The real cause of the US debt crisis? Slow growth
The pantomime political debate about the debt ceiling is distracting attention from the parlous state of the productive economy.
So it seems that a deal has finally been thrashed out in the congressional battle over raising the US government’s ‘debt ceiling’. But President Obama and the Democrats will not be doing much in the way of celebrating. On virtually everything, from accepting spending cuts to a refusal to raise taxes, Obama has caved in. ‘A sugar-coated satan sandwich’, was the verdict of Democratic congressman Emanuel Cleaver. Not that the Republicans have much to savour in their much trumpeted victory. The spending cuts amount to just $0.2 trillion a year on average out of an annual budget of $3.7 trillion, a cutback that will not make a significant dent in America’s national debt.
This rather insubstantial outcome, after all the bluster and brinkmanship of the Republicans and the Democrats, has done little but further damage the reputation of the US’s political class, both in the US and abroad. More importantly, the past few weeks of partisan bickering have been a huge distraction from a discussion of the background as to why the US government’s debt has spiralled upwards: the lack of economic growth.
If the economy had been in good shape, tax revenues would have been higher and social-security payments would have been lower, while there would have been no need to spend hundreds of billions of dollars on stimulus measures. The result would have been government finances in better shape than they are today. The bad news is that the latest gross domestic product (GDP) data show the US economy’s recovery has already come to a virtual stop.
According to the new figures, GDP grew at an annual rate of less than one per cent in the first half of 2011. Revised government data show that the recession was deeper – and the recovery has been weaker – than previously thought. GDP grew by 0.4 per cent in the first quarter of 2011 and by 1.3 per cent in the second quarter - and given that the first quarter’s number was revised downwards substantially, there’s a good chance that the second quarter’s will be too.
The financial crash of 2008, and the subsequent sharp drop in economic output, effectively showed that the model of growth for the prior two decades was no longer sustainable. This model was based on consumer spending, government spending and lots of credit - both private and public. Stagnation in productive industries was ignored as the economy relied on these other sources of growth. A credit-heavy economy meant that the crisis would take the form of a financial crash, but all the focus on finance concealed the roots of the problem: a lack of profitability in productive areas.
The crash and recession thus posed a challenge to this growth model. But, upon entering office in early 2009, the Obama administration did not meet this challenge and seek to put the economy on a different footing. Instead, the government’s stimulus package was an attempt to resurrect the house of cards: propping up consumer spending (for example, ‘cash for clunkers’ – that is, trading in old cars) and the financial sector (for example, the TARP bailout for the banks and other measures).
The latest data indicate how this approach has reached its limits, just two years later. Consumer spending, no longer receiving artificial stimulation, has been flat. This would not matter so much if consumer spending did not still represent the largest segment of the economy. Business investment and exports are up, but they are too small relative to consumer spending to make a significant difference overall. The US is paying the price for not restructuring its economy away from consumption.
Similarly, the latest data also show that government spending is becoming a drag on growth. While there was much attention on the 2009 federal government stimulus program, total government spending was flat, because the federal spending only offset the cutbacks at the state and local levels. But now that the federal programme is coming to an end, fiscal policy is going to be restrictive. Again, this wouldn’t be such a problem if the US economy did not rely so much on government spending in the absence of widespread dynamism.
It’s now the case that the US economy is teetering on the edge of a double-dip recession, or even a depression. And if it does happen, the political class is unlikely to have the same counter-crisis mechanisms it used in 2008 and 2009 at its disposal. Monetary policy is stretched: interest rates are near zero, and Federal Reserve quantitative easing – effectively, ‘printing money’ – is at its limits. And fiscal policy is also stretched: after the 2009 stimulus did not appear to work, and the resulting high level of deficit, there is no political appetite or will for further spending.
While a government default has been avoided, the economy has been revealed to be weak. Even if a default had occurred, any resulting depression would not be because of the default itself, but because the economy is already vulnerable, and there is still a serious possibility of a major contraction in economic output.
A variety of factors - economic and political - have combined to create this current fix. In particular, in the US (and Europe) we are paying the price for a ‘muddling through’ approach and a failure to face up to structural causes of the 2008 crisis. The politicians have tried to avoid hard choices, but unaddressed issues have a way of coming back again and again in new forms.
Sean Collins is a writer based in New York. Visit his blog, The American Situation, here.