The U.S. has a fiscal crisis, but not the one that everyone is talking about. Standard and Poor’s proved beyond a reasonable doubt that the U.S. still has the world’s preeminent reserve currency. When shocks hit -- and investors have no idea who or what might be next in line for a downgrade -- they buy U.S. government securities.
Downgrades don’t usually have this effect. For example, if S&P or other rating companies downgraded France, that would set off a crisis within the euro region -- pushing up interest rates on French government debt, undermining euro-area banks, and perhaps putting pressure on the fabric of the European Union itself. With a one-notch downgrade of the U.S. government, on the other hand, S&P inadvertently managed to lower the U.S.’s borrowing costs, both at the federal level and for homeowners who refinanced their mortgages.
The U.S.’s fiscal problem is not that the market questions the country’s ability to pay its debts. The willingness to pay was clearly proved by the outcome of the debt-ceiling debate, when even a majority of Tea Party adherents in the U.S. House of Representatives voted to lift the ceiling (though it would have passed without their votes). We most definitely do not have the kind of solvency crisis experienced by some emerging markets and now, for the first time, parts of Western Europe.
Instead, our crisis has two dimensions. First, we have a growth crisis. My MIT colleague, Daron Acemoglu, in a blog post on the Harvard Business Review website, makes the point vividly. In his view, one percentage point extra growth per year for the next 20 years would fix the U.S.’s budget problems. If we could manage to increase our growth rate from 2 percent a year to, say, 3 percent over the long haul, that would greatly boost average incomes, as well as tax revenue.
Acemoglu also argues that the U.S. economy can grow through innovation, but only if U.S. policies foster more basic scientific research and more effective commercialization of technology. The U.S. also needs to improve its patent system and allow more skilled foreign workers into the country, Acemoglu says.
The general policy mood may be shifting in this direction. Jeb Bush, the former Florida governor, and Kevin Warsh, a former Federal Reserve governor, made similar points in a Wall Street Journal op-ed last week. Bush’s rhetoric was suitably vague for someone who is likely to run for president in 2016. Bush and Warsh felt the need to repeat the mantra of the day, “Cutting spending is essential,” and then quickly made the right point: “But we will never cut our way to prosperity.”
Restoring growth is not easy because of a second, more debilitating element -- a paralyzing fight over the distribution of income, in which powerful people can block the government from doing anything sensible if that is against their narrow interest.
This dynamic can be seen in the debate over who will foot the bill for the 2008 financial crisis, which caused a deep recession that pushed up the federal government’s medium-term debt -- what we should expect by 2018 for example -- by about 50 percent of gross domestic product. (You can check the Congressional Budget Office numbers yourself; start with points 9 and 10 in my testimony to a July 13 joint hearing of the Senate Finance and House Ways and Means committees. The testimony was not refuted.)
To control future debt levels, someone has to pay for that fiasco. But people in high-income brackets, working with various allies, have dug a brilliant defense against tax increases in the form of the Tea Party. Backed by 30 percent of the population, this group exploits the broad design of the U.S. Constitution, which gives well-organized minorities an effective veto power over major policy changes. The result is that, instead of letting President George W. Bush’s tax cuts for the rich expire, we are headed for deep spending cuts that disproportionately affect the less-well-off.
More generally, powerful lobbies have amassed great privilege in the political system, and they can’t be easily moved from their positions. For example, Jeb Bush and Warsh say, quite reasonably, “If banks are ‘too big to fail,’ they are too big. They must be allowed to succeed or fail on their own merit, without any hint of government support.” But there is precisely no chance that Congress, the Federal Reserve or the executive branch will end the subsidies that undergird big banks, and that keep them in business through essentially free insurance against downside risk. Watch Bank of America in the weeks ahead for the next demonstration of what it means to be too big to fail.
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