The economic situations of the United States and Greece are more alike than one might think. In both countries, the government is insolvent, in the sense that its taxing power, constrained by politics, is insufficient to finance the government’s liabilities, which include not only bonds but also entitlements (such as social security and medicare) and essential public services (such as defense). (See my post, “Is the Federal Government Broke?,” Aug. 29, 2010, regarding our government’s insolvency under standard principles of bankruptcy.) In both countries, government is cutting spending when (from an economic standpoint) it should be increasing it, to take up the slack in private investment and stimulate employment and in turn consumer spending (which drives business spending, which increases the demand for labor). In both countries a major cause of the current economic problems was cheap interest rates that encouraged the governments to finance public services by borrowing rather than taxing—taxing would have generated opposition to the extravagant level of those services. And in both countries another major cause of the current problems was the opacity of key financial data, a result in part of regulatory laxity and in part of the complexity and scale of modern financial instruments and operations. And finally, both countries have dysfunctional governments, made more so by the depression triggered by the financial collapse of September 2008.
There is another, slightly less obvious, parallel between the United States and Greece: neither country can stimulate its economy by devaluing its currency. Devaluation is a traditional response to depression, because it reduces the price of exports while increasing the price of imports. This has a dual effect: exports expand, and since they are (by definition) domestically produced, the domestic demand for labor rises; and imports decline, which increases the domestic demand for domestic over imported products (unless imports are a substantial input into exported products), further stimulating the domestic demand for labor. (According to Keynes, the high rate of English unemployment in the 1920s, which is to say even before the 1930s depression, was due to the fact that the British pound was overvalued.) Greece cannot devalue its currency because it doesn’t have its own currency; in that respect it’s like a U.S. state. The U.S. has the capability of devaluing its currency simply by selling dollars abroad, but would be reluctant to devalue substantially because the dollar is the major international reserve currency (the currency used in international transactions between companies that don’t trust their local currencies), which creates a large demand by foreign central banks for U.S. dollars even when those dollars don’t buy U.S. goods, and so is a source of wealth for the United States, in part because dollars cost nothing to produce. Its status as the major international reserve currency would be imperiled if its value fluctuated as much as local currencies in many countries do.
And still another parallel between the two countries: Greece spends a much larger percentage of its budget on defense than any other member of the European Union. Greece and the United States are two of the very few countries in the world in which defense expenditures exceed 4 percent of GDP.
Among the major differences in the economic situations of the two countries, the United States can still borrow at very low rates, because there is confidence that even if it defaulted, it would not default on its bond obligations (and certainly not on its bond obligations to foreigners) but instead would default on its entitlements obligations. Greece, however, having much greater debt relative to its income, is teetering on the brink of defaulting on its bonds. It is trying to negotiate a “voluntary” halving of its debt to its foreign bondholders; the hope in getting this de facto default to be accepted as being “voluntary” is that financial institutions that have insured the bondholders’ debt through credit-default swaps and other exotic means will not be entitled to the insurance proceeds because there will be no formal default, the usual event triggering liability of an insurer of credit. Very little is known about the scope of the market in bond insurance, and so there is fear of a domino effect if the insurers of Greek debt are forced to bail out the bondholders who are being asked to take a “haircut.”
Apparently even if Greece cuts its bond indebtedness in half, this will merely postpone default. The Greek government will either have to continue borrowing, but presumably at very high rates that will maintain its debt service at a high level despite the reduction in the principal that it owes, or have to slash public expenditures to a degree that the populace simply will not accept; or both. But another odd aspect of the comparison between the two countries is that because the Greek government’s management of the economy is even more inept than our government’s, it is, in principle, easier for Greece to reform: the government can fire a large fraction of its public employees not only with no loss in efficiency but with a gain as soon as they find private jobs; it can begin to collect taxes in a serious fashion; it can sell off a variety of public assets acquired by its socialistic predecessors (it is beginning to do this); it can, correlatively with firing its employee parasites, cut the red tape that impedes the formation of new and the operation of existing businesses; it can reduce pensions and other entitlements. But that is in principle, not in reality, because of public opposition; Greece is a democracy. Moreover, although what I have outlined are measures that could be instituted immediately, their effect would be delayed, creating the following dilemmas: while the surplus public employees are seeking jobs, they will have to be supported; collecting taxes and slashing pensions and other entitlements will reduce household income and thus reduce consumption and in turn production; and uncertainty about the nation’s economic future will discourage business formation and expansion even if licenses become freely available.
There is waste in our federal government (and in state and local government as well), but proportionately much less waste than in Greece—so much less than few productive economies can be achieved without cutting entitlements, in particular the huge and rapidly growing Medicare program. But apart from the well-organized political opposition of the medical profession and the elderly to any cuts in Medicare funding, reducing public funding of medical care is more likely to shift than to reduce costs. Costs can be reduced only by heavy copays and deductibles, which would reduce demand for medical care, or by withholding treatment. These measures are unacceptable to the public.
Tax reform can go some distance toward increasing revenues without increasing tax rates—can even reduce the misallocative effects of taxation—but is immensely complex and contentious. Raising tax rates on just the wealthy will not increase revenues greatly, and raising it on the “middle class” as well (as the nonwealthy are misleadingly referred to) seems to be politically impossible.
Also off the table is further stimulus in Keynes’s sense—which is to say, borrowing by the government to finance projects that employ people. We have learned that our government is entangled in red tape (like the Greek government, thought less so), precluding prompt execution of a Keynesian program, and we are reaching our borrowing limits. In addition the $800-odd billion stimulus enacted in February 2009 is widely regarded as a failure, though most neutral observers believe that it saved several hundred thousand jobs and by doing so may have helped to arrest the downward spiral in the economy, which in the first quarter of 2009 seemed on track to match the downward spiral during the Great Depression. It is regarded as a failure because the incoming Administration foolishly predicted that without a stimulus the unemployment rate would reach 8 percent and with it would fall to 6 percent, and because the unemployment rate rose to 10 percent and has come down only to 9 percent, the stimulus has been discredited—what should have been discredited was economists’ confidence in their economic forecasts.
So, for neither country, is a solution for insolvency in sight. Fortunately, because the future is unforeseeable, despair would be premature.