For a Change, Europeans Lecture U.S. on Deficit and Finances
Business + Economy

For a Change, Europeans Lecture U.S. on Deficit and Finances

The Fiscal Times

The United States has a long history of lecturing other countries on their economic and budget problems. Whether it was prodding Europeans to increase their consumer spending, nagging China about exchange rates, or telling Argentina to slash its debt, the United States has never been hesitant about telling other countries what to do.

That’s why it was unusual to see the International Monetary Fund telling the United States to get tougher about deficit reduction and suggesting an extraordinarily detailed list of changes — a higher retirement age for Social Security, abolition of the tax break for home mortgage interest, and even über-European ideas like a national consumption tax and a tax on financial transactions.

It wasn’t the first time the IMF has made such suggestions, or the first time that it annoyed American officials. During the Bush administration, the White House and Treasury seethed when the IMF urged higher taxes and “pay-as-you-go’’ rules that would have forced Congress to pay for any extensions of the Bush tax cuts. The IMF also irked the Clinton White House, which ignored pleas for belt-tightening at a time tax revenues were flooding the Treasury.

Not surprisingly, the Obama administration’s immediate reaction was equally dismissive: The Treasury pooh-poohed the IMF’s economic assumptions as too conservative to be realistic. One official mocked the IMF for predicting an unlikely “double whammy’’ of both slower growth and higher interest rates. The president’s fiscal commission staff declined to even comment on the study.

But today, the United States is in a much weaker position to brush off outside criticism. Though the U.S. is growing faster than the European Union (about 3 percent here, compared to about 1 percent for Europe), it is no longer the engine of global growth. That role now belongs to Asia — in particular, China, India, South Korea and parts of Southeast Asia. Meanwhile, the government’s financial position is as perilous as at any time since World War II.

Indeed, the IMF’s new report highlights how little maneuvering room the United State has on fiscal policy. At least for the moment, the administration’s plan for reducing its deficits to sustainable levels — never mind actually balancing the budget — depends overwhelmingly on assuming rapid economic growth. By contrast, the IMF paints a more dire fiscal picture by assuming notably slower growth. But following the IMF’s recommendations for aggressive deficit reduction could lead to even slower growth, jeopardize the recovery and make the budget even worse.

In its budget proposal last February, the White House assumed that the economy would expand by 3.8 percent in 2011, 4.3 percent in 2012, 4.2 percent in 2013 and 4.0 percent in 2014. That would amount to four years of stellar growth. The IMF, by contrast, expects the U.S. to grow by only 2.8 percent in 2011 and by less than 3 percent through 2015.

Those differences have a big impact on the budget. The Obama administration has proposed reducing the deficit from almost 11 percent of Gross Domestic Product in 2010 to 4 percent in 2015, and called on the fiscal commission to come up with recommendations to squeeze it further. But about 80 percent of the projected deficit reduction would result from economic growth, and only about one-fifth would result from changes to spending or taxes.

Turning the Tables on the U.S.
If the IMF’s pessimism is justified, the United States would have a big problem. To stabilize the deficits at 3 percent of GDP, the IMF estimated, the government will have to narrow its shortfall by 8 percent of GDP by 2015 — on top of the normal deficit reduction that comes with an improving economy. That would be nearly $1 trillion a year in spending cuts or higher taxes, and the tightening would have to start soon.

Such arguments over belt-tightening now versus growth in the future are not new. Poorer countries in Latin American, central Europe and Asia have had countless similar battles with the IMF in decades gone by. For years, the United States sided comfortably with the IMF and the so-called “Washington consensus” that called on countries to embrace fiscal discipline, trade liberalization, open markets and deregulation.

“The IMF’s tradition has always been economic orthodoxy, and now we’re getting our own taste of it,’’ said Martin N. Baily, a senior economist at the Brookings Institution.

As a practical matter, American leaders are under no obligation to follow the IMF’s recommendations. Unlike poorer countries that tumbled into financial crises, and which needed the IMF’s money to avoid defaulting on their debts, the United States has no trouble financing its debt. Interest rates on 10-year Treasury bonds have fallen from about 4 percent last year to about 3 percent today, in part because financial turbulence in Europe has prompted investors to once again seek out Treasurys as a safe haven for their money.

But even for the United States, the IMF has become harder to ignore. For one thing, its push for fiscal austerity echoes a rising sentiment in Europe and in the Group of 20 nations. Beyond that, leaders from the Group of 20, including President Obama, endorsed a new effort last year to promote more “balance’’ between the growth strategies of export-dominated countries with big trade surpluses, like China, and countries with high consumption and high debt, like the United States. The IMF is supposed to play a consulting role in that process if it gets off the ground.

The IMF report could also help loosen the political gridlock by providing an authoritative outside voice for ideas that either Republicans or Democrats have tended to demonize. It applauded President Obama’s health care reform as a step toward controlling health care costs, though it warned that the results will depend on how firmly the cost-containment measures are carried out. It bluntly called for slowing the growth of Social Security, a sacred cow for many Democrats. In defiance of Republican orthodoxy, the IMF insisted that tax increases have to be a part of a solution.

Three-Part Attack on the Deficit
Ultimately, the IMF said, the United States needs a three-part effort: an “upfront’’ action to reduce the deficit in 2011; a credible plan to reduce deficits further in the next five years; and a long-term plan to deal with the exploding costs of old-age entitlement programs like Social Security and Medicare.

The IMF did leave room for the possibility of some additional economic stimulus over the next year, but only if the leaders can come up with a credible plan for the longer term.

James R. Horney, director of federal policy at the Center on Budget and Policy Priorities, said the IMF study likely will command some attention in Washington, but not enough to shape policy. “There’s obviously been a lot of stuff lately about the concerns of the deficit and what needs to be done, and this will be another thing people will look at, but I don’t think it will have a dramatic impact by itself.”