America Still Rules

To be credible, the administration would have to create a framework for fiscal discipline of the kind that does not exist in any shape or form now. That would mean setting public targets, endorsed by Congress, for various economic metrics. I'll leave it to the economists to decide which metrics should be used, but examples include the budget-deficit-to-GDP ratio, the national public debt to GDP, and debt service as a percentage of public spending. These ratios would have to show an improving trend over the next several years, even as spending for government-supported Social Security and health care (Medicare) increases for the 75 million–strong baby-boomer generation. For ex-ample, next year the budget deficit will be 13 percent of GDP, the highest since World War II. The goal should be for a reduction of 1 percent every year starting, say, in 2012, until it reaches 4 percent.

The only way such a system could be enacted is with substantial tax changes, probably in the form of a national sales tax that includes taxing gasoline at the pump (some of which should be rebated to low-income citizens to ease the burden on the poor). The U.S. will also need a major shift in the philosophy of who is eligible for Social Security and old-age medical benefits. This might include raising the age at which seniors can begin collecting Social Security, and reducing benefits for people with high incomes. These are extremely difficult measures, to say the least, and highly problematic politically. But if Washington doesn't do it, my prediction is that the markets—namely, those who hold U.S. bonds at home and especially abroad—will force such changes on the U.S. in a harsh, blunt way by demanding precipitously higher interest rates, tanking the currency, or both. The scene would be reminiscent of 1987, when the U.S. markets went into free fall as trade and budget deficits soared. The day after the Oct. 19 crash, Congress raced to enact meaningful budget restraints. Today, however, the deficits are relatively larger—government debt is 68 percent of the economy, compared with about 50 percent in 1987—and the degree of pain that creditors may impose could be much worse.

On the political front, the administration should continue engaging more broadly with all countries on the future of the global economy. In economic terms, it's not clear how much is accomplished at the meetings of the G7, G20, or G2 (the U.S. and China). But for the U.S. to lead, it must have followers. For that to happen, Uncle Sam must be a good listener. The political dimension of economic collaborations is not all that different from what goes on domestically. Stakeholders want to have a sense that their concerns are being heard and understood. The administration may need to augment its team with more distinguished high-level emissaries—perhaps drawn from the ranks of accomplished and experienced business leaders who are now conspicuously underrepresented in the upper echelons of the administration; Secretary Geithner cannot shoulder the burden alone. The administration must be careful, too, not to slide back into the habit of arrogant preaching that characterized so many of its predecessors, Democratic and Republican.

Finally, the next global financial sys-tem must still be designed. Despite two meetings of the G20, two meetings of the G8, and countless studies by international organizations, both in official and private sectors, the big issues are still on the table, including the disconnect between a global market and diverse national regulatory institutions, and the inherent weaknesses of international coordination. In fact, the tug of nationalism is growing, at the worst possible moment. Here are some of the issues that are being hotly debated but on which there is no consensus at all: Who should regulate big global financial institutions that affect many countries, and who is responsible for managing their restructuring? How can they oversee complex derivatives? How much capital should financial institutions hold as a cushion against losses in a roller-coaster world economy, and how should they be compelled to do it? Who is orchestrating the bevy of (weak) global institutions—the IMF, the Bank for International Settlements, the Financial Stability Forum? If Team Obama were to take the lead in dealing with these kinds of issues, it would go a long way toward ensuring an extended era for American-style capitalism, which not too long ago was given up for dead.

The bottom line is that America can lead the global recovery politically without having to do all the heavy lifting economically. To continue to do this, it will have to make excruciating decisions at home and extend itself diplomatically as no administration has in many decades. Weighed down by debt and deficits for years to come, the U.S. and the world could do worse than to adapt to this new reality.

Garten is the Juan Trippe Professor of International Trade and Finance at the Yale School of Management. He was previously Undersecretary of Commerce in the Clinton Administration and a Managing Director of The Blackstone Group.

© 2009