IB Economics Government Debt & National Debt

The Government Credit Card: What Happens When Countries Can't Pay Their Bills?

Target Question

What is sustainable government debt in IB Economics?

It's 2020, Pandemic time. The world has shut down. Restaurants are boarded up, airports are ghost towns, and millions of people are sitting at home wondering how they're going to pay their rent or mortgage. Governments everywhere face the same question: do we spend money we don't have, or do we just sit here and watch our economies collapse?

The US didn't hesitate. Stimulus cheques landed in bank accounts. Furlough schemes kept workers attached to jobs. Emergency loans kept businesses on life support. What did this create? An absolutely eye-watering budget deficit - over $3 trillion in a single year. To put that in perspective, that's roughly the entire annual GDP of the UK, spent in twelve months.

Most economists will tell you that was probably the right call. Short-term pain, long-term gain... or so thy have you believe.

The pandemic was something exceptional that deserved exceptional measures such as the one I have just mentioned. But the question is, what happens when government spending never stops? What happens when the credit card bill just keeps growing, year after year, with no plan to pay it back? That's exactly what this unit is about, and it's one of the most common - and most controversial - debates in modern economics.

So What Is A Budget Deficit?

A budget deficit occurs when a government spends more than it collects in tax revenue in a given period. In economics: G > T (government spending exceeds tax revenues).

So, A budget deficit occurs when government spending (G) exceeds tax revenues (T) in a given period, expressed as G > T.

You can easily explain it thinking as if budget deficit were your own finances. If you earn £1,200 a month but spend £1,500, you're running a monthly deficit of £300. Fine for a month or two. But if you do that every single month for ten years? You've got a serious financial issue.

Now transform that into a national economy and you start to see why government debt - sometimes called national debt - is such a relevant topic. Government debt is simply the accumulation of all those annual budget deficits over time. Every year the government spends more than it raises, that gap gets added to the total pile. It's the sum of every budget deficit the country has ever run.

So, government (national) debt is the total accumulated sum of all past government budget deficits, representing the amount owed by a government to domestic and foreign creditors.

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Why Would a Government Deliberately Spend More Than It Earns?

Running a budget deficit isn't always poor decision making. In fact, during a recession or a crisis, it can be exactly what the economy needs. Government spending is an injection into the circular flow of income. When the government pumps money into the economy - building hospitals, paying teachers, subsidising businesses - it stimulates economic activity, supports employment, and keeps things flowing.

The pandemic is a great example. The UK government borrowed billions to fund the furlough scheme, keeping unemployment from exploding. Japan has been running deficits since the 1990s - ever since its property bubble burst and the economy flatlined - deliberately spending to prevent a complete economic collapse. These are calculated decisions not ill-timed thinking.

The problem, as your IB Economics examiner will want you to point out, is that budget deficits are not sustainable in the long run. No government can permanently spend more than it earns. At some point, reality comes back to haunt you.

The Debt Spiral: How Things Get Out of Hand

When a government borrows money, it pays interest on that debt - just like you would on a loan. This is called debt servicing. And if the government doesn't actively pay off chunks of its debt, the interest just gets added to the total. Next year, you're paying interest on the original debt plus last year's interest. And on and on it goes.

So, debt servicing costs: The total cost of repaying a government loan, including both the principal repayment and accumulated interest charges.

This is why economists talk about debt growing exponentially. Left unchecked, it doesn't just rise steadily - it accelerates. And that creates an unsustainable situation: the government ends up spending a massive chunk of its budget just on interest payments, rather than on schools, hospitals, or infrastructure. The opportunity cost is enormous.

IB Economics Real-life Example: The UK knows this pain well. UK debt interest payments are now above £100 billion a year - money that could be going into the NHS, education, or green energy. The Office for Budget Responsibility has warned that, without action, debt could rise to 270% of GDP by the early 2070s. That's an uncomfortable projection.

How Do We Measure Government Debt?

The most important measure is the debt-to-GDP ratio - expressing a country's national debt as a percentage of its annual economic output (GDP).

So, debt-to-GDP ratio: A country's national debt expressed as a percentage of its annual GDP - the primary measure of debt affordability and sustainability.

Why is this better than just quoting a big number? Because the context is extremely relevant here. A £1 trillion debt means something very different to an economy producing £3 trillion of output per year versus one producing £500 billion. The ratio tells you how affordable the debt is relative to the country's ability to generate income and repay it.

The higher the debt-to-GDP ratio, the less affordable the debt - and the more nervous creditors and financial markets get.

IB Economics Real-life Examples: Here's how some of the big players are currently doing:

• 🇬🇧 UK: Public sector net debt stood at around 93% of GDP in early 2026, with borrowing in the financial year to February 2026 running at approximately 4.1% of GDP.

• 🇺🇸 USA: The US debt-to-GDP ratio sits at around 125%, with total national debt hitting $38 trillion in October 2025.

• 🇯🇵 Japan: Japan's debt-to-GDP ratio remains among the highest in the world at over 230% - a figure that would make most Western finance ministers pass out.

• 🇬🇷 Greece/Italy/France: At the start of 2025, Greece, Italy, and France all sit clearly above the 100% debt-to-GDP mark.

The EU, for context, has a formal rule - the Stability and Growth Pact - that member states should keep their debt below 60% of GDP and their annual deficit below 3% of GDP. In late 2025, many EU countries are running deficits well above that 3% limit, with France at 5.4%, Poland at 5.8%, and Romania at a remarkable 7.3%. The rules exist but enforcing them is another completely different matter.

Venezuela: The Extreme End of the Spectrum

If you want to see what happens when debt gets truly out of control, look at Venezuela. At one point, Venezuela's national debt reached 350% of GDP - meaning for every $1 million of economic output, the country owed $3.5 million. That's not a debt problem; that's debt bankruptcy. Hyperinflation, economic collapse, mass emigration. A clear warning of what unsustainable debt looks like in real time.

Greece's story, closer to home, is also instructive. By 2009, Greece's budget deficit had hit 15.4% of GDP - more than five times the EU's 3% threshold - driven by years of heavy public sector spending and insufficient tax collection. What was done about it? The implementation of a radical austerity programme, international bailouts, and years of painful economic contraction that diminished the living standards of an entire generation.

What Are the Real Costs of High Government Debt?

1. Debt Servicing Costs

Every pound or dollar borrowed must be repaid - with interest. The bigger the debt pile, the bigger the annual interest bill. That's money the government can't spend on anything else. There's a massive opportunity cost here: debt repayments crowding out investment in public services, infrastructure, and future growth.

2. Credit Ratings

Heard of a credit score? Countries have them too. Credit rating agencies - Moody's, S&P, Fitch - assess how likely a government is to repay its debts. A high credit rating means lower borrowing costs. A low rating means lenders get nervous and demand higher interest rates to compensate for the risk - making the debt even more expensive to service. A vicious cycle.

IB Economics Real-life Examples: UK 30-year gilt yields reached 5.7% in September 2025 - the highest level since 1998 - leaving the UK with the highest borrowing costs in the G7. That's a clear signal that markets are getting edgy about UK debt sustainability.

3. Austerity and Future Generations

If debt spirals out of control, governments eventually face a reckoning. They must either cut spending, raise taxes, or both. This combination - known as austerity - shifts the burden onto citizens. Fewer public services, higher taxes, slower growth. And here's what doesn't seem to be very fair: today's government borrowing is tomorrow's young person's tax bill.

So, austerity: A fiscal policy combining cuts in government spending with increases in taxation, implemented to reduce government borrowing and national debt.

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Are Budget Surpluses Always a Good Thing?

Not necessarily - and this is the typical IB Economics exam question.

The idea that "budget surpluses are always good, deficits always bad" is an oversimplification your IB Economics examiner will want you to challenge.

A budget surplus (T > G - tax revenue exceeds government spending) can be used to pay down national debt, which is genuinely useful. But a surplus also means the government has been taxing more than it needed to. That extra taxation may have dampened incentives to work and invest, potentially slowing economic growth. It's not automatically a good thing. At the end of the day, if you are paying a very high percentage of your salary towards taxes, you may start thinking you are better off not working or on unemployment benefit.

Similarly, a budget deficit - while increasing national debt - can be a smart, targeted tool during a downturn or recession. The key word throughout this entire topic is sustainable. A deficit that funds productive investment and supports the economy through a crisis is very different from a deficit driven by permanent overspending with no plan for repayment.

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IB Economics Summary

The relationship between budget deficits and government debt is direct and cumulative:

• Every budget deficit adds to the national debt

• Every budget surplus can reduce the national debt

• Compound interest means unmanaged debt grows exponentially

• The debt-to-GDP ratio is the key measure of affordability

Global government debt reached $111 trillion in 2025 - the type of figure that would have seemed a joke a generation ago. The pandemic, energy crises, defence spending surges, and ageing populations are all pushing government finances to their limits worldwide.

The question isn't whether governments should ever borrow. They should. The question is whether that borrowing is sustainable - and whether there's a credible plan to manage it and re-pay what is owed over time.

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Frequently Asked Questions

Q: What is the difference between a budget deficit and government debt? A budget deficit is the annual shortfall when government spending exceeds tax revenue in one year. Government debt is the total pile of all those annual deficits accumulated over many years.

Q: Why is the debt-to-GDP ratio important? It measures how affordable a country's debt is relative to its economic output. A higher ratio means the debt is harder to service and repay, and makes lenders more nervous - pushing up borrowing costs.

Q: Can a budget deficit ever be a good thing? Yes - especially during a recession or crisis. Government spending injects money into the circular flow of income, supporting jobs and growth. The issue is long-term sustainability, not short-term borrowing.

Q: What happens when government debt becomes unsustainable? Credit ratings fall, borrowing costs rise, and governments are often forced into austerity - cutting public spending and raising taxes. In extreme cases (like Venezuela or Greece), total economic collapse can follow.

Q: What is austerity and why is it controversial? Austerity refers to government policies combining spending cuts and tax rises to reduce debt. It's controversial because while it reduces borrowing, it can also slow economic growth, reduce public services, and disproportionately affect lower-income households.

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