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Confronting the Debt Threat
Interviewee: Ryan Avent, Economics Editor, Economist.com
Interviewer: Roya Wolverson, Staff Writer, CFR.org
February 3, 2010
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.
Ryan Avent, economics editor for the Economist.com, 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.
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.
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.
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.
How to Destroy American Jobs
Author: Matthew J. Slaughter, Adjunct Senior Fellow for Business and Globalization
February 3, 2010
Wall Street Journal
Deep in the president's budget released Monday-in Table S-8 on page 161-appear a set of proposals headed "Reform U.S. International Tax System." If these proposals are enacted, U.S.-based multinational firms will face $122.2 billion in tax increases over the next decade. This is a natural follow-up to President Obama's sweeping plan announced last May entitled "Leveling the Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas."
The fundamental assumption behind these proposals is that U.S. multinationals expand abroad only to "export" jobs out of the country. Thus, taxing their foreign operations more would boost tax revenues here and create desperately needed U.S. jobs.
This is simply wrong. These tax increases would not create American jobs, they would destroy them.
Academic research, including most recently by Harvard's Mihir Desai and Fritz Foley and University of Michigan's James Hines, has consistently found that expansion abroad by U.S. multinationals tends to support jobs based in the U.S. More investment and employment abroad is strongly associated with more investment and employment in American parent companies.
When parent firms based in the U.S. hire workers in their foreign affiliates, the skills and occupations of these workers are often complementary; they aren't substitutes. More hiring abroad stimulates more U.S. hiring. For example, as Wal-Mart has opened stores abroad, it has created hundreds of U.S. jobs for workers to coordinate the distribution of goods world-wide. The expansion of these foreign affiliates-whether to serve foreign customers, or to save costs-also expands the overall scale of multinationals.
Expanding abroad also allows firms to refine their scope of activities. For example, exporting routine production means that employees in the U.S. can focus on higher value-added tasks such as R&D, marketing and general management.
The total impact of this process is much richer than an overly simplistic story of exporting jobs. But the ultimate proof lies in the empirical evidence.
Consider total employment spanning 1988 through 2007 (the most recent year of data available from the U.S. Bureau of Economic Analysis). Over that time, employment in affiliates rose by 5.3 million-to 11.7 million from 6.4 million. Over that same period, employment in U.S. parent companies increased by nearly as much-4.3 million-to 22 million from 17.7 million. Indeed, research repeatedly shows that foreign-affiliate expansion tends to expand U.S. parent activity.
For many global firms there is no inherent substitutability between foreign and U.S. operations. Rather, there is an inherent complementarity. For example, even as IBM has been expanding abroad, last year it announced the location of a new service-delivery center in Dubuque, Iowa, where the company expects to create 1,300 new jobs and invest more than $800 million over the next 10 years.
This is true in manufacturing, too. Procter & Gamble calculates that one in five of its U.S. jobs-and two in five in Ohio-depend directly on its global business.
Compared to the rest of the world, U.S. corporate tax rates are sky-high and our system of corporate taxation is highly complex. The current U.S. federal statutory corporate tax rate of 35% is the highest among all 30 Organization for Economic Cooperation and Development countries, far above the OECD average of about 23%. Raise the international tax burden on U.S. multinationals by limiting foreign-tax credits, for example, and you will further reduce their ability to compete abroad. This, in turn, will reduce employment and investment in U.S parent companies.
Making it harder for U.S. multinationals to create U.S. jobs would be bad policy at any time. But it would be especially detrimental now because of how dramatically the private sector of the U.S. economy has contracted in the face of this recession.
Since the slowdown began in December 2007, private-sector payrolls have fallen precipitously. Today there are 2.4 million fewer private-sector jobs than 10 years ago. Moreover, in all four quarters of 2009, gross private-sector investment fell so low that it did not even cover depreciation. For the first time since at least 1947, the U.S. private capital stock shrank throughout an entire year.
The major policy challenge facing the U.S. today is not just to create jobs, but to create high-paying private-sector jobs linked to investment and trade.
Which firms can create these jobs? U.S.-based multinationals. They-along with similarly performing U.S. affiliates of foreign-based multinationals-have long been among the strongest companies in the U.S. economy.
These two groups of firms accounted for the majority of the post-1995 acceleration in U.S. productivity growth, the foundation of rising standards of living for everyone. They tend to create high-paying jobs-27.5 million in 2007.
Consider that in 2007, the average compensation per worker in these multinational firms was $65,248-about 20% above the average for all other jobs in the U.S. economy. These firms undertook $665.5 billion in capital investment, which constituted 40.6% of all private-sector nonresidential investment. They exported $731 billion in goods, 62.7% of all U.S. goods exports. And these firms also conducted $240.2 billion in research and development, a remarkable 89.2% of all U.S. private-sector R&D.
To climb out of the recession, we need to create millions of the kinds of jobs that U.S. multinationals tend to create. Economic policy on all fronts should be encouraging job growth by these firms. The proposed international-tax reforms do precisely the opposite.
International trade and investment policies are especially important to these firms. Passing the already negotiated trade agreements with Colombia, Panama and South Korea-and stopping trade barriers against key partners like China-are critical to increasing U.S. exports and related investment and jobs. If we are going to achieve the president's State of the Union aspiration to "double our exports over the next five years," we need to start now.
To help close looming fiscal deficits, the nation needs spending restraint and pro-growth sources of tax revenue. But Monday's proposals are far from that. These tax increases would destroy jobs in some of America's most dynamic companies.
Deficit Balloons Into National-Security Threat
• By GERALD F. SEIB
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The federal budget deficit has long since graduated from nuisance to headache to pressing national concern. Now, however, it has become so large and persistent that it is time to start thinking of it as something else entirely: a national-security threat.
The budget plan released Monday by the Obama administration illustrates why this escalation is warranted. The numbers are mind-numbing: a $1.6 trillion deficit this year, $1.3 trillion next year, $8.5 trillion for the next 10 years combined—and that assumes Congress enacts President Barack Obama's proposals to start bringing it down, and that the proposals work.
These numbers are often discussed as an economic and domestic problem. But it's time to start thinking of the ramifications for America's ability to continue playing its traditional global role.
The U.S. government this year will borrow one of every three dollars it spends, with many of those funds coming from foreign countries. That weakens America's standing and its freedom to act; strengthens China and other world powers including cash-rich oil producers; puts long-term defense spending at risk; undermines the power of the American system as a model for developing countries; and reduces the aura of power that has been a great intangible asset for presidents for more than a century.
"We've reached a point now where there's an intimate link between our solvency and our national security," says Richard Haass, president of the Council on Foreign Relations and a senior national-security adviser in both the first and second Bush presidencies. "What's so discouraging is that our domestic politics don't seem to be up to the challenge. And the whole world is watching."
In the 21st-century world order, the classic, narrow definition of national-security threats already has expanded in ways that make traditional foreign-policy thinking antiquated. The list of American security concerns now includes dependence on foreign oil and global warming, for example.
Consider just four of the ways that budget deficits also threaten American's national security:
• They make America vulnerable to foreign pressures.
The U.S. has about $7.5 trillion in accumulated debt held by the public, about half of that in the hands of investors abroad.
Aside from the fact that each American next year will chip in more than $800 just to pay interest on this debt, that situation means America's government is dependent on the largesse of foreign creditors and subject to the whims of international financial markets. A foreign government, through the actions of its central bank, could put pressure on the U.S. in a way its military never could. Even under a more benign scenario, a debt-ridden U.S. is vulnerable to a run on the American dollar that begins abroad.
WSJ's Jerry Seib previews his column in tomorrow's Journal in which he writes the federal budget deficit has become so large, it's time consider it a natural-security threat. Plus, the News Hub provides a February market outlook and also discusses the findings of a new autism study.
Either way, Mr. Haass says, "it reduces our independence."
• Chinese power is growing as a result.
A lot of the deficit is being financed by China, which is selling the U.S. many billions of dollars of manufactured goods, then lending the accumulated dollars back to the U.S. The IOUs are stacking up in Beijing.
So far this has been a mutually beneficial arrangement, but it is slowly increasing Chinese leverage over American consumers and the American government. At some point, the U.S. may have to bend its policies before either an implicit or explicit Chinese threat to stop the merry-go-round.
Just this weekend, for example, the U.S. angered China by agreeing to sell Taiwan $6.4 billion in arms. At some point, will the U.S. face economic servitude to China that would make such a policy decision impossible?
• Long-term national-security budgets are put at risk.
This year, thanks in some measure to continuing high costs from wars in Iraq and Afghanistan, the U.S. will spend a once-unthinkable $688 billion on defense. (Before the Sept. 11, 2001 attacks, by contrast, the figure was closer to $300 billion.)
Staggering as the defense outlays are, the deficit is twice as large. The much smaller budgets for the rest of America's international operations—diplomacy, assistance for friendly nations—are dwarfed even more dramatically by the deficit.
These national-security budgets have been largely sacrosanct in the era of terrorism. But unless the deficit arc changes, at some point they will come under pressure for cuts.
• The American model is being undermined before the rest of the world.
This is the great intangible impact of yawning budget deficits. The image of an invincible America had two large effects over the last century or so. First, it made other countries listen when Washington talked. And second, it often—not always, of course, but often—made other peoples and leaders yearn to be like America.
Sometimes that produced jealousy and resentment among leaders, but often it drew to the top of foreign lands leaders who admired the U.S. and wanted their countries to emulate it. Such leaders are good allies.
The Obama administration has pledged to create a bipartisan commission charged with balancing the budget, except for interest payments, by 2015. The damage deficits can do to America's world standing is a good reason to hope the commission works.
Write to Gerald F. Seib at jerry.seib@wsj.com
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Mark Wilson / Getty Images Obama’s budget won’t get America out of its fiscal hole. We need targeted spending cuts and tax increases—and both parties to go against their bases. Just like Canada.
To understand the fiscal catastrophe that awaits the United States, consider a single number from Monday’s budget proposal by President Obama: $700 billion. That is the revenue windfall to the Treasury over the next decade if Congress allows the Bush tax cuts for the wealthy to expire, as Obama wants. Yet by 2020 that entire amount will be swallowed up in a single year just making the additional interest payments due on the accumulating federal debt.
As bad as the budget news has been for close to a decade, it has become seriously worse. That is because, while the headlines will focus on the annual deficits (a record $1.6 trillion is the 2010 projection), budget shortfalls cumulate. This year’s budget must pay off the interest on last year’s debts and all the ones that came before. As long as deficits continue, the burden grows each year. A decade from now, even under some pretty rosy assumptions about economic growth, interest on the accumulated debt will be the third-largest budget item at more than $900 billion a year, only slightly less than the costs of Social Security and Medicare. For any country, that is a road to ruin—or in the antiseptic language of the budget documents, “the fiscal position is not sustainable in the long run without future policy changes.”
Canada too stumbled through years of half-measures and political recrimination before its leaders finally mustered the vision and political courage to do what was needed.
There is no easy way out of such a budgetary death spiral, but Democrats and Republicans would do well to take a careful look at what happened north of the border, in Canada. In the 1990s, after running more than two decades of budget deficits that had resulted in 35 cents of every dollar in revenue going to interest payments, the Canadian political elite finally got scared. It pushed through a series of tax increases and spending cuts that managed to bring the federal government’s budget back into surplus, setting off a virtuous spiral of declining debt that lasted until the 2008-09 recession.
How did such a turnaround take place? There are at least three lessons for the United States, though none will be easy to heed. First, both political parties embraced measures that were anathema to their political base. The Conservative government in 1990 pushed through a highly unpopular 7 percent tax on all goods and services, and was rewarded by the public with the worst electoral defeat in its history. Then the Liberals in 1994 launched a comprehensive review of every government program, resulting in a 10 percent absolute cut in government expenditures that pushed program spending in real terms down to levels not seen since 1950. Such drastic cuts infuriated public-sector unions and other core Liberal constituencies.
Secondly, Canada decided that across-the-board spending cuts, such as the Obama administration’s proposed freeze on discretionary, non-security spending, were not the way to go. As one of the architects of Canada’s budget cuts later argued, such mindless even-handedness only erodes public confidence in the government’s ability to make choices among priorities. One virtue of the Obama administration’s budget proposal is that new, discretionary spending is concentrated on things that actually promise a future payoff in stronger economic growth—such as education, research and development and infrastructure. The same intelligent priorities are needed in deciding what to cut.
Third, timing is everything. The Obama administration rightly argues that slashing the budget during a fragile recovery could throw the economy back into recession. That is why it proposes holding off even modest restraint measures until the economy is on firmer ground. Canada was lucky that its deepest cuts were implemented at an almost ideal time, after its economy had emerged from recession and exports were booming because of the weak Canadian dollar and strong U.S. growth. That resulted in a revenue surge that brought Canada’s budget into balance far more quickly than even the most optimistic had predicted.
Can the United States pull off a similar miracle? At the moment, with Congress unable even to agree to set up a bipartisan commission to deliberate on how the budget might eventually be balanced, it’s hard to see how. But Canada too stumbled through years of half-measures and political recrimination before its leaders finally mustered the vision and political courage to do what was needed. Surely the United States is capable of the same.
Edward Alden is the Bernard L. Schwartz senior fellow at the Council on Foreign Relations. He was previously bureau chief for the Financial Times in Washington and Toronto.