The Global Debt Crisis: Haunting U.S. and European Federalism

1: Federalism's Emerging Fiscal Crisis

part I Federalism and the Pension Crisis in the United States 01-0487-4 chap1.indd 1 10/7/13 8:38 PM 01-0487-4 chap1.indd 2 10/7/13 8:38 PM 3 1 Federalism’s Emerging Fiscal Crisis No pecuniary consideration is more urgent, than the regular redemption and discharge of the public debt: on none can delay be more injurious, or an economy of time more valuable. —George Washington, message to the House of Representatives, December 3, 1793 It is well understood that defaults, bankruptcies, and fluctuations in interest rates are shaped by business cycles, banking management, and financial engineering. However, credit risk among the lower tiers of government within a federal system also has political determinants and political consequences. Without downplaying the importance of economic conditions and technical considerations , this volume focuses on the political realities that affect the capacity of subnational governments to survive global financial crises. The material explored here serves as a reminder that the founding social science was called political economy and that visionaries from Adam Smith and David Ricardo to John Keynes, Milton Friedman, and Friedrich Hayek all considered themselves as much students of the subject identified by the first part of the term as students of that identified by the second. Such students of political economy have never been as necessary as they are today. As the title of this book suggests, we are in the midst of a global debt crisis . Economists at the International Monetary Fund (IMF) suggest that the public debt of the ten leading developed nations will rise from 78 percent of GDP in 2007 to 114 percent by 2014. These governments, including those in the United States and in many European nations, will by then owe around $50,000 for every one of their citizens. That translates into more than $10 trillion of extra debt paul e. peterson and daniel j. nadler 01-0487-4 chap1.indd 3 10/7/13 8:38 PM 4 Paul E. Peterson and Daniel J. Nadler accumulated in less than ten years. The governments of rich nations have never borrowed so much in peacetime, and their massive debts will likely shape the world economy for decades to come. If current trends continue unchecked, demographic pressures combined with political paralysis will send the combined public debt of the largest developed economies toward 200 percent of their GDP by 2030. As if the 2008 recession did not do enough to overturn national and subnational balance sheets, a far longer-term and less cyclical fiscal crunch is currently in the making: the pension and health-care costs of a rapidly graying population. By 2050 a third of the developed world’s population will be over 60 years of age, and economists estimate that this “demographic bill” is likely to be ten times larger than the recession’s fiscal costs. Politicians in most industrialized nations have failed to confront these fiscal and demographic forces. The debt that they are accumulating portends an even greater financial catastrophe than the one that the international community is still struggling to survive. And so it is that leading economists are now beginning to acknowledge the resurgence of the venerable, if old-fashioned, field of political economy. In an era that until recently was defined by quantitative economics—derivatives, default swaps, and other exotic forms of financial engineering—the quaint field of political economy is seeing a rebirth among leading economists as the lens through which the present global crisis must be viewed to be understood. In 2013, a U.S. Federal Reserve Bank president, Eric Rosengren, criticized a widely circulated and fairly conventional economic model of sovereign credit risk for its oversimplification of the subject and its “parsimoniousness,” especially the extent to which it “omitted” what Rosengren called the “political determinants of risk premiums.” In a sign of just how far the pendulum has recently swung back to the political origins of the field of economics, Rosengren—a leading monetary specialist who, like most of his central bank colleagues, usually exhibits the putatively clinical nonpartisanship of his profession—openly observed, “One frequently sees that credit default rates spike around elections, and that countries that are politically destabilized have difficulty generating the political will to address problems.”1 The notion that “political will” is as important as economic capacity in dealing with a crisis, though intuitive to students of political economy, is an important...