AI Productivity Surge: Can It Outpace Government Debt?

Alanbatnews -

A surge in productivity fueled by artificial intelligence might offer major economies some breathing room to address their mounting public debt, economists suggest. However, it's unlikely to be a complete fix.

The stakes are considerable, with public debt exceeding 100% of GDP in most wealthy economies. This figure is projected to rise further due to the costs associated with aging populations, debt servicing, and increasing pressure to spend more on defense and climate change initiatives.

Policymakers in the United States appear optimistic about AI-driven growth. Economists point out that technology could help economies recover from the productivity slump that has persisted since 2008 by enhancing worker efficiency and freeing up time for more productive tasks.

Increased economic growth could make government spending and debt burdens more manageable, helping to alleviate pressure from increasingly demanding bond investors.

The Organization for Economic Cooperation and Development (OECD) and several prominent economists have shared initial estimates with Reuters regarding the long-term impact of AI on public finances.

According to Felys Öncel, Deputy Director of Economic Policies and Research at the OECD, if AI-driven productivity leads to increased job creation, it could reduce debt in OECD countries—from the United States to Germany and Japan—by approximately 10 percentage points from the projected 150% of output in 2036. However, she noted that this would still be a significant increase compared to the current level of 110%.

She clarified that the impact depends on whether job creation ultimately outweighs job losses due to automation, whether companies pass on higher profits through increased wages, and how governments manage their overall spending.

In the United States, two other economists predict that debt will grow at a slower pace, reaching around 120% over the next decade, compared to about 100% currently, in the best-case scenarios. One economist believes there will be no significant change.

Idanna Appio, one of these economists, who previously worked at the Federal Reserve in New York and is now a fund manager at First Eagle Investment, stated that productivity is like magic, significantly supporting financial dynamics. However, she added that our financial problems are far greater than productivity alone can solve.

Ratings agency Standard & Poor's currently assumes that there will be no significant impact on public finances by the end of the decade.

Mark Patrick, Head of Macroeconomics and Country Risk at Charters for American Insurance and Pensions, commented that the path the U.S. administration is hoping for involves being saved by chance, adding that this is not something to rely on.

While economists did not provide estimates for other countries, AI could boost productivity in Britain at a similar level to the United States, but it would be about half that in Italy and Japan due to lower adoption rates and smaller sectors that can benefit from AI, according to OECD research.

Ultimately, financial dynamics will determine the extent to which AI-driven productivity can offset rising debts. The larger demographic challenges remain.

Kevin Kang, Head of Global Economic Research at Vanguard, noted that the root of the debt problem lies in aging populations and related entitlements, adding that addressing this requires reorganizing the financial system, and AI is merely a temporary fix.

Kang anticipates that AI will boost U.S. economic growth to an average rate of 3% until 2040, while the Federal Reserve sees the potential for about 2% growth. He estimates that higher growth and increased tax revenues will slow the growth of U.S. debt to about 120% of output by the late 2030s, significantly lower than the higher estimate of 180% if AI fails, growth slows, and borrowing costs rise due to market pressure.

Bond investors have been quick to punish governments for financial excesses since bond yields rose sharply after the pandemic in wealthy economies.

Appio noted that declining immigration in the United States has exacerbated the demographic challenge, stating that the labor market shock equals any growth in AI productivity. However, she added that she would be more concerned without AI.

Productivity gains at the economy-wide level should increase revenues. However, if there are fewer job opportunities or competition, and most profits go to capital, which is often taxed less than labor, revenues may be lower than expected.

On the spending side, improving public sector efficiency can help reduce costs, but there is a risk of increased spending in parallel with growth.

For this reason, Kent Smetters, Director of the Penn Wharton Budget Model at the University of Pennsylvania, expects the impact of AI on U.S. debt to be limited over a decade.

He added that even if growth is higher than currently expected, it will not significantly reduce spending on Social Security, which constitutes one-fifth of federal spending, because claims are linked to average wages. Also, other labor costs covered by the government will rise if productivity raises private sector wages.

Felys Öncel from the OECD stated that it is very important to know whether wages will rise, adding that the likelihood of rising wages is greater if AI does not lead to increased employment.

Of course, there are debt costs, which will depend on whether productivity increases real interest rates, a discussion that is already emerging at the Federal Reserve, and the extent to which growth continues to exceed any potential increase, according to economists.

Clearly, no one has a crystal ball. Any shock could quickly turn the discussion upside down. Christian Keller, Head of Global Economic Research at Barclays, stated that a recession might mean that the AI boom may not come quickly enough before the market worries about the financial path.