Debt and Taxes

What will it take to pay down sovereign debt?

Yan Barcelo 3 August, 2021 | 4:28AM
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Dark forest

Standing at unprecedented levels, debt is pressing down on all major economies of the world. The hope is that we will be able to grow out of it, as countries did after World War 2. But can we? 

Thanks to the coronavirus pandemic, global debt shot up to a record high of US$ 289 trillion at the end of Q1 2021, or about 360% of world GDP, reports the Institute of International Finance. The debt buildup is strongest in governments and in the non-financial corporate sector, both representing 105% and 100% of world GDP respectively. Household debt stands at 65% of world GDP.

Canadian debt numbers mimic the global landscape. Governmental debt at the end of 2021 is expected to stand at 91.6% of GDP according to Fraser Institute projections, and Equifax finds that household debt, now standing at $ 2.08 trillion, represents 127% of GDP.

That is a lot of debt. To repay it, Canada would need to pay out all its revenue for three years in a row – and do nothing else.

Of course, if the GDP growth accelerated, that would fill the hole more quickly. “That’s the dream, the most positive path,” says James Orlando, senior economist at TD Economics. But history is littered with countries and companies that caved under the burden of their debts, he adds.

Productivity is Depressed

The key to giving more torque to the Canadian economy is productivity, because “low productivity is making Canada poorer,” states Jack Mintz, president’s fellow at the University of Calgary’s School of Public Policy. “In 2018, wrote Mintz, Canadians produced US$50 in GDP per hour worked. By contrast, the U.S. produced roughly US$65 in GDP per hour. And the fastest-growing OECD country in the past three decades, Ireland, produced US$84 in GDP per hour.”

As Mintz’ numbers show, the productivity of Canadian companies stood at only 73% of their American peers, down from 95% in the early 1980s, according to a Business Development Bank of Canada 2016 report. If the U.S. were a productivity champion, then Canada’s standing would probably still be relatively palatable. But even the U.S. performance is shrinking. In the 1950s and 1960s, according to Bureau of Labor Statistics numbers, American productivity hovered around 2.75%, but for the last decade it barely reached the 1% mark (0.92% more precisely).

Pessimists and Exponentialists

Some pessimistic observers, like economist Robert Gordon who authored The Rise and Fall of American Growth, consider that we will be unable to get back to productivity levels of the past. The technology wave of the last 150 years, that gave us electricity, cars, planes, pharmaceuticals, audio-video) is spent. That wave spawned whole economic sectors with tremendous productive powers that the coming wave of technologies can’t replicate (artificial intelligence, smartphones, nanotechnologies, robotics, etc.). These technologies simply don’t carry as much transformative power as the preceding ones did, and they are happening within already established sectors. Ultimately, economic growth will slowly decline at a yearly snail progression of 0.2%, the level where it stood for the 400 years preceding the industrial revolution.

“Exponentialists” think that technical progress is improving exponentially and that the new technologies offer tremendous carrying power. For example, Cathy Wood, founder of ARK Investment Management, predicts a golden age for companies, workers and investors exhibiting unprecedented levels of productivity and efficiency.

Robert Atkinson, CEO of the Information Technology & Innovation Foundation, who has studied the evolution of technology more extensively than any of the pessimists and exponentialists, disagrees with both camps. In essence, he thinks, the pessimists underestimate the vigour and potential of the new technologies, but exponentialists are just as wrong, viewing these technologies as so much “magic pixie dust” that, once spread across the economy, “will generate so much productivity, we won’t know what to do with it”. In reality, he states bluntly: “Productivity is just hard.”

First of all, the so-called “fourth industrial revolution” is barely underway while we are still surfing on the previous wave of what Atkinson calls the “old” digital revolution whose productivity effects are now spent, as productivity figures for the last decade show. “Do you really care if your Internet broadband doubles?” he asks.

As for the next wave of intelligent machines, “it still has a lot of problems and may kick in only in four to five years”. But we shouldn’t expect miracles: “We might see productivity increase by one percentage point.”  However, submits Thomas Torgerson, Managing Director, Global Financial Institutions and Sovereign Ratings, at DBRS Morningstar, “projecting future productivity growth is difficult and subject to considerable margins of error. We do not expect an increase in productivity growth, but we can’t rule out the possibility.”

Vaulting Out of Debt

Growing out of our debt mess is certainly a possibility, but do we have the understanding and the will to do so? The alternatives might simply prove more painful.

Atkinson agrees that the next technology wave probably has the potential to raise productivity to a yearly clip of 3.4%, but a major problem lies elsewhere. By investing more in R&D and innovation, governments could improve productivity significantly. However, “most people have not only abandoned productivity, they oppose it,” he asserts, because they fear the job loss it could entail and the impact on the planet. Both fears are unwarranted, he thinks, especially the one about job loss as the recent record shows. Even as we were reaching the end of the “old” digital revolution, before the pandemic, “we had the lowest unemployment rate in 50 years,” he points out.

However, technology and innovation are not the whole answer, believes Torgerson. “High growth is not the only means of repaying debts, he points out. Low (or negative) real interest rates mixed with moderate growth can also gradually ease debt burdens. This may be small comfort to investors, of course, but the persistence of low interest rates suggests that advanced economy sovereigns are likely to retain considerable flexibility in financing their debts. Some sovereign debt markets are likely to remain safe havens for capital, if for no other reason than the lack of better alternatives.

Mintz proposes a train of other measures to increase productivity: removing protections for inefficient businesses, promoting competition through internal and external trade, investing in education and reforming the tax system by moving from income taxes to consumption taxes and cleaning up the mishmash of carbon policies.

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About Author

Yan Barcelo  is a veteran financial and economic journalist with more than 30 years of experience, writing for many publications in Toronto and in Montreal, including CPA MagazineLes Affaires and Commerce.

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