- To my surprise, I’ve come away more optimistic about the United States economy.
- It’s not that we’ve solved our fiscal problems or avoided the next shutdown or debt ceiling debacle.
- The IMF’s latest forecast is for 1 percent growth in gross domestic product in the euro area in 2014.
- A key challenge for countries of the euro zone is to take steps to resolve their fiscal and financial problems.
In the face of the political impasse that thwarts progress on so many economic issues facing the United States — spending changes, tax reform, immigration, and so on — it’s enlightening to get a new perspective from stepping outside the country. I’ve been doing just that this week, as part of a group of economists considering fiscal policy issues at a conference in Abu Dhabi put on by the World Economic Forum. The conference, labeled the Summit on the Global Agenda, is a sort of minor league for the big show held each year in Davos, Switzerland. It’s the wonk version of double-A ball.
To my surprise, I’ve come away more optimistic about the United States economy. It’s not that we’ve solved our fiscal problems or avoided the next shutdown or debt ceiling debacle. Nor is the United States evidently any closer to a bipartisan agreement on policies to bolster near-term growth or resolve our long-term fiscal challenge. Not by a long shot, as was captured in an insightful article this week by Jackie Calmes of The New York Times.
But my policy working group includes a sizable contingent of Europeans, and listening to their discussion of economic policy making in the euro zone makes clear just how much progress the United States has made since the financial crisis flared in the summer of 2007. Europe is still dealing with the unresolved issues of the crisis, including the debts of governments and households that hold back spending, and the overhang of bad loans at banks that deter the lending needed to support new investment and job creation. On each of these dimensions and more, the United States has taken at least some positive steps while continental Europe has virtually wasted six years.
The International Monetary Fund’s latest forecast is for 1 percent growth in gross domestic product in the euro area in 2014 — an improvement after two years of recession, but dismal compared with the 2.6 percent growth expected in the United States. (Paul Krugman puts it more sharply — that the euro recovery is worse even than that of the 1930s.) And this slim euro-area expansion masks wide disparities in the situation across countries. In Germany, the unemployment rate has remained around 5.5 percent, better than in the United States, while crisis-ridden countries like Greece, Italy, and Spain face much worse — 27 percent unemployment this year in Greece and Spain, and 12 percent in Italy.
The usual adjustment mechanism for a country in such straits would be to achieve export-led growth through expansionary monetary policy and a weaker currency. But countries in the euro area do not control their own monetary policy. That is up to the European Central Bank, which so far has not followed the Federal Reserve in aggressive monetary easing. Leaving the euro is off the table for political reasons. The E.C.B. recently made a small cut in the policy interest rate and has purchased government bonds to help the weak countries, but these actions so far have been just enough to avoid catastrophe like a default in Italy or Spain that inflicts widespread losses on European banks. One might see the E.C.B.’s reluctance to do more to stimulate the euro area economy as a means to keep the pressure on for fiscal adjustment — to ensure that the formerly profligate governments achieve rectitude.
Meanwhile, European policy makers debate how much cash can be sent south to ease the pain of the adjustment while avoiding such generosity that governments deviate from fiscal austerity. It would not be a surprise if other countries in Europe eventually are forced to take on some of the debt burdens so that the weak countries can finally grow again. But the policy debate is far from this, leaving austerity to grind down wages and incomes so that companies in the south of Europe can compete with the German export juggernaut.
European financial markets are more bank-centric than those in the United States, where bonds and securitized assets reign, amplifying the negative impact of having euro area banks weighted down by bad loans. Yet another stress test is planned in 2014 to identify the bad banks and either strengthen or weed them out, but previous such exercises in Europe did not restart lending. And policy makers are still struggling to develop mechanisms to shut down bad banks in a consistent way across the euro area — something that is routine across the 50 states here. Ultimately, a new round of bank bailouts is likely to be needed in Europe, but this requires yet more cash to flow from the strong economies to the weak ones, and the political decision for this again is far from being made. Just imagine the problem if it had taken five years instead of five weeks to pass the legislation that created TARP to stabilize the United States financial system. That is Europe.
Ultimately, achieving the stronger growth that will help European countries get out from the weight of their debts probably requires structural reforms to increase the flexibility of European labor markets. This is yet another longstanding debate in Europe, and probably means changing aspects of the cherished welfare state – another political nonstarter. In the meantime, Europe is a slow-motion train wreck, unable to switch onto a better track.
The contrast with the United States is vast, starting with the concerted efforts to stanch the financial crisis that were started in one administration and then carried on by another.
With fiscal policy, the United States came close to a debt default not too many weeks ago, but we have actually made some progress on fiscal consolidation, and more is likely in 2014 through the combined impact of the sequester that limits spending and rising revenues from stronger growth. The latest fiscal update from the Congressional Budget Office has the budget deficit down to 2 percent of G.D.P. in 2015 and the debt level falling slightly to 68 percent of G.D.P. in 2018. The long-term fiscal challenge remains: deficits and debt levels are set to soar over the ensuing decades and acting sooner will make the resulting adjustments less difficult. But there appears little prospect of a funding problem for several years at least, meaning that we can have measures to take hold over time rather than being forced into a sharp austerity.
The United States further has made considerable progress on financial policy dimensions that stymie Europe, with household and business debt burdens down (though student loan debt is a rising concern), and banks are much stronger with greater capital ratios and fewer bad loans than in 2008. Financial regulatory reform has provided United States policy makers with important new tools, albeit as yet untested, to deal with future problems including at large banks.
To be sure, the unemployment rate is still too high and job creation not yet robust. But the aspect of the American economic situation that makes me most optimistic compared to Europe is that we are not just growing, but have the potential to do even better. Immigration reform, while politically difficult, is manifestly in our economic interest and would foster growth. The same is true for policies that expand trade, such as completion of the Trans-Pacific Partnership. And the innovative sectors of the economy, if anything, appear to be accelerating in the pace of their entrepreneurial fervent.
Having taken steps to move beyond the financial crisis, the United States is thus in a favorable position, with an opportunity to take on longer-term economic challenges such as immigration, education, inequality, retirement security and the necessary fiscal adjustment over time, including reforms of entitlement programs. This last point is vital and should not be delayed simply because the fiscal situation is stable for a period. Indeed, a key point my group made to others at the Abu Dhabi conference was that fiscal sustainability is essential to ensure that resources are available for the public sector to contribute to addressing all other agenda items.
In a sense, a key challenge for countries of the euro zone is to finally take steps to resolve their fiscal and financial problems, at least enough so that policy makers can lift their horizons to address longer-term concerns. Seen from the outside perspective, it looks as if the United States has that opportunity.