France’s Debt Problem Is An AI Problem

Since everyone who is anyone is writing about France’s fiscal situation, I thought I would throw in my two cents. The basic story is that with the recent jump in interest rates, France’s fiscal situation looks very difficult to solve. Unlike the United States, it does not print its own currency. This means that its finances can be better compared to a state like Florida or Ohio than a country like the United States or Japan. Printing money to cover the tab, even at the risk of inflation, is not an option.

While that part of the France crisis story is undeniably true, it is worth digging a bit deeper. Higher interest rates are a worldwide phenomenon. The rise has been larger in France than elsewhere, presumably because investors view its default risk as growing; the cause of the rise lies elsewhere. According to the smart money, the main cause of higher interest rates is the massive demand for investment resulting from the AI boom/bubble. 

That means France’s fiscal problem is in a very fundamental way tied to the AI bubble in largely the same way as the deficit/debt problem is in the United States. As I argued last month, this means that we really don’t have to worry about it because the AI boom/bubble will take care of it one way or the other. 

The boom/bubble story leaves two options. One is that the promise of AI is real and it will juice productivity growth in a way we have never seen before. The other is that AI is all hype from flimflam artists like Elon Musk and Sam Altman.

AI Is a Bubble

Let’s take the latter option first. In that case, at some point intelligent life returns to financial markets and they stop throwing trillions of dollars at the hyperscalers constructing data centers. When that happens, demand for investment will plunge. 

We also are likely to see a plunge in consumption as the stock market returns to more normal price-to-earnings ratios. This could easily destroy $20 trillion in stock wealth and, if it’s like the collapse of the tech bubble, as much as $40 trillion. With a wealth effect on consumption usually estimated at around 3 cents on the dollar, this would imply a reduction in annual consumption of between $600 billion and $1.2 trillion, or 2-4 percent of GDP.  

At that point, not only will reduce demand for investment be pushing interest rates lower; the collapse of the bubble will almost certainly throw the economy into a recession, further lowering interest rates. In that context, reducing a budget deficit with tax increases and/or spending cuts will be horrible economic policy. It will raise unemployment and make the recession worse. In any case, since we will be back in a low-interest rate environment, we don’t have to worry about unsustainable debt burdens.

AI Is Not a Bubble

The alternative scenario is that AI will actually live up to the hype and yield an unprecedented surge in productivity growth. Boosters like Musk tell us that AI will make us so rich we won’t need money. 

Perhaps Elon is a bit overly enthusiastic. Let’s say AI just boosts productivity growth by 2.0 percentage points, from roughly 1 percent annually to 3 percent annually, the same rate the United States saw in the long Golden Age from 1947 to 1973. If these gains are passed on in wages (France has not seen the massive redistribution from wages to profits as the United States), then after a decade, real wages will be roughly 20% higher than current projections show. This will hugely improve France’s fiscal situation for two reasons.   

First, many benefits, most importantly post-retirement Social Security benefits, are price-indexed, not wage-indexed. If, after a decade, real wages are 20 percent higher than what is currently projected, that will mean 20 percent more tax revenue for the Social Security system, with benefits only rising modestly. That will hugely improve the budget situation.

On top of this direct effect, voters around the world are far more accepting of higher taxes when wages are rising than when they are stagnant or falling. While it’s a safe bet that no one will be happy to pay higher taxes, if real wages have just risen by 20 percent more than had been expected, it’s hard to believe that workers will not be willing to have 5-10 percent of this gain (1-2 percent of wage income) taxed back to pay for public benefits they value.

In the world of riches promised by the AI enthusiasts, the idea that we need to worry about deficits, and debt seems a bit crazy. It is especially absurd that we are supposed to be raising the retirement age when the enthusiasts insist that AI will take all the jobs. Which is it folks, too few workers or too few jobs?

Debt Is Too Narrow a Focus

I’ll just throw one other pet peeve with the debt whiners. Government debt and interest payments are just one measure of future burdens. We also pay for many items through granting patent and copyright monopolies. These are a huge deal in the economy.  

If the patents we grant for drugs force us to pay another $600 billion a year (2 percent of GDP) for pharmaceuticals, how is that better than having to pay another $600 billion a year in interest each year? The deficit hawks constantly yell about the interest burden but pretend that they can’t see the costs imposed by government-granted patent and copyright monopolies.

The other big item missing is any accounting of global warming-related damage. If our failure to reduce emissions and/or increase resilience leads us to spend another $300 billion a year in addressing climate-related damage, how is that better than paying another $300 billion a year in interest? Again, the focus on interest alone is failing to capture the burdens we are creating for ourselves.

The AI Boom/Bubble Will Resolve France’s Debt Problem and Ours

Anyhow, while we should have more serious discussions of the debt and the economy, the basic story here is simple. If the bubble bursts, interest rates fall, we have a recession, and we don’t have to worry about deficits. Alternatively, the AI promises are real, and we are immensely rich, and we also don’t have to worry about the deficit/debt. It’s the same story here and in France. We only get into trouble if the AI investment boom and inflated stock values of the AI bubble persist, but we never see the promised productivity boom. That would be very MAGA!