Government gross debt across G7 countries now exceeds 120% of GDP on average, rising from below 90% two decades ago, according to a recent report by the Centre for Economic Policy Research.
This debt buildup has intensified as sovereign bond yields climb, ending an era of exceptionally low financing costs and placing immediate pressure on government budgets worldwide.
The International Monetary Fund issued an urgent call for advanced economies to cut deficits and lower debt levels this month, warning that delays will make fiscal adjustments harder in future years. CEPR reported that structural fiscal pressures extend far into the future across 35 OECD members and accession-candidate countries, driven by initial fiscal imbalances, demographic shifts, interest rates, and structural spending trends.
The median country faces a long-run fiscal gap reaching 4.7 percentage points of GDP at the 2060 horizon. Ten OECD member states require adjustments exceeding 8 percentage points of GDP to stabilise public debt ratios. Denmark, Iceland, and Ireland are the only three countries where the gap is negligible or negative, supported by strong initial fiscal positions and low net debt.
Population ageing pressures
Weak initial fiscal positions contribute 0.9 percentage points of GDP to the long-run fiscal gap in the median country. Population ageing adds further strain by raising public expenditure on pensions by 2.2 percentage points, alongside 1.8 percentage points for health and long-term care.
Higher defence spending adds another 0.5 percentage points of GDP to fiscal pressures in the median country.
CEPR said that these estimates exclude future climate-related expenditures, meaning actual gaps could climb even higher.
If governments meet higher spending on pensions, health, long-term care, defence, and debt interest entirely through new borrowing rather than budgetary offsets, net government debt could rise by 43 percentage points of GDP by 2045 in the median country.
Growth-driven debt limits
While favourable cyclical conditions can reduce debt-to-GDP ratios over short-term horizons through automatic stabilisers and interest-growth differentials, the long-run arithmetic is stricter. Over longer horizons, public debt-to-GDP ratios can only sustainably decline through real interest rates remaining below potential growth rates, structural primary government surpluses, or economic growth that outpaces small structural primary deficits. Canonical macroeconomic models establish a close relationship between potential GDP growth and real neutral interest rates, meaning higher underlying real growth does not automatically expand the growth-interest differential.
CEPR said that a reform-driven 10% increase in potential output by 2060 may have a negligible effect on the median long-run fiscal gap if that growth stems entirely from higher labour productivity. Benefit indexation raises social transfers and public pensions alongside wage growth, while public services face the Baumol cost disease, where lower productivity growth in the labour-intensive public sector increases relative unit costs over time.
Labour utilisation levers
The fiscal outlook changes when higher potential output results from increased labour supply rather than labour productivity. Achieving a 10% increase in potential output by 2060 through higher employment rates could reduce the long-run fiscal gap by approximately 2.5 percentage points of GDP in the median country.
Countries with large gaps between male and female labour market participation rates, such as Italy, Belgium, Poland, and Korea, could increase labour utilisation.
Other nations face low effective retirement ages, notably Luxembourg, Slovenia, and Spain.
Empirical literature on successful public debt reductions favours expenditure control over tax increases or cyclical expansions. Spending cuts signal structural policy shifts that boost investor confidence and crowd in private investment with minimal recessionary impacts, whereas tax increases can trigger deep and persistent recessions.
Factors causing the long-run fiscal gap in OECD countries
What specific factors cause the long-run fiscal gap in OECD countries?
The main sources are weak initial fiscal positions, which contribute 0.9 percentage points of GDP to the median gap, and population ageing, which adds 2.2 percentage points for pensions and 1.8 percentage points for health and long-term care. Higher defence spending adds another 0.5 percentage points.
Which countries have negligible or negative long-run fiscal gaps?
Denmark, Iceland, and Ireland are the only three OECD members where the long-run fiscal gap is below 0.5 percentage points of GDP or negative, due to strong initial fiscal positions and low net debt.
How does labour utilisation affect the long-run fiscal gap?
Increasing potential output through higher employment rates rather than productivity alone can reduce the long-run fiscal gap by approximately 2.5 percentage points of GDP in the median country by 2060.
Related reading