To judge by media coverage, President Obama’s whistle-stop European tour was largely recreational. In Dublin he reenacted the time-honored tradition of discovering his Irish roots. In London he took part in what felt like Royal Wedding: The Sequel.
Meanwhile, in Washington, business went on as usual. The government continued borrowing money despite having breached its legal debt ceiling. Senate Democrats voted down Paul Ryan’s plan to reduce the cost of Medicare, despite having no credible plan of their own to stabilize the debt.
Yet Obama’s travels could have been a timely opportunity to learn from Europe’s fiscal mistakes.
To American commentators, notably New York Times columnist Paul Krugman, the lesson is clear. “In Europe,” he wrote last week, “the pain caucus has been in control for more than a year, insisting that sound money and balanced budgets are the answer … [But] Europe’s troubled debtor nations are … suffering further economic decline thanks to those austerity programs.” Elsewhere, Krugman has repeatedly badmouthed the British government for trying to cut its deficit.
It’s certainly true that the economies of Greece, Ireland, and Portugal—the three countries committed to austerity programs as conditions for European and International Monetary Fund bailouts—have shrunk over the past year. The unemployment rate is above 10 percent in all three. Meanwhile, the U.K. economy is growing sluggishly. But to infer from this that the United States can postpone serious attempts at fiscal stabilization would be completely wrong—and deeply dangerous.
The point is that Greece & Co. are in trouble because of excessive borrowing. Between 1999 and 2010 the structural deficit of the Greek government rose from 2 percent of gross domestic product to nearly 18 percent. Ireland went from surplus to minus 11 percent. Portugal was little better. The result was a debt explosion. The net government debt of Greece, the worst offender, soared from 76 percent of GDP to 142 percent last year.
As it became clear that there was no automatic mechanism to transfer funds from the relatively frugal European core to the profligate periphery, bond investors started to fear defaults. They dumped the debt, driving up the yield on Greek 10-year bonds—and hence the interest rate on new borrowing—to 17 percent. That simply made matters worse, necessitating ever more desperate spending cuts and tax hikes to avoid national bankruptcy.
The British story is different. Starting in a very similar fiscal hole—the structural deficit was 8 percent of GDP in 2009 and the debt–GDP ratio had doubled in seven years—the new Tory-led government acted preemptively, announcing deep budget cuts before the financial markets freaked out. As a result, Britain’s borrowing costs have actually come down.
Members of the Deficits Forever club are intellectually lazy when they assert that the U.K. economy is growing slowly because austerity doesn’t work, implying that things would be better had the spending binge continued. Maybe. But maybe not. A responsible politician wouldn’t take the gamble because the costs of being wrong are too high. Just ask the Greeks.
The real lessons for the United States are clear. Those who run up debt in good times can borrow only so much more when a recession strikes. And heavily indebted governments postpone fiscal stabilization at their peril. If you wait to reform until the bond market calls time, you are—to use a technical term from economics—screwed.
The best option is, of course, to be Switzerland, a country strangely ignored by Krugman. The Swiss have run a prudent fiscal policy throughout the economic crisis. They have had a structural surplus in each of the past five years. Their net debt is actually lower today than it was in 2005. And guess what? In 2009 their economy suffered the smallest contraction in Europe, with unemployment today below 4 percent. As for sound money, the Swiss franc is up 95 percent against the dollar since 2000.
Too bad American presidents never visit Switzerland. But I guess they can’t afford to.