The Sovereign Debt Iceberg

The irrational covid-19-induced destruction of our economy has exacerbated the north-south divisions in Europe and sparked debates on issues such as austerity, recovery funds, financial stability and, of course, national debts. But when speaking of national debts, economists consistently ignore, or forget, the issue of implicit debt and focus exclusively on explicit debt. We propose here verbatim an article published in 2013. The issue of implict debt has been conveniently forgotten since then.

“The debt situation in Europe is already looking bleak in many places. If the implicit debts, above all paid but not fully funded pension and pension commitments are included, things look much worse, as Gerhard Schwarz shows in his analysis.

Actually, what can be clearly seen in the European debt crisis is bad enough. For 2012, the explicit government debt in Greece is around 170% of gross domestic product (GDP), in Italy around 120%; in Ireland and Belgium they are around 100%. These are huge amounts in themselves. And even in the “pillars” of the EU, in Great Britain, France and Germany, they range between 90% and 80%. Because the general government ratios are somewhere between 40% and 50%, this means that even the one-eyed among the blind, if they wanted to clear the mountain of debt, did not provide any government services for about two years, did not pay the civil servants the state schools close and stop public transport, etc. In other words: States would have to trim their budgets by 10% over 20 years to achieve the same effect. All states have lived so much beyond their means.

Under the water surface

But such mountains of debt are like icebergs. You only see the top, a small part, weigh yourself safely and underestimate the dangers. For the sovereign debt of the founding states of the euro zone (Euro 12), only a quarter of the mountain of debt is visible in the form of explicit debts made in the past. Three quarters are below the water surface. This still invisible, so-called implicit government debt consists of all the enormous commitments for the future that the states make, but for which they make no provisions. One has to think about pension and pension commitments or care and health benefits that the states promise to their citizens and that will often only come up in decades. In addition, the current budget balance adjusted for interest expenses, the primary balance,

If one adds the implicit government debts calculated by Prof. Bernd Raffelhüschen (Freiburg im Breisgau) to the explicit, officially reported debts, one gets the naked horror. For the Euro 12 countries, this total debt burden, i.e. the sustainability gap, is more than three times the GDP of these countries – or 75% of the world’s GDP in 2010. In Ireland, this gap is even more than 13 times the annual one Economic output, more than 11 times in Luxembourg. But even “model boys” like Germany or Switzerland suddenly find themselves with a significantly higher debt, often a multiple of the explicit debt.

A while ago, the German “Market Economy Foundation” based on somewhat different but comparable figures and under the clear title “Honorable States? Actual public debt in Europe in comparison »(Moog & Raffelhüschen, 2011) calculated what it took to close these sustainability gaps, i.e. by how much government spending would have to be reduced (not just in one year) or how much government revenue would have to be increased by to ensure the sustainability of public finances in the long term. It averaged 5.1% of GDP (not the state budget) for the Euro-12 countries, Greece for 17.6% for the frontrunner, 12.0% for Luxembourg and 4.3 for France %, for Austria to 4.8%, for Germany to 4.0% and for Italy to 2.4%. The differences in the rankings between the sustainability gap and the need for consolidation are primarily due to population dynamics. If the population shrinks, as is expected for Germany, the debt burden will be spread over fewer shoulders.

Italy beats Germany

The graphic provides important further insights: First, the explicit guilt that is usually the focus of economic analyzes says little about the real situation in the country. Italy, for example, offsets its explicit debt by means of implicit balances and therefore shows no debt in total. Italy is in a very good position when it comes to financial sustainability. On the other hand, countries with a very low explicit debt (measured in terms of GDP) fall significantly behind when considering the implicit debt, Luxembourg, for example, to the second to last position. Switzerland is also one of the countries that are better off with explicit guilt than with implicit guilt.

Second, in the countries shown, with the exception of Italy and Germany, the implicit debt is always significantly greater than the explicit one. One is often a multiple of the other. Thirdly, taking into account these “invisible” debts, the picture of the debt situation of individual countries must be revised somewhat.

The “usual suspects” are in the lower third of the graphic, but there are also surprises like the aforementioned Luxembourg. France is in the worse half, and Austria is not shining either, while Italy, of all things, is at the forefront, both because of the small expected increase in pension and long-term care expenses and because of the relatively high primary surplus. But even Italy has to be careful, because an increase in interest rates and weak growth could quickly lead to the primary balance not being sufficient to keep the mountain of debt even stable – not to mention the other countries.”

* GS (Gerhard Schwarz) was head of the NZZ business editorial team for 16 years. He has been the director of Avenir Suisse since 2010.