U.S. `Fiscal Hawks' Mimic France: Peter Boone and Simon Johnson
The sharp budget cuts announced in the U.K. last month have people asking: could the U.S. soon take similar steps?
The two countries share some key problems, including the aftermath of a housing bust, overreliance on high-risk financial services, and government debt levels approaching the danger zone. Self-proclaimed fiscal conservatives also are likely to make a strong showing in midterm elections.
But there is a world of difference between the nations’ fiscal situations. The British, who are front-loading their cuts and may be overdoing it, are explicitly recognizing the extreme damage and future dangers to society inherent in their banks.
In contrast, our fiscal conservatives are much more French- like than British. Like President Nicolas Sarkozy, we have some politicians willing to make a fuss about tinkering around the cosmetic edges of our persistent deficits, but no one is ready to address our core issue: the U.S. financial system blew itself up, leading debt relative to gross domestic product to soar by 40 percentage points, and now is poised to do the exact same thing (or worse) again.
The macroeconomic trajectory in the U.K. is undeniably bad. The budget deficit was 11.5 percent of gross domestic product last year, with general government debt rising from 44 percent of GDP in 2007 to 80 percent in 2010. The heart of the country’s vulnerability lies with what used to be thought of as an advantage -- London’s status as a financial center.
British banks became large relative to the economy, mostly because of financial globalization, and then collapsed; total assets reached more than six times GDP and the largest bank, Royal Bank of Scotland, had a balance sheet that was almost 1.5 times the size of the economy. (In Iceland, a country completely ruined by its banks, financial sector assets peaked at around 12 times GDP.)
The bust after their disastrous bets on U.S. and U.K. real estate pushed the country into deep recession and increased the budget deficit as tax revenue fell and government spending increased, partly driven by unemployment insurance payments.
At some level, the electorate and political elite get this. Britain’s coalition government isn’t just cutting the budget deficit; it is also conducting a far-reaching review aimed to reform big banks and end the dangerous boom-bust-bailout cycle. Even the Bank of England seems to be strongly on the side of centrist reformers now in power.
This fiscal adjustment will be painful; a right-leaning cabinet has no qualms about pushing the costs of fiscal adjustment onto relatively poor people.
But the framing of this choice has been handled with admirable cynicism. If the British stick with their previous path of budget deficits and the world doesn’t get better, the continued buildup of debt will lead to a major calamity. If so, the U.K. would face a crisis, forcing even more drastic budget cuts at an ugly time. Guess who would pay for that?
Since the U.K. isn’t facing an immediate fiscal crisis, it is acting in a preemptive manner.
In contrast, what do we see in the U.S. political debate? Prevarication. The Obama administration, the Federal Reserve, and the Republican Party are curiously silent on measures that would really reduce the political power of our largest banks and ensure that creditors and shareholders -- not taxpayers -- bear the costs when global megabanks fail again.
People who call themselves fiscal conservatives propose either raising taxes or cutting non-security discretionary spending -- actions that are trivial relative to the scale of deficits. This is no surprise; the U.S. can borrow at near- record low interest rates.
Parallels With France
Americans like to think of themselves as very un-French, but the U.S. has exactly the same problem as France: entrenched interests that block any discussion of real reform.
In France, it’s the unions protesting any adjustment to pensions. In the U.S., it’s powerful and far less visible corporate interests that fended off any attempt to make banking sounder -- the financial industry lobby essentially defeated all attempts to make big banks smaller or substantially safer.
France suffers from a complete lack of social recognition that tough measures probably need to be taken. Its budget deficit is 8 percent of GDP, its debt-to-GDP ratio is 82 percent. Its society is aging, putting more pressure on the retirement system. The U.S. is in very similar shape -- with the most ironic difference being that big banks have less political power and thus pose less danger in France.
Most likely France and the U.S. will muddle through until investors grow tired of the risk or the banks blow themselves up again -- or both. Then the question becomes: who bears the cost of the necessary fiscal adjustment?
(Peter Boone, a research associate at the London School of Economics’ Center for Economic Performance, is a principal in Salute Capital Management Ltd. Simon Johnson, a professor at Massachusetts Institute of Technology’s Sloan School of Management and former chief economist of the International Monetary Fund, is co-author of “13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.” The opinions expressed are their own.)
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