It’s always the same story. Economists love to focus on government debt, but they usually look at government debt in isolation. They sever all links between the state and other macroeconomic processes and act as if the state were comparable to an extremely small private household or a small business. Consequently, such analyses completely ignore the state’s crucial task of stabilising the economy.
A striking example can be found in the Financial Times. There, Robin Brooks (senior fellow at the Brookings Institution and chief FX strategist at Goldman Sachs) writes about Japan’s ‘dangerous debt delusion’, but he never reaches the intellectual level at which relevant statements are possible.
This approach is common, but it is more than astonishing. Anyone who examines the state and its debt balance in isolation assumes that the state has no influence on the economy as a whole and that the economy, including foreign trade, has no effect on the state. This is obviously wrong. Precisely those who complain that the state has become too big and is exerting its power in all areas assume in their financial analyses that the state plays no role. Conversely, the influence is even more obvious. The state must respond to deteriorations and improvements in the economic situation because its revenues and expenditures (and the election results of politicians) depend directly on them.
The best and most logically compelling way to link the state and its debt level to the rest of the economy is through what are known as sectoral financial balances. These show at a glance how the revenue and expenditure deficits of individual sectors are interrelated throughout the economy and throughout the world. Anyone in this world who wants to achieve a surplus of income over expenditure, i.e. who wants to save (i.e. live below their means), needs a counterpart somewhere in the world who does exactly the opposite, i.e. spends more than they earn (i.e. living beyond their means). If they cannot find such a counterpart, they must cut back on their savings plans, or the overall economic income (and their income) will fall until they are forced to reduce their savings plans.
The world as a whole can only ever spend as much as it earns and, this is the part that many people do not understand, it can only earn as much as it spends. The world cannot live either below or above its means. Only individual countries can have surpluses of income over expenditure (current account surpluses), which are necessarily offset by current account deficits in other countries. The state must ensure that savings plans on the one hand and the willingness to take on debt on the other lead to satisfactory overall economic development. This means that the state can never assess and evaluate its debt situation in a rational manner if it does not know or does not consider what is happening in other sectors.
It is no different in Japan. Since the early 1980s, Japan has been under massive American pressure to reduce its current account surpluses. However, when it succeeded in doing so in the early 1990s, the country fell into a financial crisis that led to a fundamental change in corporate behaviour. On balance, companies began to save, generating revenue surpluses year after year. Richard Koo was the first economist to describe this behaviour and draw the right conclusions from it (“The Holy Grail of Macroeconomics”).
Together with savings by private households, the private sector’s revenue surpluses reached values of between 8 and 12 per cent of GDP in Japan by the turn of the millennium. At that time, this shortfall in private demand was offset only by foreign expenditure surpluses (Japanese current account surpluses) of two to three per cent of GDP. Who should have filled the demand gap? Anyone who cannot answer this question cannot make an expert judgement on public finances in Japan.
Over the last ten years, Japan’s current account surplus has been in the range of two to three per cent. Private savings (households and businesses) have been in the range of 7 to 8 per cent. What should the Japanese government have done? Any economic slump would have necessitated government aid measures, which in turn would have driven up government debt.
In Japan, a conservative government has just approved an economic stimulus package worth more than €100 billion. It did so even though Japan’s national debt is well over 200 per cent of GDP, which is incomparably higher than in Germany and even in the United States. But that is the economic logic: No matter how high the level of government debt is, when a recession is looming, the government must significantly increase its debt in order to stimulate the economy so that private individuals also save less or take on debt and invest. If it does not do so, it cannot avoid higher new debt, but it will then be in a much worse position because it will have to combat a deep recession instead of preventing it.
From the MMT (by Stephanie Kelton) environment, a data set has been made available that contains the most important financial balances for 195 countries around the world – and for most countries from 1980 to 2024. These international data are remarkable and a real help in empirical work. To compile it, the current account balances and government deficits were collected and the total private balance (households and businesses) was simply calculated, because the balances always add up to zero. This means that there is no balance for businesses, which is unfortunate for some questions, but for many applications the private balance is sufficient.
In Europe, these relationships are ignored by the vast majority of economists because they do not fit into their ideological concept of a night watchman state. The German debt brake and the European debt rules are legal constructs that have no inherent economic logic. Both systematically lead to fiscal policy actions that are damaging or unsustainable because they completely neglect the state’s crucial task of stabilising the economy.
Germany in particular shows how closely mercantilism and fiscal ignorance are linked to macroeconomic relationships. Without foreign debt, Germany would not have been able to keep its public debt ratio low over the past two decades. In 2019, foreign countries were still the only net debtors. Because current account surpluses have since declined, the state has had to step in in all subsequent years. German companies and private households have been net savers since the beginning of the century.
Anyone with a basic understanding of economics must recognise that only a theory that could prove beyond doubt that saving always and immediately leads to investment and debt on the part of companies could solve the savings problem. However, no such theory exists. Neoclassical economics, however, having at least understood the significance of the problem, has attempted to construct an automatic conversion of savings into investment via interest rates. This has clearly failed, but there is no need to dwell on it. The fact that the financing balance has shown companies in most Western countries to be net savers for around 20 years now proves beyond doubt that the neoclassical nexus does not exist. Anyone who ignores this when analysing government debt will arrive at absurd conclusions and can no longer claim to be based on science.