The COVID pandemic has almost universally expanded the role of the state around the globe.
Despite the high borrowing needed to fund a response, low interest rates have magnified the scale of sustainable borrowing by governments around the world.
The post-COVID period could see a generational shift towards the state taking a larger role in the economy, particularly in health.
One of the legacies of the COVID pandemic could be a generational shift towards higher government spending, as fiscal policymakers adjust to the new reality of rising demands for government support while interest rates remain low.
The shock of the COVID pandemic has pushed governments to increase spending to record levels, with over USD10trillion being allocated around the world. Much of this effort has been financed by additional borrowing, adding to the already large debt piles that governments had accumulated before the pandemic began. However, as interest rates have also fallen around the world1 - the cost of servicing that debt has remained low, which could mean that some of the extra spending may remain until the crisis period of the pandemic has passed.
The Arithmetic of Debt and Growth
In a world where interest rates are low, the traditional view of debt as a stock against income levels has less relevance. As long as the rate of interest is below the rate of economic growth, the total stock of debt will tend to decrease as a share of GDP without the need to run fiscal surpluses. This means that deciding whether a given level of debt is sustainable becomes more a question of growth paths and interest rates than one of a balance of government revenues and spending.
Low interest rates are expected to persist well into the next decade. Historically, the overall decline in the interest rates took place gradually over a 30-year period and across multiple economies while more recently, the impact of COVID has revised down interest rate expectations.
Spending on health could be the main beneficiary, as public health systems are strengthened against further pandemics and capacity expands to reverse the backlog in postponed treatments from the last 12 months.
Spending in health is a category where levels tend to increase, both in absolute terms and as a share of overall GDP. The frontier of new treatments coupled with the rising cost of healthcare of an ageing population translates into the overall share of public sector spending also tending to increase over time. Across the more advanced economies, estimates by the WHO show that between 6% and 8% of GDP was devoted to health.
Risks of Higher Debt
However, pursuing the strategy of higher spending funded by persistent deficits does carry risks. While interest rates are low, a large stock of debt remains affordable - but even a small increase in rates could see the costs of servicing that debt spiral upwards. These risks are even greater in those countries that face a significant credit or exchange rate risk. For many, the space afforded by low interest rates may be far more limited.