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Learning the Lessons of Debt
The drama/tragedy being played out in Greece — and potentially in the rest of the Europe — has two major lessons for the economic growth prospects of the U.S. Lesson one: Budget deficits catch up with you. Even after two debt “restructurings” (a polite word for default), Greece clearly can’t service its public debt, still around 160% of GDP, especially at the sky-high interest rates the market is demanding. U.S. federal debt is now around 65% of our GDP, but is heading north rapidly. It will continue to do so without a very significant budget deal; a deal that is much more aggressive than the one agreed to by Congress and the President last August (but waiting to be implemented before the end of the year). Ken Rogoff and Carmen Reinhart argue in their already classic book, “This Time is Different,” that a crisis is imminent when a nation’s debt gets close to or exceeds 80% of GDP. Japan crossed that threshold long ago, but it has the benefit of being able to sell government securities to the Postal Savings system, which warehouses much of Japanese saving. Few other countries have that luxury; Greece certainly does not. These countries must persuade both domestic and foreign investors to buy their bonds, which is difficult, if not impossible, to do once markets realize that debt is out of control and likely will be haircut or inflated away through the printing of money. As the world’s safe haven in a very turbulent world, the U.S. too has the luxury of being able to cross the 80% of GDP threshold without suffering a crisis. But at some point above that number — no one knows where — that luxury will evaporate quickly. My hunch is that point will be reached sometime during the next Presidential administration if no budget is forthcoming or in sight. Markets are expecting a deal in 2013, or in 2014 at the latest. The Greek tragedy provides a telling illustration of what happens when markets are disappointed. Lesson two: The costs of various off-budget protections mount over time and eventually put economies in straightjackets when crises occur. Labor rules that prevent employers from adjusting their workforces according to economic realities are a prime example of these harmful protections. Greece is painfully learning this lesson, but much of Western Europe has yet to learn it — with the notable exceptions of Germany and Sweden (which have liberalized their labor markets in recent years). The U.S. has its own rigidities which are introducing a form of sclerosis that is holding back growth here as well. Occupational licensing rules now govern roughly 30% of the workforce, up from about 5% 40 years ago. A panoply of protections prevent public school superintendents from firing bad teachers and giving good ones performance pay. On top of these examples, our overly litigious society diverts money from the productive to the rent-seeking and their attorneys. Fortunately, the U.S. has a long list of pluses that so far have helped off-set these self-inflicted wounds. The country’s fantastic university system still attracts the best and brightest from around the world, and America’s entrepreneurial culture remains the envy of other countries. Despite the rising anti-immigrant tenor of public discourse, few other countries can match America’s ability to absorb immigrants into the mainstream of society. Still, if the sclerosis gets worse, it can put a drag on our growth. In a worst case, the U.S. will be like the proverbial frog that sits in slowly heating water until one day the temperature is boiling and it is too late for the frog to avoid its inevitable fate. Greece is like that frog already. Americans should take heed, we could be that frog too if we don’t address the rigidities that are boiling our own economic water.
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