By Simon Johnson
October 14, 2010 | New York Times
Simon Johnson, the former chief economist at the International Monetary Fund, is a co-author of "13 Bankers."
In most industrialized countries, attention is now shifting to some form of fiscal austerity — meaning the need to bring budget deficits under control.
In Britain, for example, an active debate is under way between those on the right of the political spectrum (who want more cuts sooner) and those to the left (who would rather delay cuts as much as possible). There is a similar discussion across the European continent, with the precise terms of the debate depending on which party was most profligate during the long boom of the 2000s.
The United States stands out as quite different. No one is yet seriously proposing to address our underlying budget problems. Certainly, some people consider themselves fiscal conservatives — some of the right and some of the left — but none can yet be taken seriously. The implications for our fiscal future are dire.
The background, of course, is that the United States budget was in relatively good shape at the end of the Clinton years (culminating in a surplus of 2.5 percent of gross domestic product in 2000), but it turned sharply into deficit during the George W. Bush era. The 2 percent deficit in 2006 perhaps did not look too bad, for example, but it was a remarkably poor performance given how well the economy was doing.
The notion that tax cuts would lead to productivity increases, bolstering growth and in turn fixing the budget, turned out to be completely illusory. In fact, the tax cuts encouraged consumption, leading to overspending at the national level (and reflected in a current account deficit that reached 6 percent of G.D.P., with a large increase in borrowing from foreigners by both the private sector and the government).
But what really busted the United States budget and pushed up our debt-to-G.D.P. ratio was the way the financial system amplified the housing-based boom-and-bust through 2008. While there were some "feel good" effects through the end of 2007, we then faced the worst recession since World War II.
Net government debt held by the private sector will increase to around 80 percent of G.D.P., from about 42 percent, as a direct result of the economic crisis — and the measures taken to prevent it from turning into another Great Depression.
The
Congressional Budget Office agrees that the increase in debt-to-G.D.P. from the crisis is about 40 percentage points. Treasury Secretary Timothy F. Geithner has
offered a very different view — and an overly narrow one — framed in terms of an assessment of only the Troubled Asset Relief Program: "The direct costs of the government's overall rescue strategy are likely to be less than 1 percent of G.D.P."
The increase in our budget deficit to 10 percent in 2009 and 2010 was primarily because of our automatic stabilizers; the government took in less revenue as tax receipts fell and paid people more in unemployment benefits. Only 17 percent of the increase in government debt (in the baseline budget of the Congressional Budget Office) is because of discretionary spending of any kind.
Think what you like of the fiscal stimulus — either the Bush 2008 version or the Obama 2009 effort: it is simply not the big-ticket item its critics make it out to be.
If you want to fix the United States budget, keeping the deficit under control and reducing government's debt, you must address the risk-seeking behavior of big banks. No fiscal strategy can be credible without addressing the major problem that brought us to this point.
Of course, you can make proposals that seek to cut spending and raise revenue — see, for example, the
recent effort by Bill Galston and Maya MacGuineas from the Committee for a Responsible Federal Budget. Some of their ideas are worth discussing — and they are right to put everything on the table (although, personally, I would err on the side of more comprehensive tax reform).
But the simple fact of the matter is that our fiscal position has been ruined by the behavior of big banks — and these banks are now free to make the same or larger mistakes as we head into the next credit cycle.
The unfortunate fact is that those who style themselves as fiscal conservatives largely stayed on the sidelines during the financial regulation debate. And the problem of too-big-to-fail was absolutely not addressed adequately either by the
Dodd-Frank legislation or the subsequent
Basel III framework (as The Financial Times reported this week).
There is no way to handle the failure of a global megabank, and the management of such banks know this and so do their creditors (as Gillian Tett noted in a trenchant Financial Times column). This amounts to carte blanche for further uncontrolled expansion of risk-taking.
In some sense, this is all water under the bridge — like it or not, the overhaul process for systemic risk is done, and achieved little. But in that case, any true fiscal conservative should recognize the risks posed by megabanks going forward and adjust their budget targets accordingly.
In particular, the commonly discussed target for our government debt-to-G.D.P. ratio of 60 percent seems unreasonably high, given the risks posed by our financial system. We should probably aim instead for a target of 20 percent or lower, as do the most responsible emerging markets in Asia or the Baltics.
Fiscal conservatives — and everyone else — will most likely ignore this advice. In that case, we'll soon face a major fiscal crisis in the United States, again as a direct result of financial sector irresponsibility. Then taxes will rise as Social Security benefits fall sharply, and unemployment increases beyond current levels.
