Counting the cost: Why rising government debts matter for investors

Government debt levels have surged across advanced economies, and they’re now a hot topic in politics and financial markets alike. For investors, the key question is what this means for their portfolios, in terms of both risks and opportunities. We answer some of the most pressing questions.

Why is government debt back in the spotlight?

After the Global Financial Crisis in 2008 and the pandemic in 2020, governments borrowed heavily to support their economies. For a while, this seemed manageable because interest rates stayed low. But with bond yields rising sharply in recent years, debt has become more expensive to service, putting public finances under more pressure.

For investors, this matters because government bonds are a foundation of the financial system. Rising debt and higher borrowing costs can ripple through markets, affecting inflation, growth and long-term returns across all asset classes. 

How high is government debt and how did we get here?

Debt has been climbing relative to GDP for at least the past two decades across most major economies. According to the IMF, US government debt has risen from around 55% of GDP in 2000 to more than 120% today. The UK has followed a similar path, moving from about 35% to over 100% over the same period.

The biggest jumps came after the major shocks already discussed — the Global Financial Crisis and the pandemic — when governments borrowed to stabilise their economies. But what’s striking is that in most cases, debt hasn’t come back down in the good years. Slower growth, ageing populations and the end of the post-Cold War peace dividend that allowed governments to reduce defence spending all mean governments have found it hard to reduce their debt burdens.

As figure 1 shows, this is not just a UK or US story. Across almost all G7 economies, debt-to-GDP ratios have ratcheted higher with each crisis, and the trend has been persistently upward. 

Figure 1: Debt keeps climbing

G7 government debt has risen sharply as a percentage of GDP since 2000 in most major advanced economies. 

Why does an ageing population matter?

Demographics are a key driver of future debt. For much of the second half of the 20th century, the share of dependants — children and pensioners — relative to the working-age population was falling. That eased pressure on public finances and gave governments more fiscal room. But the trend has reversed.

As figure 2 highlights, dependency ratios have been rising across the G7, in some cases since the 1990s, and this shift is likely to continue for decades. Governments tend to spend two to three times more on pensioners than on children, while taxes on workers’ incomes account for the lion’s share of government revenues in most large economies.

Figure 2: Fewer workers, more dependants

Ageing populations are adding pressure to government finances, with G7 dependency ratios rising as the share of pensioners grows relative to the working-age population 

This means more money going out just as fewer workers are contributing to tax revenues. For investors, it signals that public finances are likely to remain stretched and that governments may increasingly rely on debt markets to bridge the gap. Doing so is often politically preferable to cutting public spending or hiking taxes.