AI Growth Won’t Solve Major Economies’ Mounting Debt Crisis, Experts Warn

While artificial intelligence could boost economic productivity and provide some relief for debt-burdened nations, economists say it won't be enough to fix the fundamental fiscal problems facing major economies. Government debt across wealthy countries has climbed above 100% of economic output and continues rising due to aging populations and increased spending pressures.

Economic experts are cautioning that while artificial intelligence may deliver productivity gains, it won’t serve as a cure-all for the mounting debt challenges facing wealthy nations around the world.

The financial pressures are immense. Government debt has surpassed 100% of economic output in most developed countries and continues climbing due to costs associated with aging populations, rising interest payments, and increased spending demands for defense and climate initiatives.

American officials have expressed optimism about AI’s potential to drive economic expansion, and researchers believe the technology could help reverse the productivity decline that has persisted since the 2008 financial crisis by enhancing worker efficiency and allowing employees to concentrate on higher-value activities.

Stronger economic growth could make government expenditures and debt burdens more sustainable while reducing concerns from bond market investors.

The Organization for Economic Cooperation and Development, along with three prominent economists, provided preliminary projections to Reuters regarding AI’s potential impact on government finances if the technology does enhance worker productivity over time.

Filiz Unsal, who serves as the OECD’s deputy director of economic policy and research, indicated that an AI-driven productivity increase that boosts employment could reduce debt levels across OECD member nations, including the United States, Germany, and Japan, by 10 percentage points from the approximately 150% of economic output the organization anticipates by 2036.

However, this would still represent a significant increase from the current 110% level.

The outcome will largely depend on whether new job creation ultimately exceeds job losses from automation, whether companies share higher profits through wage increases, and how governments handle their overall expenditures.

For the United States specifically, two economists projected debt would climb more gradually to roughly 120% over the coming decade from the current 100% of output in their most optimistic scenarios. A third economist anticipated minimal change.

“Productivity is like magic… It helps the fiscal dynamics dramatically,” stated Idanna Appio, a former New York Federal Reserve economist who now works as a fund manager at First Eagle Investment Management.

“But our fiscal problems are well beyond what productivity can fix,” Appio added.

Currently, credit rating agency S&P expects no significant public finance impact by decade’s end.

“The one (path) that the (U.S.) administration is hoping for would be you get saved by the bell,” explained Mark Patrick, who leads macro and country risk at Teachers Insurance and Annuity Association of America, while noting this isn’t “something we can set our clocks by.”

While the economists didn’t provide projections for other nations, OECD research suggests AI could enhance productivity in Britain at levels similar to the United States, but would have roughly half the impact in Italy and Japan due to slower adoption rates and smaller sectors that could benefit from AI technology.

Demographic trends represent the most significant obstacle to AI’s potential fiscal benefits.

“The root of the debt issue is with ageing demographics and the entitlements that are tied to that,” said Kevin Khang, who directs global economic research at Vanguard, the world’s second-largest asset management firm.

Tackling this challenge “requires getting the fiscal house in order and (AI is) just buying us the time,” he explained.

Khang considers a scenario where AI helps U.S. growth average 3% through 2040 as the most probable outcome. The Federal Reserve estimates potential growth at around 2%.

He calculates that enhanced growth and tax collections would slow U.S. debt expansion to approximately 120% of output by the late 2030s. This compares favorably to the 180% he predicts if AI fails to deliver, growth weakens, and market pressures increase borrowing costs.

Bond market participants have rapidly penalized governments for excessive spending since bond yields spiked following the pandemic across developed economies.

Appio noted that declining U.S. immigration compounds the demographic challenge.

“The labour shock offsets any (AI) productivity growth,” she observed, while adding she would be significantly more concerned without AI’s potential.

Broader productivity improvements should boost government revenues. However, if AI decreases employment or competition, with profits and capital receiving most benefits instead of labor, tax collections could fall short of expectations.

Regarding government spending, public sector efficiency improvements could help control costs, but there’s risk that expenditures will increase alongside economic growth.

This explains why Kent Smetters, who directs the University of Pennsylvania’s Penn Wharton Budget Model analysis group, anticipates minimal impact on U.S. debt within a decade.

Even with higher-than-expected growth, this would have limited effect on social security spending, which comprises one-fifth of federal expenditures, because benefits are tied to average wage levels, Smetters explained. Other government labor costs would also rise if productivity gains increase private sector wages, he added.

“It’s very important to see whether wages are going to increase,” the OECD’s Unsal commented, noting that wage growth becomes more likely if AI doesn’t boost employment levels.

Debt servicing costs will depend on whether productivity gains raise real interest rates, a discussion already underway at the Federal Reserve, and how long growth can outpace any increases, economists noted.

Obviously, economic forecasters cannot predict the future with certainty. An unexpected shock could rapidly change this entire discussion.

A recession might mean “the AI boom may not come quick enough before the market gets nervous about the fiscal trajectory,” warned Christian Keller, Barclays’ global head of economics research.