While Europe has regained its strength, some countries are still experiencing high levels of debt and their labor markets already seem to be slowing down. Should we be concerned about a new public-debt crisis?
1. How has public debt changed over time?
To really understand how European debt works, you have to take a step back. When you look at this from an historic point of view, starting with the end of WWII, you can see that public debt enjoyed virtually steady growth until the end of the 1970s. It was only the turmoil coming from the Italian economy that led to rising debt starting in the 1960s. According to Bruno Tinel, an economist who works at the University of Paris 1-Pantheon-Sorbonne, this trend can be seen in industrialized countries outside of Europe and it represents “stylized facts from the neoliberal period.”
First, you can see a sharp rise in interest rates from the end of the 1970s to the middle of the 1990s. With all the attention on fighting inflation, central banks greatly increased their own rates. Hence, the price of the debt climbed and a growing part of that debt was being used to pay off the old debt. This created a devastating snowball effect.
Then you have the tax cuts starting in the 1980s, which would be expanded in the early 2000s. The tax rate was cut for high-income earners, companies and capital. (In the case of countries, capital tax cuts were achieved in a more tiered-like fashion.) Less tax revenue contributes to a rise in the deficit and the debt, unless drastic spending cuts are implemented, which then puts a strain on growth.
It should be noted that the rise in social inequalities, occurring at a time when you have an increase in wealth, translates into increasingly more income gravitating to those who prefer to save than consume. Also, when you have shareholder-based capitalism, the profits are more likely to turn into dividends instead of investments. Moreover, there are just as many factors constricting the growth rate and causing the debt-to-GDP ratio to rise. In the end, European countries suffered in the aftermath of the subprime crisis which, in part, can be blamed on financial liberalization policies and the rise of the housing bubble.
Strong monetary policies, cuts in tax revenue, the financialization of the economy, the rise in inequalities, and financial deregulation, make up just a few of the elements behind the surge in Europe’s public debt.
2. Who holds the debt?
Who are the investors who have confidence in European countries?
The so-called quantitative easing monetary policies — basically, the purchasing of public debt securities by central banks in the eurozone on behalf of the European Central Bank (ECB) — have changed the playing field. The amount of domestic investors has grown significantly. Also, national central banks hold about 20 percent of public debts. As a result, the influence wielded by foreign investors has declined.
Starting in January of 2019, the ECB will no longer purchase public-debt securities. Will this have an effect on its ability to finance? Theoretically, no. And there are two reasons for this. The first reason is because whenever securities already held expire, the central bank will continue reinvesting money in new debt. The second reason is that investors on the hunt for new and risk-