Getting hold of national debt figures is often difficult. Few countries publish them. But for the G7 countries, that do, an interesting picture emerges (see Figure 1).
Figure 1: National net debt as a % of Gross Domestic Product (GDP) 
Italy has had large national debt for decades and Japan’s has increased over the last ten years, almost reaching the scale of Italy’s. Every country, however, has registered an increase in national debt as a percentage of GDP since the credit crunch materialised in 2007. The rate at which these countries’ national debt as a percentage of GDP has grown (and for 2010 is projected to grow) varies considerably (see Figure 2).
Figure 2: Compounded Annual Growth Rate (CAGR) of national debt as a % of GDP (2010 est. using 2007 as a base)
This throws up a number of questions, most notably relating to the anticipated growth of debt. Why do countries have such problems with national debt, and what are the likely consequences for countries like the UK and US if it continues? At current rates, for example, the UK will have the highest percentage of national debt as a proportion of GDP out of the G7 countries by 2021.
To really understand, we need to look at the two countries with the highest debt problems: Italy and Japan.
Italy
Italy began to run into serious economic problems in the 1970s, particularly in 1974 and 1976, each of which required extreme policy measures and the creation of large deficits. The combination of these led to the creation of a sizeable national debt in the early ‘80s, which was then exacerbated by the rate at which the debt service costs increased. In other words, the amount that the Italian government was paying on its debt (the ‘real interest rate’) was greater than the rate at which Italy was creating wealth (the ‘GDP growth rate’). Italy had to run faster just to stand still.
Italian national debt has persisted for so long partly due partly to political factors and partly to the fact that the average maturity of the debt was shortened to make it more attractive to the private sector. This had the result of increasing the real cost of debt service. This peaked in 1997 and has been falling ever since except for the sudden rise again over the past two years.
Japan
The story of Japan’s national debt is really the story of a system that failed. This was the system that existed post World War II, based on: (1) an export-driven economy reliant on a low dollar-to-yen exchange rate (2) a state-directed banking system that made loans on the basis of political favoritism rather than to the most efficient companies and (3) banking regulations that allowed banks to count equity holdings as part of their capital reserves, so the higher the prices, the more they could lend.
It was the collapse of this system, the resulting recession and the political turmoil surrounding the financial situation, which led to delays and failures to reform the financial system that dramatically sped up the accumulation of public budget deficits and ultimately government debt. Total government debt grew twice as fast in the 1990s as it did in the 1980s and net as a % of GDP grew by 238% from 1993-2005 (source: FreshMinds analysis based on IMF data).
The fact that Japan’s national debt is so heavily geared has made it very vulnerable to the effects of the 2007-2009 global credit crunch and recession which, together with a variety of other factors, has increased its budget deficit further as it has launched stimulus packages . In essence, its debt is both part of a general economic malaise that is a hangover from the ‘lost decade’ and a current millstone around policy-makers’ necks as they attempt to use the tools available to them to prevent a further downward spiral. At the very least, the interest and capital payments to service the debt divert much-needed funds from more directly beneficial activities such as cutting taxation, investing in research and development and investing in pensions for its increasingly elderly population. See RealClearWorld for further information.
Summary – do we need to worry?
But should high debt levels really concern us? Italian macroeconomic performance has not apparently suffered. In the 1980s, in fact, real growth on the whole slightly exceeded the European average. However, there are some real reasons why we should be concerned with an excessive level of debt.
1. It means the government is paying a large amount of its tax revenues simply to pay off the interest on its debt. This is money that could be more profitably spent on making direct investments in infrastructure or on giving tax cuts to stimulate enterprise. It’s like you or me having a bank overdraft and having to pay money to our bank that simply does not benefit us at all; ok once in a while, but unproductive as a long-term policy. The budget deficit cuts and tax rises that would need to happen to curtail a persistent debt might actually be bad for GDP growth. Therefore, you’re stuck in such a deep hole that even the remedy is painful.
2. Persistent national debt increases risk. It increases the likelihood that the government will default on it obligations to the private sector and the country will lose its international reputation. This is what happened in the Latin American debt crisis in the 1980s where, notably, Brazil, Argentina and Mexico defaulted on their loans, leading to a mass outflow of foreign capital and reluctance of foreign investors to finance these governments’ projects in the future. The required spread on government bonds increases to compensate for this risk. That means that you need to offer higher interest rates just to keep your current customers happy (what’s referred to as ‘the downward spiral’).
3. A rapidly rising national debt is an indicator that taxes are likely to rise in the future. This leads to large capital outflows as investors seek to evade future tax increases.
The combination of these three factors means a high national debt relative to GDP should definitely be a concern.











