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The Debt Crisis in the West

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The Debt Crisis in the West

This is the summer of debt. The key words in nearly every business, university, and government office are “cut” and “reduce.” From Greece and Italy to the United Kingdom and the United States, the major Western democracies are struggling to pay past due bills. The levels of personal and government debt have grown so high that the costs of servicing existing loans have become a major source of further indebtedness. Consumers and politicians are in a spiraling debt cycle, where they borrow ever more just to stay afloat.

By 2012, for example, interest payments for the United States federal debt will exceed all payments for Medicaid to the country’s poor. Interest payments on the U.S. debt will amount to more than 70 percent of all federal spending on discretionary non-security programs, that is all things outside of national security and entitlement obligations. Like any household crushed by accumulated debt, the United States is one of many Western governments that now finds itself sacrificing the investments that matter most for future prosperity (education, research, and infrastructure) in order to keep the bill collectors at bay.

The same is true throughout Europe. Western societies continue to glitter with fancy consumer products, but their core capital investments are shrinking at alarming rates. Americans and Europeans will continue to live well for the next few years, but they are, quite literally, starving their children of a chance to live equally well. That is the consequence of excess debt carried by parents and politicians alike.

Diagnosing debt addiction is always simple: just look at the balance sheets. Assessing causes is complicated. They always involve a complex mix of structural and psychological factors.

Which groups exert the most influence on fiscal policy in the advanced democracies? Large corporations and soon-to-retire citizens, two groups that want to preserve income from taxes and increase government protections. They encourage tax reductions and simultaneous spending increases for contracts and entitlement payments.

What are the character qualities that Western societies today value in citizens? Consumption, materialism, and a flaunting of wealth attract popular adulation for their glamour, while modesty, frugality, and measures of humility are treated as old-fashioned, even un-patriotic. Just think: who was the last major Western figure to model frugality? Do we even use the word anymore?

Observers will differ on the balance between these factors, but they are in evidence throughout the United States and Europe. The real question is where we go from here. Any person or nation drowning in debt must stop quibbling about causes and focus in a forthright way on a path to safe harbor. The last few months of endless argument in Washington and the European capitals have not helped. The United States is now only a few weeks away from a possible debt default. Greece, Italy, Spain, and Portugal are almost there too. Not only is the future of the European Union at stake; the future of post-war Western prosperity hangs in the balance as it has not since the oil and currency crises of the early 1970s and the massive economic dislocations of the late 1940s – both periods of heavy indebtedness, especially in Europe.

Those are, in fact, the historical precedents that policy-makers and citizens should examine to think about how to get out of this mess. Too often the historical analogy to the Great Depression of the 1930s is invoked, encouraging only more spending and accumulated debt to cover short-term needs. That is not the correct framework for a period when too much debt, not too little spending, is the main problem.

What are the historical lessons from the indebtedness of the 1940s and 1970s?

1. Cut long-term financial and monetary obligations that are unproductive. This is, of course, hard to do, but it is necessary during a time of heavy debt. In the late 1940s West European countries curtailed their spending on inherited imperial and other obligations. In the 1970s the British, the Americans, and others severed their commitments to a system of fixed currency exchange that constrained domestic resources. In both periods, economic recovery meant reducing legacy commitments that cost a lot of money but contributed little to economic growth and opportunity.

Entitlement programs are the obvious analogy in the twenty-first century. They are unsustainable in the United States and every major European country. It is a mark of humanity that each of these societies has promised aging populations more health and consumption than ever before. It is a mark of financial irresponsibility to borrow so heavily, and jeopardize future growth, to maintain these commitments at anywhere near present levels.

Take the United States as an example again. According to present projections, in 2012 federal expenditures on Social Security and Medicare (programs for the aging and mostly retired) will equal all federal spending on discretionary programs, including the military, education, research, infrastructure, and the arts. At a time of feeble growth and ubiquitous cuts, about 8 percent of the entire gross domestic product will go toward non-working-age people. The situation will only get worse, especially in Europe, as a higher percentage of the population enters its retirement years, living longer and collecting more from government than any predecessor generation.

Aging citizens deserve respect, they deserve gratitude, and they deserve some support. These obligations have gone too far, however, and the debt crisis of the West will only end when government commitments to retirees are adjusted. This will be very difficult, but it must happen soon. Every day these commitments sink us further in the debt hole.

2. Invest in productivity within countries. One of the remarkable attributes of policy-making in the late 1940s and early 1970s was that politicians found the will to support (and even expand) productive enterprises as they cut unproductive commitments. After the Second World War this meant investment in industrial capacity in Western Europe through programs like the Marshall Plan, matched in part with precious resource allocations from societies recovering from war. In the early 1970s this meant increased government support for the research and development that produced the digital revolution of the next decade, despite cuts to other inherited obligations.

For contemporary governments the lesson is clear. Across-the-board cuts are not the way out of debt. Non-productive commitments need the knife, but programs that will produce growth and opportunity need protection, and even some additional assistance. Luckily, investments in future growth are much cheaper than continued non-productive commitments.

If each Western government cut its entitlement programs by 20 percent and then allocated only 2-3 percent of that saving to education, research, and infrastructure, the combined cuts and investments would reduce debt while raising productivity significantly. Targeted investments in productive capital are indeed affordable, and necessary, as entitlements are cut to deal with burdensome debt. It makes perfect sense, after all, to place the burden for debt repayments on those who collect the most from government, while investing in areas of growth that collect the least.

3. Raise taxes. Despite the ballooning unemployment and slow growth of the late 1940s and early 1970s, the countries of Western Europe and the United States raised taxes. They recognized that while excessive taxation can choke off economic activity, modest increases in government revenue are necessary to restore financial solvency. You can never escape spiraling debt from cuts alone. You cannot stop eating and paying for electricity if you are a household. You cannot close the schools, highways, and bridges that make your society function if you are a government.

In the late 1940s and early 1970s tax increases, in fact, contributed to productivity, growth, and an escape from debt. New government revenues in both periods built the roads, the airports, and the universities that fuel economic activity in the West to this day. New government revenues in both periods sponsored the very research on nuclear energy, digital technology, biomedical engineering, and artistic creativity that made the West so prosperous and secure through the present.

Raising taxes is for government what taking a second job is for a head of household. Too much taxation or moonlighting undermines productivity. Too little, however, leaves one short of money. To escape debt, governments and households must cut non-productive spending, they must invest selectively in growth, and they must raise some new revenue. For the head of household this means fewer contributions to worthy causes, possible enrollment in a course for new skill development, and an additional part-time job. For the government this means real cuts in entitlements, small but significant increases in domestic capital investments, and some new taxes.

Despite the controversy surrounding each of these elements, they are all quite feasible. Citizens in the United States and Europe receive larger entitlements than any previous generation. They can afford a significant cut. That is not unjust. Societies on both sides of Atlantic have invested less in education, research, and infrastructure during the last decade than in the decades before. They can afford a small increase. That is sensible and appropriate. Taxpayers in Europe and the United States (particularly in the latter) pay a smaller share of their income to government than the previous generations. In the United States, the wealthiest individuals and corporations pay far less than at anytime since the Second World War. Modest tax increases are necessary, just, and productive for the economy.

Our summer of debt is alarming, but it need not end in disaster. The solutions are not easy, and they will not bring instant relief. Clear steps toward entitlement cuts, targeted capital investments, and modest tax increases will, however, begin to turn things around. As in the past, the first steps are the most important.

It is time to admit our debt addiction and embark on constructive measures. The debt crisis is an opportunity for the West, if only its leaders will seize upon it for the sake of reforming their economies. Partisanship in this context is the real treason of our age.

The opinions expressed in this blog are personal and do not necessarily reflect the views of either Global Brief or the Glendon School of Public and International Affairs.

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3 Comments

  1. Arnold Levy July 12, 2011

    Excellent article that gets to the point in the last sentence. Our financial crisis is a symptom of our bankrupt political system. Our country is economically strong but incapable of managing its resources. If our politicians can’t ask the right questions, how do we get to the right answers. I fear that real pain will have to be experienced before our so-called leaders figure this out.

  2. FIona Wright July 17, 2011

    Good article that draws out some of the common challenges quite well. It would have benefitted from slightly more recognition of the differences in scale – most recent figures on debt to GDP ratios in Greece are 144% compared to 59% in the US. Quantification does not tell the whole story however as France and Portugal have the same levels of debt-GDP but the latter situation requires a bailout while the former does not. Structural problems in certain societies (over and above ageng populations) are clearly fuelling the debt crisis in Europe whereas in the US the structural problems seem to be political barriers to raising taxes/ partisanship in general. Behind all of this is a broader question of the point at which debt becomes unsustainable as it seems unlikely that any Western governments could ever entirely elimiate it. The EU’s stability and growth pact requires Member States to maintain debt-GDP ratios of below 60% but as the current crises show there is clearly much more to it than this. In many countries, sensible fiscal rules are both popular and very well entrenched (in particular Sweden and the Netherlands) and there may be further lessons there regarding possible ways forward.

  3. Jeremi Suri July 17, 2011

    Excellent points, Fiona. As you say debt to GDP ratios vary, but they only tell part of the story. The deeper question is whether Western societies have adjusted to the structural challenges of financing programs (especially entitlements) that are growing at a faster rate than GDP growth. Some countries like Greece are in dire circumstances. Others, like the United States and the United Kingdom, still have a lot of room for maneuver, but they cannot go on as they have in the last decade. Political will and structural reform are indeed needed, in varying degrees, throughout North America and Europe.

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