Fiscal Deficit and Public Debt in Industrial Countries, 1970-19941/

This paper assembles a set of relevant fiscal data, for both the individual countries and for the aggregate G-7 and 18 industrial countries, which covers a period long enough to allow an assessment of trends and the conduct of econometric tests. The “world” fiscal deficit has been rising since the 1970s and reached a historic high in 1993-94; the rise of the deficit has been accompanied by a significant decline in world saving. The paper argues that the increase in public debt, which has been the consequence of the accumulation of the fiscal deficits, has pushed up worldwide interest rates. Econometric evidence in support of this relationship is presented on the basis of panel data for the period 1970-93.


This paper assembles a set of relevant fiscal data, for both the individual countries and for the aggregate G-7 and 18 industrial countries, which covers a period long enough to allow an assessment of trends and the conduct of econometric tests. The “world” fiscal deficit has been rising since the 1970s and reached a historic high in 1993-94; the rise of the deficit has been accompanied by a significant decline in world saving. The paper argues that the increase in public debt, which has been the consequence of the accumulation of the fiscal deficits, has pushed up worldwide interest rates. Econometric evidence in support of this relationship is presented on the basis of panel data for the period 1970-93.

I. Introduction

Since the early 1980s much attention has been paid to the fiscal situation, and especially to the fiscal deficit, of industrial countries. The fiscal deficit has been blamed for many economic difficulties including inflation, slow growth, unemployment, low investment, balance of payments disequilibria, and high real interest rates. Some economists, on the other hand, have considered it as a largely irrelevant variable. Not until the mid-1980s did the growth in the share of public debt (D) as a percentage of GDP (GDP) also gain notice. A 1984 speech by the then Managing Director of the International Monetary Fund, Jacques de Larosière, calling attention to this growth, was widely reported in economic magazines and newspapers. 1/

Much of the focus over the years has been country-specific, dealing frequently with the United States or with countries, such as Belgium or Italy, where the fiscal situation was an obvious cause for concern. Difficulty in assembling relevant data has discouraged most experts from attempting to deal with groups of countries such as the G-7 or the industrial countries. However, the fluidity of capital movements, which has made it increasingly possible for deficit countries to finance their fiscal deficits with the savings of other countries, implies that the country by country approach can fruitfully be complemented by a more aggregative approach. 2/

The aim of this paper is both modest and ambitious: to try to assemble as complete a set of relevant fiscal data--for individual countries and for groups of countries such as the G-7, and most and the industrial countries--for a period long enough to be able to assess trends and to allow some econometric tests. The period covered is 1970-1994, the longest for which the needed data could be assembled.

II. Fiscal Developments

Table 1 shows, for the 1970-94 periods and for each of 18 industrial countries and for two groupings--G-7 and 18 industrial countries--four different measures of general government budget balance all expressed as shares of GDP. Chart 1 gives a graphical view of the behavior of these measures for the two groupings. The four balance measures are:

Table 1.

Measures of General Government Budget Balances of G-7 and Industrial Countries, 1970 - 1994

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Sources: OECD, National Accounts Statistics 1970-94 (Paris: OECD); and World Economic Outlook (WEO) (Washington, D.C: IMF) various issues and authors’ calculations.Note: A = General Government Balance; B = General Government Structural Balance (as a percent of potential gdp); C = General Government Inflation Adjusted Ba D = General Government Primary Balance; N.A. = not available.

A: The general government balance which is the normal or conventional definition of the fiscal deficit including local governments;

B: The general government structural balance which attempts to remove the effect of the business cycle on the fiscal balance. This measure is expressed as a share of potential GDP;

C: The general government inflation adjusted balance which corrects the normal measure (A above) for the impact of inflation on the public debt; and finally,

D: The general government primary balance which removes from government expenditure the interest payments made to the holders of the public debt.

The various reasons why these four alternative versions of the government budget balance have come into use have been discussed at length in the literature. 1/ Each of them is useful for some purpose and none is clearly superior to all the others. Jointly, these four measures provide more information, especially about short-term developments, than individually. For example, a country undergoing a recession would find it useful to pay some attention to measure B, which corrects the fiscal deficit for the effect of the recession; and one undergoing significant inflation would find it useful to estimate measure C, which removes from the deficit the implicit amortization of the public debt that inflation causes. It is wrong, however, to claim that any of these measures is superior for all uses to the others. Furthermore, important and at time questionable assumptions need to be made to calculate B and C.

What messages are conveyed by Table 1 and Chart 1? The first is that a serious deterioration of the fiscal situation of the industrial countries probably started with the oil-shock-induced recession of 1975. This recession came at a time when Keynesian views about the role of the fiscal deficit, as the “balancing factor” in stabilizing aggregate demand, and the general economic role of the public sector in the economy were still strongly held by many policymakers and economists. The skepticism about these views, that came to influence policy in the 1980s, had still not taken hold although the voices of dissidents were already heard. Thus, in orthodox Keynesian fashion, during the first oil shock, governments tried to fight the recession and the fall in real income caused by the oil shock with a fiscal expansion. Government expenditure increased, revenue fell and fiscal deficits widened. The figures for the G-7 and for the industrial countries combined eloquently show the change.

The second message is that the poor fiscal performance continued until around the mid-1980s when growing concern for the deteriorating fiscal situation, which led some governments to start taking corrective measures, plus the economic boom that characterized many of these countries for the next several years, led to falls in the fiscal deficit in many of them. The combined normal deficits for the two groups of countries fell by more than 3 percent of GDP between 1983 (a recession year) and 1989 (a boom year). Of course, the cyclically adjusted, or structural, measure of the deficit indicates a much smaller reduction between these two periods.

The third message is that after 1989, the situation started deteriorating once again partly, but not entirely, for cyclical reasons. Between 1989 and 1993 all four measures of the fiscal deficit deteriorated for the two groups of countries. By 1993, the gains made between 1983 and 1989 were lost. For both groups of countries, 1993 was among the worst years, in terms of the fiscal situation, in the 23-year period covered by Table 1. Preliminary figures for 1994 show that some improvement took place in this year, due in part to the economic recovery, but the improvement was marginal.

The fourth message is that no country seems to have completely escaped the trend toward fiscal deterioration even though some countries experienced far more fiscal deterioration than others. Fiscal virtue has not been very popular since 1970. The political, economic and social reasons that have brought about this situation are complex. But the situation is different from, say, the one that prevailed in the period before 1970. The reasons for this deterioration, which, it should be mentioned, has not come from a fall in public sector revenue or in the countries’ per capita incomes, deserves a serious analysis which is beyond the scope of this paper. 1/ A disturbing aspect is that the demographic changes such as aging of the population that are expected to impact negatively on the fiscal accounts of most of these countries have not yet started. One would hope that by the time they do, the countries will be fiscally stronger enough to be able to cope successfully with them. However, the data in Table 1 do not invite optimism.

The table also provides information on specific countries. Several nations, including Belgium, Greece and Italy, have had very large fiscal deficits for much of the period. Belgium has been trying for several years to improve its fiscal situation mainly by cutting its non-interest public spending. Italy has been attempting to reduce its fiscal deficit mainly by increasing its level of taxation. Italy’s tax level has risen sharply since 1980 but its fiscal deficit has remained high. Ireland faced a serious fiscal situation in the 1974-86 period but has made remarkable adjustment since 1986 showing that these adjustments are possible and that they do not have the dire effects on output that some economists predict. Canada experienced a serious fiscal deterioration in the period up to 1982-85, made some significant adjustments in the next few years and has seen its fiscal deficit--measure A--rise again largely as a result of the recession. Spain, Sweden and the United Kingdom have also experienced sharp fiscal deteriorations in recent years. The fiscal accounts of France and Germany also recently deteriorated, while Japan remains the only major country without a large fiscal imbalance. In the United States, the fiscal deficit in 1992-93 was at its highest level in the whole 1970-94 period, especially if measures B, C, and D are considered. Some significant improvement occurred in 1994.

Looking at measure A for the G-7 countries combined, the years in which the deficit was highest were 1975, 1982-1983 and 1993. Similar results are seen for the combined industrial countries. If one takes measure C, the inflation adjusted measures of the fiscal deficit, 1993 was the worst year for both the G-7 and the industrial countries combined. In fact, the fall in the rate of inflation in most countries, since the beginning of the 1980s, implies that a conventionally defined fiscal deficit of a certain share of GDP now contributes to a faster debt accumulation than when inflation was higher.

III. Fiscal Deficits and Private Saving Rates

A continuing worry on the part of those who have commented on the fiscal scene has been that fiscal deficits will absorb private savings, thus diverting resources from potentially more productive private investment to, presumably, less productive public sector spending. The early optimism of the early 1980s, based on the Ricardian equivalence principle promoted by Robert Barro--that fiscal deficits would be self-financing by inducing more private saving--seems to have evaporated. Some economists such as Robert Eisner and, less forcefully, Franco Modigliani, have also argued that a fiscal deficit that finances public investment should not cause concern, because, in time, the investment will generate enough extra income to finance the additional fiscal obligations created by the deficit. Today, many observers appear unconvinced by this argument. In any case, there is no evidence that indicates that higher public sector capital accumulation has accompanied the rise in the fiscal deficit. 1/ Furthermore, public investment tends to be less productive than private investment. Fiscal deficits have been caused mostly by larger transfers to groups of individuals (the poor, the unemployed, the pensioners) who have relatively high propensities to consume. At the same time higher taxes have often been collected from taxpayers with higher incomes and, possibly, higher propensity to save.

When countries’ economies were relatively closed, a country’s fiscal deficit had to be financed by the country’s own savings; thus, if crowding out occurred it was within a country. However, because of the much greater freedom of capital movements internationally, especially in the past decade, a country’s deficit need not, In the short run be financed by the country’s own savings, but it can now be financed by the savings of other countries. Thus, at least for the short-run, crowding out may go international. This implies that the country’s interest rate does not need to rise as much as in the past to finance its own deficit. However, collective fiscal deficits may still have an impact on world real interest rates. For this reason, it may be worthwhile to aggregate the fiscal deficits and the private saving of relevant groups of countries to see whether a relationship exists between them and possibly between them and the rate of interest. Table 2 shows this relationship for the G-7 countries taken as a group for the 1970-94 period.

Table 2.

Aggregated Fiscal Deficits and Savings of G-7 Countries, 1970-1994

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Sources: OECD, National Account Statistics 1970-94 (Paris: OECD); and IMF, World Economic Outlook (WEO) (Washington, D.C.: IMF) various issues.

Figures are PPP-weighted averages of national figures, as percentage of GDP.

Excludes Italy from 1970-1979.

Table 2 shows, for the G-7 countries combined, general government deficit (GGD), gross private saving (GPS) and net private saving (NPS) as percentages of the combined G-7 countries’ GDP for the 1970-94 period. It also shows GGD as a percent of GPS and NPS.

As a share of GDP, GPS fluctuated over the period within a range of 18.7 in 1989 and over 21.0 in 1975-1979. Some increase in the share is noticeable for the 1973-79 period, but this increase is likely to be partly spurious due to the higher inflation rate in those years and the fact that the national accounts authorities of the various countries are unlikely to have distinguished nominal from real interest incomes. 1/ The 1973-1979 increase shows up as a higher saving rate because during inflation individuals are likely to save a higher share of the nominal than of the real interest incomes that they receive in order to maintain the real value of their financial wealth, this shows up as a higher saving rate. Thus, higher inflation in the 1970s is likely to have led to an overestimate of both genuine interest incomes and genuine saving rates. GPS and NPS declined, from 1979 to the later period, by two-three percentage points.

The share of gross private saving absorbed by the general government deficit of the G-7 countries combined rose considerably between the 1970s and the 1980s. This share reached the highest level in 1993 when 21 percent of the G-7 countries’ total gross private saving went to finance these countries’ fiscal deficits. This resulted in a decrease in the saving available for private investment. Table 2 also shows that a much higher share of net private saving was absorbed by the financing of the fiscal deficit. This share was particularly high in recession years when it occasionally reached or exceeded 40 percent. In 1992, almost half of the G-7 countries’ net national saving went to finance the fiscal deficit of these countries. This was the largest percentage for the whole 1970-92 period. If figures were available for 1993 they would likely exceed 50 percent. Because net private saving is the most liquid source of financing of private investment, this large absorption of NPS by the fiscal deficit, if maintained over time could have serious growth implications for the G-7 countries as a group.

Similar data can be assembled and similar questions can be asked in relation to particular countries. This is done In Tables 1A and 2A in appendix, which refer to the United States and Japan respectively. Each table shows these countries’ gross private saving (GPS) and net private saving (NPS) as percentages of the G-7 countries’ aggregate GPS and NPS. The tables also show each country’s fiscal balance as a share of the G-7 countries’ fiscal balance, of the G-7 countries GPS and of the G-7 countries’ NPS.

Appendix Table 1A shows the falling share of the American GPS and NPS in the G-7 countries’ total. It also shows the increasing share of the U.S. fiscal balance in the combined G-7 countries’ fiscal balance until 1989, when the United States accounted for 67.2 percent of the G-7 countries’ combined fiscal deficit. After 1989, the U.S. share fell considerably (due to the increase in the deficit of other countries). Between 1989 and 1994, the U.S. share fell from 67.2 percent to 25.2 percent. The share of the U.S. fiscal balance in the G-7 countries’ GPS and NPS can also be seen from appendix Table 1A. Appendix Table 2a which refers to Japan, which shows the sharply increasing contribution of Japan to the aggregate GPS and NPS of the G-7 countries. Japan’s increasing share in total saving, and Its falling share in total fiscal deficit, must have facilitated the financing of the large and increasing deficits of the other G-7 countries. It may also have contributed to keeping low the world rate of interest.

IV. The Growth of Public Debt

Up to now we have focused on the yearly deficits as shown in Table 1. During the 1970-1994 period, fiscal surpluses were rare indeed. Fiscal deficits sustained over time result in public debts. Given the size of the fiscal deficits, the level of interest rates, and the rate of growth of the countries’ economies, these public debts can rise or fall as shares of GDP. 1/ Table 3 has assembled the data available on the share of gross public debt as a percentage of GDP for general government for 18 countries and two groups: the G-7 countries and 18 industrial countries, for the period 1970-94.

Table 3.

Gross Public Debt of Industrial Countries, 1970 - 1994

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Sources: OECD, National Account Statistics 1970-94 (Paris: OECD); and IMF, World Economic Outlook (WEO) (Washington, D.C.: IMF) various issues.

Focusing on the G-7 countries as a group, the table shows that there was little change in the ratio of public debt to GDP throughout the 1970s. In 1980 the debt/GDP ratio was roughly the same as in 1970. However, from 1980 to 1987 that ratio grew from 41.9 percent to 57.5 percent. After a pause in the 1987-1990 period, the ratio started increasing again at a rapid pace and by 1994 had reached the rather high level of 70.6 percent. The behavior of the debt/GDP ratios for the group of 18 industrial countries was similar, not surprising in the light of the weight of the G-7 countries among the industrial countries.

Should one worry about the rise of the public debt? It may seem strange to ask this question because we know that governments and financial markets do worry about it. Several books have recently dealt specifically with the various reasons why a high public debt is cause for concern. 1/

First is the concern that a high and growing public debt will crowd out private investment by absorbing the private saving that would have financed it; we saw from Table 2 that the rate of absorption can be high. This crowding out may come from different channels: (a) public debt may raise interest rates--by increasing the total demand for credit--and the rise in interest rates may in turn reduce borrowing by private investors; (b) the growth of public debt as a share of GDP may crowd out private debt directly if, as Benjamin Friedman (1987) has argued, there tend to be a more-or-less maximum share of total debt (public plus private) in GDP that individuals are willing to hold; if he is right, then if the share of public debt goes up, the share of private debt must come down; and (c) investment (and especially investment in projects with long maturity) may be discouraged by the expectation that growing public debt may lead to higher taxes in the future so that the decision on whether or not to invest will have to take the possibility of this increase into account.

Second, Edmunds Phelps (1994) has argued that decisions on the part of enterprises about whether or not to hire additional workers are similar to investment decisions and are thus affected by similar considerations. The reason is that firms make an investment in the training of new employees. If public debt raises interest rates and increases the possibility that taxes will go up in the future, it will discourage not just investment but also employment.

Third, under normal circumstances, an increasing debt/GDP ratio will lead to an increase in total public spending, ceteris paribus. This will occur because of the higher interest bill that will accompany the increase in the debt ratio. If the increase in spending is financed through borrowing, this may set in motion a debt dynamic that might, under extreme circumstances, lead to a debt explosion. If the increase in interest spending is accommodated at least in part by cuts in other public spending, the most likely candidate for cuts will be capital spending. This, in fact, is what seems to have happened in many industrial countries. 1/ If the expenditure increase that accompanies higher debt is partly accommodated through higher taxes, as in fact it has happened in many industrial countries, the inefficiencies and distortions connected with higher marginal tax rates will increase. All of these factors will contribute to a reduction in the prospects for economic growth.

Fourth, if domestically financed, higher debt will lead to higher incomes for the holders of government securities. These individuals tend to be older or retired individuals with lower (remaining) life expectancy thus, with higher propensity to consume. Therefore, higher debt may lead to higher consumption and lower saving. This will, once again, tend to reduce a country’s growth potential. If the higher debt has been financed by foreigners, potential balance of payments problems may develop, because a heavily indebted country needs to transfer a growing portion of domestic resources abroad to service its debt. Unless the country keeps borrowing abroad, it will need to run a surplus in Its trade balance, to earn the foreign exchange to make the foreign interest payments. Because this surplus occurs in the private sector, from which the government needs to buy the foreign exchange, the country will need to have a surplus in its domestic fiscal accounts in order to buy the foreign exchange from the private sector in a noninflationary way. Creating this surplus through higher taxes will create more distortions in the economy. 2/

Finally, a public debt that is both large and growing, always brings some potential or actual financial instability. This may occur because of several reasons including implicit or explicit pressures on the central bank to facilitate the financing of the debt; concerns on the part of those who hold the debt about the ability of the government to keep servicing it or, more likely, about future taxation of the stock of public debt or of the interest on it, which reduces the debt holders’ willingness to hold the debt instruments and leads to an interest rate premium; or the impact of changes in international interest rates on the cost of financing the debt; and varying psychological attitudes on the part of the current or potential bond holders. 3/

Table 4 shows the increasing cost of the public debt in terms of interest payments. For the G-7 countries combined that cost has increased from less than two percent of GDP in the early 1970s to five percent in 1994. The percentage increase would be shown to be greater if the fall in the rate of inflation in recent years had been taken into account. This fall, of course, increases the real expenditure component of interest payment expenditures.

Table 4.

Gross Interest Payments of Industrial Countries, 1970 - 1994

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Source: OECD National Accounts 1970-94 (Paris: OECD), and world Economic Outlook (WEO) (Washington, D.C.: IMF), various issues.