It might seem like Europe has its financial house in better order than the United States. But hold on a moment — this might just be an optical illusion!
At first glance, the numbers seem to paint a rosy picture for the eurozone. In the first quarter of this year, Eurostat, the European statistical office, reported that the eurozone’s public debt stood at 88.7 percent of GDP, with a budget deficit of just 3.2 percent. Compare that to the U.S., where public debt has soared to over 100 percent of GDP, and the budget deficit is running as high as 7 percent of the economy.
When we talk about public debt, the key issue isn’t just the numbers themselves but how sustainable they are. Sustainability depends on several factors, including the growth capacity of an economy—essentially, the government’s future income—and potential long-term challenges. It’s not just about where things stand today but about where they’re heading.
More dynamic and adaptable
The U.S. economy, for example, is generally more dynamic and adaptable than those in Europe, with labour productivity growing faster than across the Atlantic. This matters a great deal because rising productivity is a strong indicator of how fast an economy can grow in the future. From this perspective, the U.S. appears to be on more solid footing than many European countries, which has significant implications for state finances. Higher growth means more income (from taxes like income tax and VAT) and less spending on things like unemployment benefits, as more people are employed.
Another crucial factor to consider is future pension costs, especially in the context of an ageing population. Countries like France and Italy have almost no pension reserves, which could spell trouble down the road. In contrast, while the U.S. also faces challenges with underfunded state pensions, private pension funds are substantial, holding around 37.8 trillion dollars by the end of 2022—about 130 percent of U.S. GDP. Moreover, the U.S. population is younger on average than that of France or Italy, which means the impact of an ageing population will hit later. And despite various political debates, the U.S. continues to attract young immigrants, further boosting its economic potential.
So, determining how sustainable a country’s debt is involves more than just looking at current debt levels. It requires considering various factors, such as the economy’s growth capacity and demographic outlook. This isn’t to say the U.S. debt situation isn’t concerning—it certainly is. The debt is high, and politicians aren’t discussing solutions nearly enough.
Collection of different countries
There’s another key point to consider: the U.S. is a single country, while the eurozone is a collection of different countries. This distinction is crucial when discussing sovereign debt. The reported debt figure for the eurozone as a whole (88.7 percent) is somewhat misleading because it averages the debts of all member countries, obscuring the financial weaknesses of some. In reality, it’s the weakest link that often determines the strength of the whole.
Take a closer look, and the picture for the eurozone changes dramatically. Italy’s public debt is at 137.7 percent of GDP, France’s at 110.8 percent, and Spain’s at 108.9 percent. That’s three of the four largest economies in the eurozone, all with troublingly high debt levels. Even though Germany’s debt is relatively low at 64.4 percent, it hardly balances out the higher debts of its neighbours. Plus, Germany faces its own challenges, like a rapidly ageing population and a lack of substantial pension reserves, which could strain its finances in the not-too-distant future.
While the U.S. debt situation is alarming, the differences between the U.S. and the eurozone—or even Germany—are significant. Think of it like comparing two cars: one with brakes and one without. Even at higher speeds, the car with brakes is safer than the one without, just as a high debt level in a dynamic U.S. economy could be less problematic than lower debt in a less flexible European economy.
Soft measures
So, what does this mean for the European Central Bank (ECB)? The ECB needs to take a firm stance on inflation. Soft measures today could mean higher inflation and interest rates tomorrow, especially as most eurozone countries continue heavy borrowing. The ECB must also advocate for sound public finances across the eurozone and resist being swayed by countries pursuing irresponsible fiscal policies. Unfortunately, such firm actions often seem to be missing, replaced by weak statements at the end of meetings.
The ECB must act, not just speak. Remember Mario Draghi’s famous «whatever it takes» promise in 2012? While it may have saved the euro then, it also gave eurozone countries free rein to pursue reckless fiscal policies. In doing so, the ECB traded its monetary credibility for short-term stability. The need now is for the ECB to foster responsible fiscal behaviour to ensure long-term economic health.
Edin Mujagić is an economist, manager of Hoofbosch Investment Fund, and author of «Turning Point 1971.” He writes a monthly column, ECB Watch, on European Central Bank monetary policy for Investment Officer.