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Last week’s G20 summit was unexpectedly dominated by Europe, due to Greece’s surprise announcement to hold a referendum on the bailout package.
Fortunately, the process of coordination among the G20 nations no longer depends on the annual summit meetings. With the global economy, not just the European economy remaining on the brink, the leaders assembled in Cannes are in constant touch with each other anyway.
While under the circumstances the idea of a “debt brake” couldn’t rise to the prominence it deserves at the just concluded G20 summit in France, it is one of the most important policy tools to get fiscal policy under control. It must now rapidly move to the center of the global debate.
This is of great importance not just for the “old world.” It includes not just Europe and Japan, but also the United States whose debt level will soon enough dominate international headlines again. Emerging markets are also most keenly interested in the topic.
These countries and their vast populations feel with good reason that this is their time at long last, and that a shadow that laid over them for centuries has been lifted. On most of these nations' minds, the past is closely associated with the legacy of colonialism.
Look at the debt issue from a historic perspective: If the former colonial powers ― read: today's G7 nations, plus some countries like Spain and Portugal ― now don't get their fiscal acts together, there is a very real danger of a new form of colonialism.
That new "colonialism" would manifest itself in the very serious growth tax that would be imposed on the developing nations. That "tax" would take the form of a global economic collapse and a decline in development aid related to an unresolved Western debt overhang that may very soon prove unsustainable. Or it may take the form of high inflation, which would have the same effect on emerging market countries, which depend on macroeconomic stability in order to move out from under the shackles of centuries-long underdevelopment.
And unlike on the CO2 emissions issue, where the debate about responsibilities for past actions is far more complex, nobody can argue that the consequences of over-indebtedness are anything new. Unlike climate change science, the science of public finance is as old as the idea of nation states themselves.
To deal with the consequences of the debt mountain already accumulated, a continuation of wishful thinking isn’t a policy choice. We need the introduction of a “debt brake.” This measure would go a long way toward stabilizing the long-term expectations in financial markets about the future fiscal path of rich countries’ governments.
To be sure, an immediate imposition of the debt brake would be neither wise nor desirable, given current economic conditions. But the time is certainly right for agreeing on the launch at a fixed date in the not-too-distant future. In Germany, for example, the debt brake, approved by parliament in 2010, will take force in 2016.
To be effective, such a debt brake mechanism must meet three tests: First, it must be anchored in countries’ constitutions, underscoring the hard-to-revoke character of the commitment. Second, countries must undertake commitments mutually, as is now the case in countries in the eurozone from Spain and Portugal to Italy.
And third, in light of the past failure of effective monitoring and enforcement (whether the Maastricht criteria in the EU or pay-go rules in the United States), there must be independent watchdog agencies, equipped with penalizing powers in case of malfeasance.
But it is not just past practice that makes us in the West accountable for our past actions in running up debt. Our future-oriented self-interest dictates no less. Perhaps the most important number ever generated by the International Monetary Fund (IMF), an institution in the business of producing millions of numbers, is this: 441 percent.
That is the expected debt-to-GDP ratio that the G7 countries will arrive at on average by 2050 under present policies, if we continue business as usual. Concerned as we rightly are about debt levels approaching 100 percent for major G7 nations (other than the eternal culprits of Japan and Italy which are both way past that marker), some policymakers and policy analysts are still inclined to just wish that number away, believing in a magic healing function of the economy.
Since we are collectively on the road to 441 percent, not even the most fantastical economic and political minds can really be prepared to go on with business-as-usual. The debt brake is a very useful instrument to achieve the turnaround. All its adoption signals is this: First, we need to live within our means. And second, we need to understand that the pre-crisis spending levels were the maximum level of public spending and that any future needs or desires can essentially only be financed by cutting other, already funded activities by an identical amount.
Over the past several decades, it was usually emerging market countries that, in various waves of debt crises, were forced to learn to live within their means, often at the behest of their Western creditors. Now that situation has reversed itself. This time, it is the West that has to take the tough medicine.
Klaus F. Zimmermann is director of IZA (Institute for the Study of Labor) in Bonn, Germany.
