International | Apr 21 2021
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In search of a solution to ever-expanding debt-to-GDP ratios, Dr Roy van Keulen offers some food for thought, alongside a few ideas of companies likely to benefit
-How will governments improve their debt-to-GDP?
-Taxing lower and middle incomes seems politically impossible for quite some time to come
-Most solutions might simply be to tax the wealthy, reduce spending on healthcare and sell off public assets like roads
By Dr Roy van Keulen
As the US looks close to surpassing an unprecedented debt-to-GDP ratio of 150% (or US$225,000 per US taxpayer), I wanted to explore what happens when governments reach the end of their credit line and are forced to start deleveraging.
In essence, governments can only improve their debt-to-GDP levels in one of two ways: they can either increase their GDP or they can reduce their debt.
The most popular option seems to be to increase GDP. This used to work – after WWII, most OECD countries had record high debt to GDP ratios which they subsequently managed to outgrow.
However, this was achieved through a combination of high population growth and high productivity growth, neither of which OECD countries can reasonably expect to see much of again in the near future.
Whereas most OECD countries saw a baby boom after WWII, today the natural population growth (births – deaths) is negative in most OECD countries (and even more so for the working age population). Immigration seems to be pushing up against the limits of social cohesion in many places. Productivity growth similarly seems to be a distant memory.
What about me: debt reduction
With increasing GDP not providing much respite in improving debt to GDP levels, let’s explore the options for reducing debt levels. Broadly speaking, debt levels can be reduced in three main ways: governments can increase revenues through taxes, decrease public spending or sell off public assets.
Increasing revenue through taxation can go some way towards improving debt-to-GDP levels, but not nearly as much as is commonly assumed.
Taxing lower and middle incomes seems politically impossible for quite some time to come (and it’s also deflationary) so let’s start looking at the politically most feasible options.
If the US would confiscate all the wealth of its billionaires, that would only raise US$4trn out of a US$30trn total debt (after including the US$2.5trn Biden Stimulus Package). It can also only be done once.
Moving down to the 1%, a complete confiscation of all the wealth of the 1% could raise more than the required US$30trn (US$34trn), but it would require emptying out the bank accounts and selling the houses of every high-earning professional in medicine, IT and finance (and generally a large share of the population with a 30 year career behind them).
A more politically tenable option would be to significantly raise income and wealth taxes on this cohort and on the broader top 10%.
However, none of this is without consequences – the top 10% of earners are also among the most mobile. Given that raising taxes on the wealthiest is a likely outcome of today’s high debt levels, we should expect a steep increase in demand for emigration from high-debt countries – the right passport or visa may very well become one of the most valuable assets.
Companies like Moelis Australia ((MOE)), which is one of Australia’s largest Significant Investor Visa (SIV) fund managers and a pioneer in the program, looks positively exposed to the tailwind of wealth looking for a safe harbor.
What about me: decreasing spending
Although increasing revenue by taxing the wealthy will go some way towards stabilising the debt-to-GDP ratio, governments will most likely also have to look at decreasing their spending.
By and large, government budgets in OECD countries consist of three big buckets; healthcare spending, welfare payments and traditional government tasks such as education, police, military and infrastructure.
Over the past decades, OECD countries have already stripped their traditional government tasks to the bare bones – Infrastructure is now backlogged in most OECD countries and teachers, police officers and soldiers are often underpaid and overstretched.
Decreasing spending in this bucket is likely to yield diminishing returns and result in significant pushback.
Cutting welfare payments (mostly old age pensions) could potentially yield more savings, but taking away entitlements is one of the most politically challenging policies due to the sheer amount of welfare recipients (and it’s also deflationary).
Which leaves only healthcare spending. Healthcare stocks are commonly considered defensive, due to the supposed non-discretionary nature of the underlying spending. However, as Greece’s recent experience shows, when countries are heading towards bankruptcy and interest rates on government debt start to rise, healthcare spending increasingly moves towards the ‘discretionary spending’ category.
Greece ended up managing to cut its healthcare spending by more than -40% during 2009-2015, despite an aging population.
As countries throughout the OECD look likely to be forced to decrease their healthcare spending, one outcome could be a global deflation in the price of healthcare products and services. Companies like Medibank Private ((MPL)) and nib Holdings ((NHF)) could see significant margin expansion from this if they can maintain their premiums while being able to spend less on claims.
What about me: asset sales
Finally, governments can sell off their assets. Since the fall of the Soviet Union, most countries around the world have been selling off much of their public assets in energy, telecommunications and transportation (airports, marine ports, air/rail/tram/bus lines).
Companies like Macquarie Group ((MQG)), which helped establish infrastructure as an asset class during this time, stand to benefit from a continuation of this trend.
However, in 2021, for many countries, there isn’t nearly as much left on the books in these categories. Governments will therefore also have to start looking for new types of assets to sell off.
Realistically speaking, the only type of asset which many of these countries still have on their books which is of significant value is their public roads (valued at US$3.4trn in the US).
Although few people enjoy paying tolls, at this stage, for many countries, it is the only asset they have left to put a meaningful dent in their debt. Privatising roads and highways is therefore a logical and necessary option for governments to pursue.
As governments become forced sellers of these assets, companies like Transurban ((TCL)) and Atlas Arteria ((ALX)), which have the expertise and experience in managing toll roads, have the opportunity to pick up these assets at bargain prices. (Transurban originally got its start in the 1990s when the Victorian government was forced to sell off CityLink to pay down its debt.)
For most OECD countries, improving their debt-to-GDP ratios will require taxing the wealthy, reducing spending on healthcare and selling off public assets like roads.
This is not to say that all countries will do so in exactly the same way. However, with countries with a debt-to-GDP ratio of over 150% now representing well over 30% of global GDP, we can expect that as these countries are forced to deleverage, that this will result in an unprecedented global movement of High-Net-Worth individuals, deflation in healthcare costs and an unprecedented increase in the privatisation of public roads.
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