GUEST AUTHOR BLOG by Paolo Mauro, editor of “Chipping Away at Public Debt”,written by an International Monetary Fund team.
The scale of the problem
Chipping Away at Public Debt
The global financial crisis has caused government debt to soar in advanced economies. Public concern is rising and debates rage on how to fix the problem.
For the advanced economies, the average debt to GDP ratio is now approaching 100 percent—higher than at any time since World War II, and set to increase further.
In many countries the required fiscal adjustment is historically unprecedented. It will take many years of chipping away at the public debt to bring it back down to more prudent levels.
In the United States, we have just gone through an acrimonious debate on how to fix the state of the public finances in the context of the negotiations to lift the debt ceiling. And that debate will develop further in the months and possibly years ahead. In Europe, fiscal adjustment is well under way—in many cases triggered by severe market pressures.
Fiscal adjustment will be one of the defining economic challenges for the advanced economies over the next decade.
Lessons for Today from Past Attempts at Fiscal Adjustment
In a new book, "Chipping Away at Public Debt,"we examine past attempts to re-establish sustainable public finances.
Using a case history approach, the book seeks to explain what worked, what did not, and why. We look in detail at the cases of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. Here are a few lessons.
Past pitfalls to learn from
Don't overestimate your ability to cut spending. In Europe, governments wanted to cut spending, but were unable to cut as much as planned. Eventually, European governments had to raise revenues more than they had originally intended. We saw this in Italy and France in the mid-1990s, but in countries outside Europe too.
Don't mistake strong growth and booming asset prices for fiscal adjustment. In the 1990s, the United States saw revenues increase, and by the end of the decade there was widespread concern that the public debt might disappear. Nevertheless, the deficit soon started increasing again. In hindsight, we know the good times of the 1990s and 2000s should have been used more wisely.
Keys to success
1. Have a plan. This is crucial to reassure markets and the public, and to keep the cost of borrowing low.
2. But be aware that the underlying environment may well change. Economic growth may turn out different than assumed. New expenditure pressures may arise. And so on.
3. So when you design a plan, make sure you spell out what you will do should you face shocks, especially to economic growth. As President Dwight Eisenhower said, referring to a military context in which the situation often shifts abruptly, “planning is everything.”
4. When reducing deficits, think through the role of the state, and what expenditures offer the best value for money. The most successful case we review in the book, Canada, did exactly that. Germany in the mid-2000s is another good example.
5. Raise public awareness of what needs to be done and explain how it will be done. Fiscal adjustment is achievable, but it requires support by the general public. So explain that fiscal adjustment is ultimately needed to keep borrowing costs low, to ensure that investment gets going, jobs are created, and economic growth revives. Opinion polls in Canada in the early 1990s showed that citizens saw public debt as the number one problem. This made it easier for the fiscal adjustment plan to be successful.
Paolo Mauro is editor of “Chipping Away at Public Debt” and specializes in fiscal policy at the International Monetary Fund. You can watch the book’s video here. The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.
Email me at bullishonbooks@cnbc.com — And follow me on Twitter @BullishonBooks