U.S. Debt and the French Connection

U.S. Debt and the French Connection

Rejecting austerity and falling into their old ways may ruin France and Greece. If we are not careful, America will follow suit.

To understand the domestic-policy lapse represented by President Obama’s refusal to embrace the recommendations of his own Simpson-Bowles Commission, one might look to Europe, where fiscal and economic woes are roiling politics ominously. The same will happen here, and soon, if the U.S. government doesn’t address its debt overhang with more force and effectiveness than the Europeans have managed to muster—or than Obama has managed to muster.

This warning was on display in France’s presidential elections Sunday, in which voters chose socialist François Hollande over incumbent conservative Nicolas Sarkozy and set the country upon a new course. The result can be seen as what happens when a country feels itself in a political bind emanating from an economic bind. Although Europe’s debt crisis did not emerge explicitly as the primary campaign issue, nearly all the major domestic issues that did emerge can be traced to that overarching fiscal emergency.

The French majority rejected the "austerity" policies fashioned by Sarkozy and German chancellor Angela Merkel to address the massive and rising public debt on the Continent, particularly in Europe’s southern-tier countries of Greece, Italy and Spain. The idea was that spending cuts were necessary to place these and other governments on a more solid fiscal footing in order to tame the debt monsters stalking Europe.

But this formula hasn’t been working. Austerity has constricted enterprise, thwarted economic growth and exacerbated the fiscal woes that were the policy’s targets. So now France has rejected that approach in favor of what are called "growth" policies.

And France is not alone. The weekend’s Greek elections roiled that nation’s political waters even more powerfully, slamming the ineffectual centrist parties that had dominated the country’s politics and boosting the standing of more extremist forces, including the Coalition of the Radical Left (or Syriza), which nearly tripled its share of the vote; the KKE Communist Party; and the neo-Nazi Golden Dawn Party.

 

Even Merkel’s own Christian Democrats suffered a serious setback in state elections in Schleswig-Holstein as increasing numbers of Germans there expressed discontent with her financial support for Greece and other financially strapped southern nations (largess that was extended in exchange for those countries adopting austerity policies).

These voters are not wrong in pummeling this austerity agenda. No debt-reduction plan can work if it is unconnected to growth measures. As economic consultant David M. Smick has noted, the European bureaucrats demanded the Greeks reduce their debt without offering reforms to encourage growth. The result is that Greece’s debt-to-GDP ratio, at 120 percent before the crisis, increased to 170 percent (in part because of a declining GDP).

 

So if austerity is under assault in Europe, what’s to replace it? In France, Hollande’s answer is his "growth" agenda, but this basically means more governmental spending of the kind that generated the country’s debt crisis in the first place. Debt is 90 percent of France’s GDP, and the country faces trillions of euros in unfunded pension and retiree health-care liabilities. Hollande also wants to boost the top tax rate to 75 percent to fund a government that currently accounts for 56 percent of GDP.

The political mood in Greece seems even more vehemently in favor of simply returning to the old ways, which rewarded citizens for not working and for enjoying the status of being a drag on the state. As the Wall Street Journal editorialized on Monday, "As for the rise of the extremist fringes [in Greece], this should serve as a warning of what happens in countries where mainstream parties fail."

What is likely to emerge as austerity’s counterpoint is an "inflation fix" of the kind touted constantly by The New York Times’s Paul Krugman—more governmental spending tied to greater monetary easing by the European Central Bank. No doubt Hollande and his counterparts in the southern countries will try to move boldly in that direction.

But it won’t work. It’s frivolous to think that these nations can address their debt problems through Keynesian spending designed to spur sufficient demand—and hence growth—to diminish the debt. Besides, Germany’s Merkel, whose nation must fund such policies, isn’t likely to bend easily to these initiatives or to accept inflationary policies by the central bank. Thus do we see prospects for a major rift in the politics of the European Union accompanied by further spiraling debt, further societal frustration and further lurches toward fringe politicians. It isn’t hyperbolic to suggest the future of the euro and the European Union itself could hang in the balance as this political drama unfolds.

Meanwhile, the crucial element of any solution gets ignored. Raghuram Rajan of the University of Chicago, writing in Foreign Affairs, tells us that "today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side." But the European debate between Merkel’s austerity and Hollande’s "growth" ignores this reality and calls forth no serious policy proposals designed to spur economic activity by lubricating the wheels of production.

America faces a danger that its fiscal debate will unfold along similar lines, with all the focus on simply cutting spending and increasing taxes (each incendiary to one party or the other) and with little or no attention paid to the kinds of initiatives that really spur growth (the only approach that could possibly stir a bipartisan exploration). America’s debt crisis isn’t as stark as Europe’s. But U.S. public debt exceeds 70 percent of the economy—up from just 40 percent in 2008. And it is rising fast toward the 90 percent level that normally begins to debilitate an economy.

Before it gets there, it would be nice to see President Obama bring forth the kind of presidential leadership that could inject some serious growth initiatives into the debate. And that’s where the Simpson-Bowles Commission comes in. Former Republican senator Alan Simpson and former White House chief of staff Erskine Bowles cochaired the presidentially established commission in 2010 and led it to a collection of proposals that both cut spending and increased taxation.

But it also recommended a major overhaul of the tax system designed to reduce rates while broadening the tax base through elimination of a vast array of tax preferences that now distort economic decision making and thwart economic expansion. There was much to criticize in the plan, but overall it formed the foundation for a governmental discussion on how the country can head off the debt tsunami in part by unleashing the power of economic growth.

Obama ignored it. Former Fed chairman Alan Greenspan said the other day that this was a serious error in judgment. "The worst mistake the president made was not embracing that vehicle right away," he told a meeting sponsored by Bloomberg. "It is the ideal vehicle."

It may or may not be the ideal vehicle, but it does contain the right mix of policy initiatives designed to address the debt overhang in purely fiscal terms while adding a component for spurring economic growth. And addressing the debt overhang is the country’s most pressing domestic imperative. To see what happens when it is ignored, we only have to look toward Europe.

Robert W. Merry is editor of The National Interest and the author of books on American history and foreign policy. His next book, Where They Stand: The American Presidents in the Eyes of Voters and Historians, is due out on June 26 from Simon & Schuster.

Image: Mat2057