Like it or not, we are now part of a great experiment with little certainty it will work. If it fails, we face a lost decade of economic difficulty and high unemployment.
This is the plan of the Western world to embark on a strategy of fiscal constraint even though unemployment remains high and economic recovery is faltering.
In Canada, we are beginning to see the signs of federal cutbacks and the layoff of government employees, in order to return to a budget surplus by 2015-16. Fortunately, we are better off than the United States, where an ugly level of political debate, the corrupting power of Big Money, and a dysfunctional political system have combined to create both an economic and a political crisis that could escalate until the November 2012 elections.
After months of nasty political posturing, the U.S. Congress and U.S. President Barack Obama have agreed on a plan to raise the U.S. debt ceiling, thus avoiding the potential catastrophe from a debt default, and have set the stage for what promise to be acrimonious negotiations over US$2.9 trillion in government spending cuts over the coming decade to be agreed to by the end of this year.
This is being done at a time when the U.S. economy is still in poor shape and unemployment is high. Yet the new mantra is that deficit reduction must have priority over a stronger economy. Some deficit reduction hawks argue that this will mean a stronger economy.
But this assumes that the U.S. can drive down the value of its dollar — the converse of which is to drive up the Canadian dollar, already above parity with its U.S. counterpart — and rely on a massive increase in exports to support growth and employment. But that’s what Europe and Japan want to do as well, and not everyone can devalue.
Meanwhile, the 17 countries that use the Euro are facing their own crisis, also generated over fears of rising public debt and the risk of debt defaults.
So serious budgetary constraints are also being imposed in Greece, Ireland and Portugal, despite weak economies, and now Spain and Italy are also threatened. Both Spain and Italy are being forced to borrow at much higher interest rates and should Italy, one of the world’s largest economies, get into serious trouble, it would be too big to bail out. A radical new approach would be needed. Relative to GDP, Italy has one of the largest debt burdens in Europe.
Japan, for its part, has been forced to intervene in world currency markets to bring down the value of the yen, which has been rising sharply as the U.S. dollar and the euro exchange rates have fallen. The rising yen has been undermining the sluggish recovery of the Japanese economy. Japan’s public debt is double the size of its GDP and is among the highest among the advanced nations of the West.
One of the risks that the global economy faces is that the Western nations, faced with stagnant growth, high unemployment and declining public services and infrastructure, will resort to currency manipulation and trade protectionism to preserve jobs. This is what happened in the 1930s, when governments then pursued fiscal constraint despite high unemployment and slow growth, making the economic crisis worse.
There are two ideas at issue.
In the U.S., in particular, there is a sharp political divide over the size and role of government. The Republican party, especially its ideological Tea Party wing (a “grassroots” protest movement funded by wealthy Americans and corporations), wants to radically shrink the size of government and opposes any tax increase, including closing tax loopholes for corporations and wealthy individuals. This makes it extraordinarily difficult to further stimulate the economy, for example through large-scale infrastructure spending.
At the same time, there is the issue of whether it is good economic, let alone social policy, to make balanced budgets the top priority when the economy is weak and unemployment high.
Weak economic growth and high unemployment mean less revenue for governments, making the deficit and debt issues harder to deal with, as well as risking a deeper social divide.
But there is another concern as well in an age of negative advertising and seven-second sound bites. Are the democratic institutions of the West capable of engaging in serious debate and making tough choices? They will certainly be put to the test in the months and years ahead.
Economist David Crane is a syndicated Toronto Star columnist. He can be reached at email@example.com.