America's Unfolding Greek Tragedy

Similar to Western Europe, the U.S. has been slowly but steadily expanding entitlements and the regulatory state, setting the nation up for a future of slow growth, high taxes and loads of debt.

I should point out first the agreements between Eli Lehrer and me in this debate. Obviously there are big quantitative and qualitative differences between the American and the Greek economy. Let me also concede that even if these differences were minimal, even a slight variation in time of occurrence of a debt crisis and other factors could result in an important differentiation of outcomes.

So if and when the U.S. has to face a debt crisis the circumstances of the moment will determine a lot. I think Eli Lehrer like many others believes in an American economic exceptionalism.  That certainly has been true in the past and continues to be so up to a degree even now.  The U.S. has indeed been slower than Western Europe in expanding the welfare and regulatory state. But here we must note that the emphasis is on slower.

American conservatives may be reluctant to admit that the U.S. has already a welfare state. Lehrer mentions the COBRA subsidy but what about Social Security, Medicare and Medicaid? Those are the big government programs, which if they are not reformed will generate debt in the trillions of dollars.

America may be exceptional in many things except its welfare state. The American welfare state in many ways functions like a European one. It’s expensive, redistributive, provides the wrong incentives to too many people, and has strong political support.  Watching the debate over Obamacare, it wasn’t surprising to see Republicans oppose it because it would cut Medicare and Democrats support it because it would be as ‘good’ as Medicare.

David Leonhardt of the Times estimates that in order to avoid serious debt problems “the government will need to find spending cuts and tax increases equal to 7 to 10 percent of G.D.P. The longer we wait, the bigger the cuts will need to be (because of the accumulating interest costs). Seven percent of G.D.P. is about $1 trillion today. In concrete terms, Medicare’s entire budget is about $450 billion. The combined budgets of the Education, Energy, Homeland Security, Justice, Labor, State, Transportation and Veterans Affairs Departments are less than $600 billion.”

Of course, we will not increase taxes or cut spending by a trillion now or even later. The most likely scenario is that we will be increasing our debt as much as possible while avoiding tax increases and spending cuts. At certain points and depending on the political winds we will have some spending cuts and/or tax increases. In the long run we will have reductions in the rate of growth of the welfare state accompanied by rising tax rates and debt levels.

It is this combination of events that makes a crisis like the one that Greece faces now possible for the U.S. America is indeed a very productive country but it’s becoming less so. One has only to look at the current account deficit.  That’s an important similarity between Greece and the US. Another one is the percentage of consumption as part of GDP. In both cases consumption and economic growth has been recently financed by debt.

Up to now it has been very difficult for the American political class to reform the entitlements in order to make them economically viable. If the Republican party does not find a way to articulate a convincing political narrative out of this mess, the future will be one of slow growth, high taxes and loads of debt.

At some point bond investors will take another look at the U.S. balance sheet and they will realize the unsustainability of the whole enterprise. Interest rates will start to rise and pretty soon we might find ourselves in a very Greek predicament.

All the certainties that for so long we have held sacrosanct will be quickly transformed to the peculiar superstitions of yesteryear. All of a sudden, we will be wiser but at a very high price.