Debt and the Social Contract
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”Albert Einstein.
Scale of Debt
The world is awash with unprecedented levels of debt. By 2018 global debt had already reached a record high of $184 trillion. This debt equated to 225% of global GDP, $86,000 per capita. By 2020 the Covid pandemic had increased indebtedness and stretched public finances even further, as global economic activity contracted and governments implemented emergency lifelines to protect people, preserve jobs, and prevent bankruptcies. Higher government debt means higher taxes or more state interference until the debt is repaid—or, if this is impossible, the risk of default and economic crises for that country, and probably its neighbours.
Private sector debt has also tripled since 1950. Initially, private debt levels rose in the advanced economies, but China and other emerging markets have now overtaken them.
The Problem with Debt
We live in a ‘buy now, pay later’ era of consumption. Consumer debt is the lifeblood of the economy, enabling consumers to take the waiting out of wanting. Whilst once stigmatised, debt is now the normal state of affairs. But with debt comes compound interest, added to the original sum borrowed, which will grow exponentially until settled. The longer debt remains unpaid, the larger the sum owed becomes.
While repayment is more likely to be possible when incomes and assets are rising, the risks of a vicious debt cycle of crises, bankruptcy and default materialise when the economy stalls, expectations about future earnings are proven incorrect, or there is some shock, such as the global financial crisis or the Covid-19 pandemic.
Debt and the Social Contract
There is an unwritten social contract across generations within countries, societies and families. A reciprocal intergenerational network of financial obligations enables society collectively to support the young and the old. If it works well, the social contract allows nation states to make long-term strategic investments in transport, energy and other infrastructure or public goods which will be paid for and enjoyed by future generations.
However, the social contract has now become one-sided. The extent of public debt has now reached unprecedented levels. In many countries, an additional aggravating demographic factor is a growing older population. This affects pensions and other obligations, requiring support by a smaller cohort of young people, at a time when the youth have unstable job prospects. The considerable expenses relating to climate change exacerbate this. Intergenerational equity is likely to become more important as the implications of indebtedness become more apparent. Cooperation requires the perception of fairness, and when this weakens, the social contract and social cohesion are likely to be adversely affected, challenged by a generation of aggrieved young people.