The current debt crisis, of which Greece serves as the most critical example, shows that the risks associated with debt accumulation have been vastly underestimated, writes Tomi Huhtanen, director of the Centre for European Studies.
The following piece was sent to EURACTIV by the Centre for European Studies.
"European economies have entered a phase in which almost any apocalyptic scenario seems suddenly possible. The main cause of the current circumstances is the global financial crisis. As a result, extensive discussion is taking place on which regulatory structures should be established in order to avoid similar crises of the financial markets in the future.
However, a second critical debate is needed on the ease with which governments have accumulated debt. As the financial crisis hit Europe, governments were forced to create massive stimulus programmes, which destabilised public finances and created large debts. Due to the fact that governments had already accumulated large and, in some cases, unsustainable debts, the financial capacity of governments reached its limit and the financial markets began to doubt the capacity of governments to manage their debt burdens.
The bad habit of debt accumulation quietly ingrained itself during the post-war period. The political logic behind the phenomenon is very simple. Politicians face pressure to deliver services to citizens and tax increases to finance those services are never popular. As a result, the most convenient solution was to finance the cost of public services through deficit spending.
Government loans have been justified by being labelling them as temporary measures or investments for the future. Only too often, however, there was very little financial return on these investments.
This phenomenon was underpinned by mainstream Keynesian argumentation stating that in the case of cyclical economic decline, governments should increase public spending, thereby reducing the downturn's impact. Keynesian thinking was embraced, especially by leftist governments, and duly implemented. However, many governments only partially acted upon Keynesian theory. Keynes also suggested that during periods of economic growth, governments should strengthen public finances by paying down their debts. This part of Keynesian theory was often disregarded.
As a result, public debts kept growing. This trend continued, mainly because it seemed that governments could effortlessly handle large public debt, such as in the case of Japan. The fact that future generations would be responsible for large public debts did not seem to matter.
The current debt crisis, for which Greece serves as the most critical example, has shown us that the risks associated with debt accumulation have been vastly underestimated. Against our best wishes, aggressive cyclical changes can still happen in the global economy and as result, governments must practise sound financial management and maintain public debt at levels that are much lower than they are currently. In addition, the current crisis has shown that financial markets are far more sensitive to high public debt than first thought and they will approach public debt more cautiously in the future.
Consequently, it is necessary for politicians to explain to citizens why caution in spending is needed. Governments are now realising that the irresponsible accumulation of debt during good economic times was a grave error and that the Era of Easy Debt is over."