From Italy to the US, utopia vs reality
By Martin Wolf
In the eurozone, the fiscal crisis is lapping on Italy’s shores. In the US, the administration declares it will run out of funding early next month if the debt ceiling is not raised. Far fewer Europeans than Americans believe public sector defaults are beneficial. But important Europeans share with Republicans the view that there are still worse outcomes. For reluctant Europeans, the eurozone must not be a “transfer union”. For recalcitrant Republicans, taxes must not be raised. Fiat justitia, et pereat mundus – let right be done even if the world perishes – is the motto.
The fiscal crises we see are a legacy of the west’s private and public sector debt binges of recent decades. As the McKinsey Global Institute tells us in an update of last year’s study of the aftermath of the credit bubble, this is an early stage of a painful process of deleveraging in several economies (see chart). “If history is a guide,” noted the 2010 report, “we would expect many years of debt reduction in specific sectors of some of the world’s largest economies, and this process will exert a significant drag on GDP growth.” So it is proving, with disappointment almost everywhere.
The link between private and public sector debt is intimate. In some countries, notably Greece, easy credit led to an upsurge in public sector borrowing. In others, notably Italy, it encouraged governments to relax attention to debt reduction: its primary fiscal budget (before interest) moved from a surplus of 6 per cent of gross domestic product in 1997, before joining the currency union, to 0.6 per cent in 2005. Elsewhere, the sudden end of private sector credit booms led directly to collapses in government revenue and surges in public spending: the US, UK, Spain and Ireland are examples.
Exploding fiscal deficits are mainly the result of collapses in activity and revenue rather than of bank bail-outs. But fiscal weakness then undermines the banks, partly because the latter hold large quantities of domestic public debt and partly because they rely on fiscal support. The private and public sectors are intertwined. The view of Republican hawks in the US and of German or Dutch hawks in Europe that the crisis has fiscal roots alone is wrong. Easy credit ends up in fiscal crises.
US evidence is striking. Compare the forecasts for fiscal years 2010, 2011 and 2012 in the 2008 and 2012 presidential budgets, the first under George W. Bush shortly before the crisis and the second under Barack Obama well after it (see chart). The 2011 deficit was forecast in 2008 to be a mere $54bn (0.3 per cent of GDP). But in the 2012 budget, it is forecast to be $1,645bn (10.9 per cent of GDP). 58 per cent of this rise is due to unexpectedly low revenue and only 42 per cent due to a surge in spending, both of these changes mostly due to the financial crisis, not the modest stimulus package (about 6 per cent of GDP).
The astonishing feature of the federal fiscal position is that revenues are forecast to be a mere 14.4 per cent of GDP in 2011, far below their postwar average of close to 18 per cent. Individual income tax is forecast to be a mere 6.3 per cent of GDP in 2011. This non-American cannot understand what the fuss is about: in 1988, at the end of Ronald Reagan’s term, receipts were 18.2 per cent of GDP. Tax revenue has to rise substantially if the deficit is to close.
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