Kuta Beach

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Saturday, 8 May 2010

Greece and the Problem with Public Debt

The public debt crisis in Greece certainly looks serious. Riots in the country have caused the deaths of three innocent bank employees already. But what is public debt and why is it so bad?

A country has public debt when the government borrows money. When governments borrow money, they eventually need to pay it back. Governments make money by increasing taxes or lowering spending, and so if suddenly a government needs to repay debt, it may need to increase taxes or decrease spending, or both. This means less welfare spending and taxation will burden the private sector. Public debt is a major problem in democratic countries because often voters are short-term thinkers who want immediate gratification. Political parties who are desperate to stay in power may pander to these wants and, to fund them, may borrow money. This is great for the short term but in the long term it is not good.

According to Indexmundi, here is a ranking of select countries with their public debt to GDP ratio. Public debt is divided by GDP because GDP is a rough measure of a country's ability to pay back its debt with taxation. A $10,000 debt may be crippling for a janitor earning $10,000 per year, but a $10,000 debt is not going to harm a CEO with a $500,000 salary. Likewise, countries with strong economies and therefore high tax revenues are able to take on more debt than countries with weak economies and low tax revenues.

194% - Japan
81% - Greece
58% - India
43% - Brazil
36% - USA
33% - South Korea
31% - Taiwan
18% - China
15% - Australia
8% - Hong Kong
7% - Russia

As this ranking of countries show, Japan has the highest debt. To compound this problem even more, Japan has a massively aging population and because of the Japanese government's reluctance to increase immigration its labor force is shrinking, which therefore means its tax revenue must decline as public health costs will increase due to the aging population. I am extremely pessimistic about Japan's economy and discourage anyone from investing in that country.

A lot is said about India and Brazil but surprisingly their public debt is quite high. I would have initially thought that Brazil with its massive resources would benefit from some sort of mining tax but perhaps public spending in the country is very high. These debt figures put doubt on whether the BRIC countries are doing well. Brazil and India have high debt, although Russia and China have low debt.

America's debt does not seem that bad. Many people like Peter Schiff claim that the USA has major debt problems but given that American GDP is very high.

China, Australia, Hong Kong, and Russia all have low debt. Russia especially looks good because its public debt is extremely low and the country has massive reserves of natural gas. The same may apply to Australia, although to a smaller extent.

Public debt is a problem, but private debt is also a problem. If individuals have massive private debt, they may need to curb spending to pay off these debts.

Image: Petr Kratochvil

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