from Global Economy in Crisis

Confronting the Debt Threat

Some of Obama’s budget proposals are sound policy, but congressional gridlock and faster economic reforms in China and Europe could jeopardize U.S. competitiveness, says editor Ryan Avent.

February 2, 2010

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

U.S. President Barack Obama’s 2011 budget aims to tame the budget deficit while stimulating economic growth. But his proposals--which include cutting 120 government programs and creating tax incentives to boost employment--have been criticized by Republicans and some economists as too meager to avert a looming debt crisis.

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Ryan Avent, economics editor for the, says U.S. debt levels--moderate compared to those of many developed countries--will not become unwieldy for roughly ten years. In the short term, he says, Obama should focus on job-creating and revenue-generating investments that help decrease debts long term.

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Budget, Debt, and Deficits

United States

The biggest problem is not Obama’s overall debt-reduction strategy, says Avent, but constraints he faces in Congress on stronger stimulus measures. Those constraints put the United States at a disadvantage to faster-moving economies like China, which acts more authoritatively, and Europe, "where they have a generally more progressive attitude" on issues such as spending on the environment. Still, Avent notes, the fact that foreign investors continue to see the U.S. dollar as a safe haven buys the government time to address the debt issue before borrowing rates rise.

Could you put the United States’ current deficit levels in perspective--historically and compared to other countries?

Currently, we’re looking at deficit levels at around 10 percent of gross domestic product, and that for the United States is quite high, relative to the post-war levels. They haven’t really been that high since the Second World War. Those levels are expected to come down in the next few years. As the economy comes back, we’re going to get more in tax revenues, we’re going to be spending less on things like unemployment insurance. So just without doing anything, those levels will probably come down to around 5 percent of GDP.

The United States hasn’t had any trouble financing its debt so far, and if you compare U.S. debt levels to some other developed countries, then we’re doing quite well.

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But the broader problem is that in the meantime we will have added quite a lot to debt, and then after 2015, the deficits are expected to grow again, primarily based on increases in spending on Social Security and Medicare and Medicaid. Now things aren’t as bad as some are suggesting. The United States hasn’t had any trouble financing its debt so far, and if you compare U.S. debt levels to some other developed countries, then we’re doing quite well. There are countries like Japan, or we hear a lot about Greece and Spain, which are having some serious troubles in capital markets funding their debt. They’re looking at debt ratios over 100 percent of GDP. So they owe more than they produce in a year.

We’re not there yet. But by the end of the ten-year budget window, if current policy prevails, we’ll be looking at debt at around 100 percent of GDP. There is a concern that at that point interest rates will begin to rise and there will be some question about whether the United States is going to be able to handle the debt without taking drastic steps that will really cause pain for the economy.

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How does the U.S. debt compare to that of countries like China, Britain, or Germany, which are fairly fiscally conservative?

Those are three interesting cases. In Britain, debt levels aren’t as bad as in some of the countries that are on the southern periphery of Europe. But capital markets are starting to bristle a little, and the government is concerned. So you’ve heard a lot of talk from the Tories about reining in spending, and both parties are trying to take on a mantle of fiscal conservatism. In Germany, they are actually in pretty good shape. They tend to be pretty good stewards of their budget debt. And China actually is actually in a pretty strong position and had plenty of fiscal room to provide a big fiscal boost during the recession, so much so that they are now sort of thinking about pulling back on that. They are growing at over 10 percent a year again, and inflation is becoming a problem. Around the world, there are two dynamics in place: the expected rate of economic growth, and the fiscal picture. If you have a bad fiscal picture but you are growing very rapidly, debt isn’t as big a concern. If you are a country like Britain or Greece, where you have a bad fiscal position and expected growth rates are modest to slow, then you are going to have a very difficult time growing your way out of debt, and you are going to have some hard cuts.

What is President Obama’s take on growing the U.S. out of debt, and will his strategy work?

What he has generally said is that in a recession the government needs to step on the accelerator and provide a boost to the economy. That’s what they did with the recovery package that passed last spring. They are trying to boost that again with a new jobs package. But then you need to sort of pivot at some point to taking care of the longer-run budget issue, or as interest rates rise they’ll choke off the economy and send you back into recession. The danger there is that if you make that shift too quickly, if you raise taxes too quickly and cut spending too quickly, then you will damage yourself trying to fix the budget problem. So there is a fine line to be walked, and Obama is trying to do that. The problem he is having is that he doesn’t have the freedom to make the policies he would probably like to have [because] everything has to go through Congress. I think Christina Romer [chair of the Obama administration’s Council of Economic Advisers] would recommend a much larger fiscal package right now, and then much more serious cuts five or ten years down the road. But those cuts aren’t going to be stomached by Congress, and neither is a big stimulus. So what he has done is taken very modest steps that are going to leave a lot of people unsatisfied.

Obama proposed about $15 billion a year for renewable energy programs, $650 billion for a carbon reduction program, and increased spending on education. Where would those put the U.S. economy in relation to countries like China, which is already ahead on green energy?

[I]t’s going to be very difficult to achieve the potential we can achieve, [which] is not going to be a problem for countries like China, where they don’t have these roadblocks in the rule-making process.

They are positive steps, if they can pass the congressional hurdle. What Obama has recognized is that by putting relatively small amounts of money into education and into energy research, there can be some potentially big gains in innovation that will eventually lead to some business investment and provide the foundation for more rapid growth over the medium term. Things are quite promising there. We still have a very highly educated workforce relative to a lot of the world. There are still a lot of talented workers elsewhere who want to work here, so I don’t think we need to worry about losing our competitive advantage.

But we have these constraints that we can’t take steps to price carbon, we can’t take steps to sort of eliminate fossil fuel subsidies for example. That’s something that he proposed last year that didn’t happen; he proposed it again this year, and it probably won’t happen again this year. Because we are unable to make these changes we need to make, it’s going to be very difficult to achieve the potential we can achieve. That is not going to be a problem for countries like China, where they don’t have these roadblocks in the rule-making process, or in Europe, where they have a generally more progressive attitude.

On Medicare, Medicaid, and Social Security--the biggest drags on U.S. deficits--do we need to decrease services, or will addressing cost-effectiveness suffice?

It’s not going to be enough to just cut what we are doing with these programs. That has to be part of it, but unless you do something about the underlying cost, then you are just shifting those expenses onto private individuals and you still have a crisis situation. One of the big goals with health reforms was to try to control growth in cost. I don’t know that they achieved that. Those are some of the really tough choices of figuring out what services you need to deny people based on cost-effectiveness. Those are not decisions that people are happy about. So what you see is both parties looking to this commission idea to make some of these difficult decisions. But eventually someone’s going to have to take a vote, and I don’t know that we’ll reach that point until we face the edge of the cliff, the point where we say: "If we don’t address this, we’re going to face debt downgrades and high interest rates that choke off growth." We’re not at that crisis point yet.

What would push the United States to that point when foreign investors lose confidence in its sovereign debt? Why aren’t yields on government-issued debt reflecting that yet?

We sort of were getting to that point in the early ’90s. Then there was a deal to cut the budget deficit, and we returned to surplus eventually. We’re not there yet. Part of it has been that the dollar is still seen as a refuge, and so long as there is uncertainty in global markets, there will be many people looking for the safety associated with the dollar, which keeps debt relatively cheap. It has also helped that the Federal Reserve, in looking to boost the economy, has been making a lot of Treasury purchases. But this isn’t going to last. As other emerging markets become more attractive and as markets continue to return to normal, people will be less interested in holding onto dollars as an insurance policy. Then investors are going to take a hard look at whether there is a credible plan to address [the debt]. So it is a matter of time. We have a ten-year window to get spending under control and revenues up to where need to be. After 2020, the rates of deficit and debt growth are going to take off.

When it comes to lenders that are also economic competitors, like China, how should the administration balance the tradeoff between tackling debt versus spending on economic growth?

One key part of it has to be investment. If you spend money now on programs that boost the economy but also lay the groundwork for future growth, then you kill two birds with one stone. And that’s things like funding for education, funding for infrastructure, and for energy research. [Obama] has begun to push those things. Obviously we could do more. There’s a modest proposal for a new transportation bill that would be $450 billion. That would double the last transportation bill, and that would still leave a lot of needs unmet.

It’s important to get the labor market back on a stronger footing. We should be doing more to boost hiring this year and next year, because without unemployment near normal levels, we’re not going to be able to take strong steps to address the budget. Then you need to have a credible framework for cutting the budget deficit over the long term. That has to involve new revenue streams, and there has to be a serious discussion about how we can get some additional tax revenues.


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