US economic folly should worry us all
In 2001, President Bush misled the American people. He said that a tax cut that was not designed to stimulate the economy would stimulate it.
But it did not.
He told Americans that the large surpluses that were part of President Clinton’s legacy meant the US could afford to cut taxes massively. Wrong again. He did not warn Americans how dubious such estimates can be.
This year President Bush again misled the American people about the economy. Weeks after persuading Congress to pass another tax cut - in some ways even more inequitable than the first - his administration revealed how bad the fiscal position had become. The $230bn surplus inherited from Clinton had turned into a $450bn deficit.
Now, after handing billions to rich Americans through tax cuts, the Bush administration is passing the hat around, asking for contributions from other countries to help to pay for the Iraq war. Even setting aside other dubious aspects of Bush’s Iraq policy, the conjunction of misguided giveaways to America’s richest people with an international US begging bowl is hardly likely to evoke an outpouring of sympathy.
Meanwhile, the US trade deficit is mounting. America, the world’s richest country, evidently can’t live within its means, borrowing more than a billion dollars a day. As the US thrashes around for someone to blame, it is inevitable that it will focus on China, with its large trade surplus, just as the deficits of the Reagan era led to a focus on Japan two decades ago.
But this is blame shifting, nothing more. America’s fiscal and trade deficits are intimately linked. If a country saves less than it invests, it must borrow the difference from abroad, and foreign borrowing and trade deficits are two sides of the same coin.
National saving has two components - private and public. Reagan’s irresponsible tax cuts, combined with America’s paltry savings, meant the US had no choice but to borrow abroad. Now America is repeating that folly. Matters may get even worse once investment is rekindled, unless private savings increase in a way the US has not seen.
Some people abroad now tend to gloat at America’s problems. For many, it is another reason to question America’s ability to provide effective leadership. It took America a dozen years to work its way out of Reagan’s fiscal mess. It may take just as long to clean up the mess Bush has created.
But the schadenfreude of non-Americans is misguided. Globalisation means that mistakes in one country - especially the world’s largest economy - have powerful repercussions elsewhere.
Three things are worth noting here. First, America’s deficits are certain to sop up vast amounts of the world’s pool of savings. But the world will eventually recover from the current slowdown, and that shortage of savings will become important. It will mean higher real interest rates, lower investment and lower growth, all of which will be particularly costly for developing countries.
Second, America’s huge trade deficit may be a source of global instability. Will the world continue to finance this deficit willingly, to put its money into a country with a demonstrable lack of competence in macroeconomic management (to say nothing of the corporate, banking and accounting scandals)?
What happens if global investors decide to change their portfolio mix, shifting slightly from US assets? A weak Europe and skittishness about emerging markets have been American strengths, but how long can the US rely on the weakness of others?
Third, in searching for others to blame, America may again enter an era of protectionism, as it did under Reagan. Bush may trumpet free markets, just as Reagan did, but just as he may exceed Reagan in fiscal irresponsibility, so he may outflank Reagan in trade hypocrisy.
By one reckoning, close to a quarter of American imports were covered by some form of trade restriction at the peak of Reagan protectionism. Expect no less from Bush. Last year he showed little reluctance in imposing steel tariffs, in clear violation of WTO rules. The good news is that the world is beginning to see a rule of law in trade - a legal framework that, although not totally fair to developing countries with economic power still counting for a great deal, may circumscribe America’s ability to revert to the protectionism of the past.
Europe has committed itself to fiscal responsibility - with almost too much zeal, failing to recognise that a well-designed deficit in times of recession may yield high returns. The Bush administration has pushed forward tax cuts that lead to deficits while providing only a modest amount of stimulus.
Equally worrying - for America and the world - is the path on which it has embarked: deficits as far as the eye can see. In the long run, this policy bodes ill for the US - and hence for the world.
Joseph Stiglitz, professor of economics at Columbia University, is a Nobel Prize winner and author of Globalisation and Its Discontents. Â