expectancy has risen, which means adding immigrants or babies delays but does not prevent the average age of the population from going up in tandem.
Eventually you face the same problem again on a bigger scale.
“The rise in population needed to completely offset ageing…is very great and gets bigger over time,” wrote David Miles of Britain’s Office for Budget Responsibility, its fiscal watchdog, in a recent essay warning of a “population Ponzi scheme”.
In some countries that might sound less like a warning than an enticement.
Both Japan and Italy have birth rates that are so low that their populations are shrinking.
More migrants would forestall population collapse as well as delaying a budget catastrophe.
Yet many Western voters increasingly fear congestion, especially around successful cities.
Regulations often prevent adequate homebuilding.
Infrastructure and public services have in many places failed to keep up with the pace of arrivals in the 2020s, creating a backlash.
Research by the Bank of Canada has found that in some areas a 1% increase in skilled migrant populations produces a 6-8% rise in house prices.
Britain has seven times the population density of the average rich country and an acute housing shortage in its most productive region around London; it looks the least well-placed of rich countries to plug a fiscal hole with more people.
America has lots of space overall, but local bottlenecks on housing supply in its most successful places, to which migrants would most naturally be drawn.
If you thought balancing a budget was a difficult political job, try taking on NIMBYs.
Countries have also proved to be poor at admitting the most fiscally beneficial migrants.
Progressive taxation and welfare states mean there is a chasm between the lifetime fiscal impact of a high-skilled and a low-skilled one.
The average migrant who arrives in America aged 25-34 with a graduate degree brings discounted lifetime fiscal benefits (excluding descendants) of nearly $2.3m, in 2024 prices, to the federal government, calculates David Bier of the Cato Institute, a libertarian think-tank, in a working paper.
A migrant of the same age who arrives without a high-school diploma brings in less than $15,000 in lifetime benefits.
Similar evidence from the Netherlands suggests that migrants must have at least a bachelor’s degree to have a positive fiscal effect.
Unfortunately the surge in migration that the rich world has experienced since 2020 has, on the whole, involved an unusually high proportion of lower-skilled migrants, including asylum-seekers.
Yet even if there were a pivot to the highest-skilled, the numbers required to plug the hole in the budget are enormous.
Take the nearly $2.3m benefit of a young, high-skilled migrant and compare it with America’s total forward-looking fiscal gap, estimated to be $163trn by the Penn Wharton Budget Model.
It would take an implausible 71m such migrants to close the gap.
What about the dream of faster productivity growth?
“We may see a productivity revolution in this country over the next ten years that we just can’t anticipate,” Senator Ron Johnson of Wisconsin told reporters in June while defending a deficit-swelling budget bill.
A scenario produced by America’s Congressional Budget Office finds that if average annual total factor productivity growth were half a percentage point higher than it forecast, the public-debt-to-GDP ratio in 2055 would be 113% rather than 156%, all else being equal.
“AI could solve the US fiscal problem,” declared Torsten Slok of Apollo, a private-equity firm, in July.
You will (not) grow out of it
Yet in fiscal terms even productivity growth can come with downsides.
Public pension schemes like social security are often linked to wages, which rise with productivity, limiting the fiscal gain.
More fundamentally, what matters for improving debt sustainability is not just boosting growth, but boosting growth relative to interest rates.
Since Frank Ramsey wrote the canonical model of economic growth in 1928, economists typically have argued (though it is hard to prove) that productivity and interest rates rise and fall together.
As a result you might not lower the interest rate-growth rate gap “much if at all” with pro-growth policies, wrote Jason Furman of Harvard University last year.
Faster growth will “prompt additional investment, putting upward pressure on real interest rates”, warn Serkan Arslanalp of the IMF and Barry Eichengreen of the University of California, Berkeley.
Although empirical evidence on the matter is scattered and inconsistent, some research implies that when growth rises, interest rates rise even more—which would make debt sustainability worse.
Suppose AI does turbocharge productivity.
Investment demand is already rapacious: data-centre, server and chips investment will be nearly $500bn globally in 2025, says Morgan Stanley, a bank.
The more optimistic you are about AI’s growth potential, the greater the outlays should be.
An uber-optimistic model by Epoch AI, a think-tank, suggests that optimal investment in AI this year is $25trn, almost the size of the entire US economy.
Even for America, which can import oodles of capital, eventually a greater demand to invest pushes up interest rates.
And, according to Ramsey’s framework, faster expected growth also makes savings fall, because people think they will be richer tomorrow.
This makes the capital shortage even worse.
The effect is global—and can be painful when countries grow at differing paces, according to Neil Mehrotra, now of the Federal Reserve Bank of Minneapolis.
Cross-border capital flows keep interest rates highly correlated across countries.
Fast growth in America can, therefore, push up the cost of capital for everybody—even if nobody else is sharing in the boom.
Europe, with its regulatory burdens and lack of technological dynamism, must be especially cautious.
The alternative to succeeding in AI is “importing higher rates while productivity stays flat”, warns Luis Garicano of the London School of Economics.
A last issue with AI is that it could increase the demand for redistribution.
That is the expectation in Silicon Valley, which anticipates most knowledge work becoming redundant, and where many techies advocate a universal basic income (UBI).
Even if they are wrong about UBI, it is likely that an era of economic disruption would lead to greater demands on welfare states.
A larger economic pie would make that easier—Messrs Arslanalp and Eichengreen find that faster economic growth does predict successful fiscal adjustments, in part because it makes it easier to run surpluses.
Yet with a disruption as profound as AI, there are plenty of reasons to be careful what you wish for.
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