World is right to worry about US debt
We’ll send you a myFT Daily Digest email rounding up the latest US news every morning.
Many foreign observers look at the US budget shenanigans with confusion and dismay, wondering how a country that seems to have it all can manage its fiscal affairs so chaotically. The root problem is not just a hugely elevated level of public debt, or a patently unsustainable trajectory for old age entitlements. It is an electorate deeply divided over the direction of government, with differences compounded by changing demographics and sustained sluggish growth. It is hard to escape the notion that today’s budget battles are but a skirmish in a much longer-term war that won’t be settled soon.
America must shortly answer a series of fundamental questions. For example, as its share of global gross domestic product shrinks from about 20 per cent today to as little as 10 per cent in five decades, should it try to continue to play the role of global policeman? The US spends more than 4 per cent of GDP a year on defence, roughly twice the global average. The Obama administration’s fiscal plans anticipate a peace dividend after withdrawals from wars in Iraq and Afghanistan. The Republican party has reasonably argued that it is unrealistic to expect this quiet to last. At the very least, if military expenditures continue to fall, it becomes more important to have the fiscal capacity to ramp them up in response to new threats. It is also worth noting that if the US were ever forced to surrender the mantle of world policeman to, say, China, foreigners may no longer have quite the same desire for its debt.
Another huge area of disagreement surrounds the question of what services should be provided by the federal government versus the states or the private sector. There is a lot of “low-hanging fruit” here. Productivity improvements in government services have been glacial compared with many other sectors of the economy. A visit to a primary school classroom in many US cities is the closest thing one can get to time travel. One idea that economists have been enamoured with for years is school vouchers but there is strong resistance from entrenched interests. How long will these same interests forestall online classes and computer-graded feedback, initially as a supplement for traditional education structures but eventually as a significant substitute. The fiscal implications are huge, as are the disagreements.
In contrast, infrastructure should be a place of common ground but again there is paralysis. Aside from funding priorities, there is a wide chasm between those who see union domination of infrastructure as key to ensuring high-paying jobs versus those who want infrastructure built, but at reasonable rates. There is the joke about the visiting Chinese group that asks their New York tour guide how long it will take to finish the Second Avenue subway. On being told two years, the Chinese translator hesitates before conveying the response and asks: “Wait a second, you mean two weeks, right?”
One of the US’s greatest assets is its ability to expand immigration without running into land or resource constraints anytime soon. But US immigration policy has long been dominated by emotion, not the cold-blooded, rational economic calculus many other countries apply. There are rigid visa restrictions aimed at keeping out terrorists, some of which remain incredibly counterproductive. Immigration policy has large implications for US debt and the sustainability of entitlements for the indigent population, yet the link seldom receives serious attention.
And of course, healthcare is the mother of all fiscal challenges, as costs rise and the population ages.
The idea that one should just ignore all these problems and apply crude Keynesian stimulus is a dangerous one. It matters a great deal how the government taxes and spends, not just how much. The US debt level is a constraint. A growing number of empirical studies, including my own joint work with Carmen Reinhart, suggest that the US has already reached a debt level that has been associated with slower growth in advanced countries. The fact interest rates are low today does not necessarily mean the US is an exception to this rule – take one look at stagnant Japan’s rates. The dollar’s reserve currency status buys America more room, but how much and for how long? A high debt burden is a problem precisely because it reduces a country’s capacity to deal with future shocks.
The US remains an incredible franchise with many remarkable strengths. The world’s overwhelming presumption is that Americans will find a path to budget sustainability. Nevertheless, it is hard for many in the US to escape the nagging feeling that just maybe this time we won’t. With more than $5tn of US Treasury debt, and memories of the huge inflation of the 1970s and default on gold clauses in the 1930s, foreigners would be right to worry a little.
The writer is professor of economics at Harvard University and the co-author of ‘This Time Is Different’