Globalization, High Public Debt, and Interdependence

This chapter presents the major issues arising from widespread fiscal laxity and the increase in public debt. The debt cycle in which advanced countries and EMDEs (emerging market and developing economies) are engaged began with the 1973 oil shock and accelerated with the advent of globalization in the late 1980s. Several factors explain this trend. Most governments avoided significant tax hikes or cut tax rates to remain competitive and attract foreign investors, while some increased spending to preserve the welfare state. The phasing out of capital controls, the financialization of economies, and the global saving glut facilitated government borrowing, thereby perpetuating fiscal deficits. The accommodative monetary policies implemented by central banks during 2008–2021 created exceptional opportunities for advanced economies to continue borrowing at very low rates. However, since 2020, governments have been compelled to increase fiscal deficits and public debt to respond to the COVID-19 pandemic, compensate for slower economic growth, and, in the specific case of European countries, expand military expenditures. In 2024, public debt to GDP ratios reached record highs amid elevated financing costs. It is noteworthy that the surge in public debt has intensified interdependence between governments and various economic and financial actors. On the one hand, governments in advanced economies have relied on large banks to secure financing in capital markets. In return, these institutions have been allowed to pursue their race for bigness, becoming “too big to fail,” increasing their risk-taking, and exacerbating financial market instability, thereby forcing governments to borrow to contain systemic risk, as happened in 2008. On the other hand, EMDEs with the heaviest debt burdens struggle to reach restructuring agreements, mainly because negotiations have become more complex and time-consuming since China emerged as a major sovereign lender. To restore their creditworthiness in the medium term, advanced economies and EMDEs should implement fiscal consolidation measures, rationalize public expenditures, and reduce certain forms of financial interdependence.