WHATEVER HAPPENED TO PRUDENCE? / THE FINANCIAL TIMES OP EDITORIAL

Whatever happened to prudence?

Governments have stopped correcting budget deficits but — so far — bond markets have let them

Chris Giles

© Matt Kenyon

As the energy shock intensified earlier this year, the IMF dished out its standard advice on how countries should respond if they wanted to offset the pain for their households and companies. 

Any support should be timely, targeted and temporary, it said. 

Nations did respond quickly, with nearly 900 measures implemented to offset the shock across 170 countries at the latest count in mid-June. 

But the measures were broad-brush, had no end date and subsidised energy — undermining the incentive to conserve fuel in the middle of an energy shock. 

They will be difficult to reverse.

This year’s energy subsidies signify more than countries being unwilling to heed IMF advice. 

They are just the latest example in a growing international trend to fix problems with additional government borrowing and leave the resulting higher deficits and debt for future governments to manage.

This has been standard practice in the US since the 1990s. 

French politics has long found it impossible to rein in high deficits to meet European targets. 

The current German government has decided to borrow more to repair its broken infrastructure and improve its defence capabilities. 

Japan has pledged new tax cuts and a massive public and private investment programme and the new UK prime minister Andy Burnham said he would exploit flexibilities in his budgetary rules to allow more borrowing.

There has been no co-ordination at a global level. 

The G20 group can barely agree on anything these days and in April its finance ministers could not devise even a bland unanimous joint statement on whether all of this borrowing and spending was sensible.

It was not always thus. 

At the 2010 Toronto G20 summit, all significant economies pledged to repair their public finances after the disaster of the 2008-09 global financial crisis. 

“Sound fiscal finances are essential to sustain recovery, provide flexibility to respond to new shocks, ensure the capacity to meet the challenges of ageing populations, and avoid leaving future generations with a legacy of deficits and debt,” the communiqué said.

Whatever the optimal fiscal consolidation path in the 2010s may have been, more urgency is required today. 

IMF estimates of gross government debt have risen sharply. 

In 2010 it was 94 per cent of GDP in advanced economies and 37 per cent in emerging economies. 

Debt is now expected to be 108 per cent and 77 per cent respectively this year. 

These higher levels of debt also attract higher interest rates, leaving public finances across the world looking ever more fragile.

Recent evidence from both the IMF and the Bank for International Settlements has found that past relationships between rising debt and fiscal repair have broken down. 

There is no longer evidence that rising government debt generates political pressure for public spending cuts or tax increases. 

Instead, the BIS found that countries aggressively use budgetary stimulus in difficult times to mitigate the losses, and instead of running surpluses in good times, have begun to use these moments to ease the purse strings and cut taxes.

The important question is why governments across the world stopped finding time for prudence. 

Part of the answer in the 2010s was that interest rates were low and appeared to be stable, giving a justification for persistently higher borrowing. 

That argument no longer applies and governments rarely offer any excuse, merely promising to do better in future and then failing.

The more concerning explanations rest on megatrends in the global economy and the current inability of domestic or international politics to address them.

Russia’s invasion of Ukraine, the US war with Iran, China’s aggressive stance and wider geopolitical tensions are raising pressure on governments globally to spend much more on defence with little prospect of any respite in the years ahead. 

Adapting to climate change and mitigating its effects costs money now. 

And ageing societies generate greater pressures on governments for pensions, health services and the costs of social care. 

The AI revolution might increase economic growth rates, but will also bring public finances pressures to support those who have lost their jobs.

Greater co-operation at the international level could mitigate all of these costs. 

Greater trust between nations would enable less to be spent on defence. 

More joint action on global warming would lower the eventual costs of adapting to a warmer climate. 

And managed migration could ease some demographic pressures in both advanced and emerging economies.

But only the most naive should expect any of this to happen. 

In recent years, polarised geopolitics has killed almost all attempts at co-operative solutions on issues from trade to defence, climate, migration and taxation. 

Polarised domestic politics makes it harder for governments to build national support for the difficult choices needed for reducing budget deficits.

And what about the bond vigilantes? 

Will they restore discipline?

So far, they have been benevolent jailers, merely rattling their keys occasionally rather than forcing countries to take their public finances seriously. 

But make no mistake, the megatrends are persistent, fiscal pressures are rising and few countries are addressing them. 

This uneasy truce may continue for some time. 

But it will not last for ever.