Private Markets Investor Europe: Public debt snowball effect needs monitoring

Xavier Debrun, a member of the European Fiscal Board, assesses the megatrends affecting global markets, including risks and potential upsides.

Andrew Putwain POSTED ON 4/3/2023 8:00:00 AM

Xavier Debrun, a member of the European Fiscal Board.

The four main megatrends that are affecting global markets create a “toxic mix for public debt”, said Xavier Debrun, Head of Economics and Research, National Bank of Belgium, and a member of the European Fiscal Board.

Debrun presented the opening keynote on “Megatrends and public debts: towards a mass extinction of safe assets?” at the second day of Clear Path Analysis’s Private Markets Investor | Europe event in London.

Debrun identified the four megatrends as 1) ageing populations, 2) climate change, 3) trade fragmentation, and 4) income inequality. These, he said, emerged as global trends partly because of the unsustainability of public debt and how it both reflected wider markets and created – and exacerbated – new pressures.

He still urged that “public debt is a good thing,” however, due to the positive effects it could have in creating opportunity in society and helping governments pay for innovation. To achieve these goals, he noted, its sustainability must be carefully monitored. If not, Dubren said, there could be large consequences for the countries in which it fails.

Emerging megatrends

Debrun added that these four global megatrends are threatening the sustainability of public debt – and could potentially lead to its mass extinction.

“These trends mean governments need an overall higher primary surplus,” he said, offering as an example the difficulties that low-to-medium wage earners have experienced trying to save in current circumstances with a high cost of living. This trend could in turn mean enhanced reliance on government pensions, which would have reverberating effects on the global economy.

This issue is not new, however; it’s been debated for several years now. In 2023, a UK government report estimated that the level of ‘undersaving’ was already high and further increasing – to 43% of working aged people when 75% of an individual’s defined contribution (DC) pension was converted into an annuity.

“Productivity will be affected,” Debrun continued.

Trade fragmentation

The second megatrend, trade fragmentation, could affect supply chains and hurt growth, Debrun said – a phenomenon that has already occurred in global markets throughout the bumpy road back from COVID-19 lockdowns.

The Suez Canal blockage, for example, and trouble getting goods to and from countries in lockdown has sent shockwaves throughout the economy, leading to high anxiety over the past few years.

According to a recent KPMG survey, 71% of global companies highlighted raw material costs as their number one supply chain threat for 2023.

Trade fragmentation could also bring further geopolitical tensions, which will mean higher defence spending and lower public spending – such as the situation in Poland after the invasion of Ukraine. This will in turn reduce the peace dividend, which refers to the economic benefits that result from a country partly reallocating its defence spending to civilian projects in times of no conflict. Another result would be further income inequality. Debrun also pointed out that because high-income workers save more than others in the workforce, higher income equality will overall have a different effect.

The issue of ageing populations then becomes relevant, Dubren said, as society will have two groups – an older wealthier section and those who are more financially unstable – who will then experience or feel a different level of engagement with society.

“The median voter is getting closer to retirement age, and this will mean the issue becomes a political hot potato,” said Debrun, pointing to the recent troubles in France over retirement ages. “If this issue is avoided when it needs to be reformed it will make affected areas less insurable,” he said.

However, the income inequality issue has spread into many other areas, such as homeownership rates, which could go on to affect overall income asset levels for voters and increase societal fragmentation.

Debrun’s conclusion was that income equality meant political fragmentation, which led to higher incentives to let debt grow further. He said he was unsure as to whether politicians would work to stop this snowball effect – but emphasised that they must.

Snowball effect

Debrun’s conclusion on the potential future of current market trends was that it boiled down to how safe sovereign bonds are. When this dynamic isn’t carefully controlled, he said, economies will face more difficulties.

“Stable debt behaviour requires primary surpluses to offset snowball effect,” he added. “But these megatrends are destabilising for public debt. But we can hope. Market discipline isn’t always disruptive – such as the case of Greece during the Euro crisis – and can sometimes improve the political economy of public debt without drama. For example, the UK LDI crisis last year was market discipline at work.”

Debrun’s ultimate warning was that public debt came with a budgetary footprint, which is taxpayer’s money being dedicated to paying off public debt. The interest would then lead to less money for public services, which is important to voters – and, noticeably, what has been happening in the UK since the austerity measures .

Debt complacency, he concluded, should gradually abate – especially because it affects public services – and governments will learn from this phenomenon when they’re voted out.


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