Now usually when I say this sort of thing I am often pushing forward something wonderful that is present in non-American countries that America could use. Universal health care, increased public education and stricter gun laws come to mind here.
This time, however, I am going to use a negative example as well as a positive one. Rather than just showing America what it could become if it does the right thing, I am also going to show what America could become if it does the wrong thing.
In previous posts (here and, more recently, here) I have pointed out that the fiscal irresponsibility of the US Federal government is, by itself, a clear threat to medium-long term economic growth. When combined with other factors (namely Peak Oil, the subprime mortgage crisis and an unsustainable current account deficit), its negative effect is amplified.
When a government does not have enough tax revenue to fund its expenditures, it turns to the market to borrow the required amount. Government bonds are an integral part of credit markets worldwide and function as a baseline measurement for corporate bonds and mortgages and other forms of debt-based activity.
Notwithstanding the part that government debt plays within the world's financial markets, if a government runs deficits over the long term then the debt to GDP ratio increases. In the case of the United States, this number is probably somewhere between 40 and 60% of GDP.
The country that I am setting up as a warning for America to heed is Italy. The following image is one I scanned from a pdf file about the 2007 Italian Budget (download here. pdf, 627.2kb):
This is obviously not a detailed report on the budget, but it gives more than enough information for our purposes.
There are two very important figures in this budget summary. The first is the section marked burden of national debt, which totals €74,564 million. The second is the bottom section marked redemption of national debt, which totals €189,099 million.
That first figure - burden of national debt - represents the interest repayments that the Italian government has to make on its borrowings. Like all bonds, government bonds first have to pay back interest and then, once it matures, the principal. This figure in the budget represents the amount of interest they have to pay on bonds owing. The second figure - redemption of national debt - is the amount of money the government pays back on maturing bonds.
Together, the amount of money the Italian government spends on debt servicing (interest plus paying back principal) is €263,663 million.
Now let's put that number in perspective.
€263,663 million represents a whopping 41.2% of the Italian government's spending in 2007. According to the same document, Italy's GDP in 2007 was estimated to be €1.475 trillion, which means that debt servicing also represents 17.9% GDP.
Such figures almost defy comprehension. Italy's net public debt is around 107% of GDP. Moreover, Italy's public debt has been at this size or even higher for more than a decade (it was 113.6% in 1999).
By way of comparison, America's fiscal irresponsibility is mild. Debt servicing so far represents 15.75% of government spending and 3.13% of GDP - figures that are dangerously high but not as extreme as Italy's.
This is not the place to discuss in detail the reasons for Italy's fiscal nightmare - the nature of Italian politics is probably a major contributing factor. The fact that Italy's political leaders have been unable to find bipartisan support to control government spending has meant impoverishment for their nation.
But just how impoverished is Italy? After all, they are a sophisticated and educated western nation with a high standard of living. That may be true, but the key to understanding how impoverished they are is to examine the opportunity costs of such massive debt servicing.
From a leftist point of view - the point of view which supports high levels of government spending to support universal health care, free and/or cheap public education and so on - the €263,663 million in debt servicing (41.2% of the budget) is money that could have been used for public spending. Education spending in 2007, for example, was €50,066 million. Health spending was €11,661 million. Public order and safety spending was €21,122 million. Every Eurodollar spent in debt servicing was money not spent on improving the nation's social services.
But the leftist view is not the only valid one. From a more economically conservative point of view, that €263,663 million was money that could have been returned to people and businesses in the form of lower taxes. And imagine what sort of tax rates they could have been - 17.9% of GDP not taken up by the taxman.
The message here is clear - governments that have run long term deficits have, over the long term, created a combination of less government services and higher taxes. Money that could have gone into government spending or lower tax rates are instead being used to pay back a national credit card bill that, in the case of Italy, defies logic.
Fiscal responsibility is therefore not a left/right issue. From whatever ideological position you come from, ensuring that public debt does not spiral out of control must be a common goal.
Italy does, of course, have a number of natural advantages. As part of Europe they are in close proximity to an immensely rich and wealthy group of nations that have enriched it through trade. The fact that Italy has adopted the Euro means that any concerns that investors have in Italy's financial position are cushioned by the economic strengths of other nations that have adopted the Euro as well. This fact is tempered, however, by the fact that many other nations in the Eurozone have problems with fiscal irresponsibility as well - though nowhere near that of Italy's (with the notable exception of Belgium).
The good news is that it is possible for politicians - even those in Italy - to work together in a bipartisan way to fix their budgets. The solution is actually simple - either increase revenue or decrease expenditure and run a fiscal surplus over many years. When it comes to politics, however, this is easier said than done, especially when increasing revenue means raising taxes and decreasing expenditure means cutting spending on health, education and public welfare.
While the Clinton years are often seen as a period of intense political partisanship, it is important to remember that the Democratic president and a Republican Congress - for all their bitter fighting - were able to agree very early on to fix the nation's public debt. The result was a series of budget surpluses late in Clinton's second term (helped in no small part by the 1990s Tech boom) and a reduction in national debt. Although Bush and the Republican Congress have ruined this since 2001, there is every reason to believe that a bipartisan solution can be found. Sadly, however, the current political discourse rarely mentions the fiscal imblances which means that, when the next US president takes office in 2009, neither Republicans nor Democrats will see balancing the budget as a priority.
There is one country that has, however, managed to eliminate net public debt - and has done so without resorting to profits from oil but from pure budgetary discipline. That nation is Australia.
Australia's fiscal example should stand as an example to other nations. In 1996 when the conservative Howard government came to power, net public debt was around 20% of GDP. While this was quite small in comparison to other nations - both now and at the time - steps were taken very early to cut spending. So although net debt was comparatively small, it was never allowed to increase. Importantly, cuts to spending were made when unemployment was moderately high - at around 8%. This meant that, when the economy recovered from the effects of the spending cuts, economic growth in the years that followed produced large and growing budget surpluses and steady improvements in unemployment. Moreover, the government could then afford to make incremental tax cuts on an annual basis - a process that was quite politically rewarding. Since 2005, unemployment has dropped below 5%, big budget surpluses are run regularly, income tax rates are lower than ever and net public debt is now negative.
The Howard government did, of course, lose power in 2007, which shows that no poitical party should rely solely upon economic performance to drive their political fortunes. Nevertheless, Australia should serve as an example of what can be achieved if politicians take a long view on important things like fiscal responsibility.
It is likely that the effects of Peak Oil and the subprime meltdown will be far reaching. Countries that are fiscally weak like Italy will either be forced into making painful fiscal readjustments or else run their nations into bankruptcy-in-all-but-name by increasing their deficits. On the other hand, countries like Australia will be in a more flexible position and will have room to cut taxes or increase public spending.
What will become of America, though? While I would like to think that America could avoid Italy's fate I am not at all certain that bipartisan steps can be made to rectify the situation before net public debt hits record levels - say between 75-85% of GDP.
One thing is certain, however, and that is that America's fiscal position will determine its influence in the world over the next 20 years. If America should go down Italy's route, you can almost guarantee that America, as a society and as an economy, will be a pathetic reflection of what it was for most of the 20th century.
In the face of a semi-permanent energy crisis along with the spectre of global warming, what the world of the 21st century needs is a strong, free America. Being fiscally responsible is an important step in that direction.