Debt Crisis: The U. S. Abandons Its Roots of Success

The debt crisis is shaking the world, with Spain and Italy adding to the European problems and the United States receiving a downgrading of the credit rating. The American situation is naturally particularly worrying, since this country for so long has been the world’s leading engine of growth and prosperity.

Spectacular growth is now emerging from other parts of the world and the global economic shift towards the east is speeding up. Other countries are racing ahead of the United States because they are beating the U. S. where it always used to lead: Economic freedom. Partly inspired by American freedom, many countries reformed – and their teacher went in the opposite direction.

Total size of government – public expenditure – in the United States is now more than 40 per cent, up from below 10 per cent a century ago. In dollars, the U. S. federal budget increased from 9.5 billion in 1940 to 3 517 billion in 2009. At times, such as under Reagan and Clinton, government sometimes and in some ways retreated, but lately it has exploded.

The country that became so successful thanks to strict limits on government, as intended by the founding fathers, has moved far away from those roots. The major step that increased the size of government in recent years was the biggest stimulus package the world had ever seen. And the latest growth figures barely reach beyond zero.

The 2011 deficit is some 1500 trillion dollars. Repealing the Bush tax cuts would fill one tenth of that hole. The stimulus package contained practically every proposal from recent years for increased government spending. But Keynes is not working; government cannot create growth by spending.

In the OECD, it is countries that kept their public finances in order and launched reforms for growth and competitiveness that are leading the way. Northern Europe – countries like Germany, Sweden and Estonia – shows high rates of economic growth. They managed to resist the choirs during the first phase of the financial crisis that yelled “spend more”.

Financial crises or debt crises are far from new. And many countries have returned from them stronger than before. But policymakers have to find the courage to tell the truth and make decisions that will have an effect. Perhaps the United States that inspired so many can receive some lessons from others now?

Sweden de-regulated most markets, rejected protectionism and cut taxes and public expenditure by ten percentage points during the last decade. Those lessons were not least learned during a financial crisis in the 1990s. Countries that stuck more to Hayek than Keynes during the crisis – relying on entrepreneurs, investors and consumers rather than government – are developing well.

Some politicians have upheld the image of what the philosopher Bastiat described as “the state is the great illusion where everyone think they can live at the expense of someone else”. They say that only the rich pay and everyone else will receive. In truth, everyone pay – and with high debts, the children of tomorrow will pay for today’s expenditure.

This is unacceptable and most politicians know it. But some fear adverse political consequences of cuts in public expenditure. Harvard scholar Alberto Alesina has discarded this notion. His studies show that in times of urgency and crisis, responsible politicians campaigning on a platform of discipline and adjustments often get elected. The UK and Sweden are recent examples.

Alberto Alsina’s findings also show that not all fiscal adjustment causes contractions, contrary to conventional wisdom. His findings show that sharp reductions in public expenditure can be accompanied and followed by growth even in the short run. An early adjustment eliminates the need for larger and maybe much more disruptive adjustments in the future.

Responsible action is not only economically but also politically rewarding. This is a lesson for all countries. There is always reason to be optimistic about the United States in the long run, but how long it takes to come back as the prosperity engine is decided by today’s politicians.