James Clark

The Public Policy and Governance Review asked current and former students to write a series of posts on the major policy events of the summer as we begin the fall semester. Today is the first of the series.

The summer of 2011 was tumultuous. European and North American governments worked to reduce budget deficits, and in some cases, to stave-off outright national default. In Europe, the ongoing sovereign debt crisis continued to threaten the integrity of the European Monetary Union. In the United States, politically charged negotiations over raising the national debt ceiling came dangerously close to the selective default of the world’s largest economy.

To begin, let’s look at the basics of budgeting: a government takes in revenue mainly through taxes on things like consumption, personal income and corporate profits. At the same time, the government spends these funds on the delivery of programming through the civil service as well as transfers to persons, organizations and other levels of government. The difference between government revenues and expenditures is a nation’s budgetary surplus or deficit.  In the short to medium-term, a budget deficit can be financed by government borrowing in the capital markets – the sale of government bonds. However, in the long term, a country cannot continue to borrow indefinably, and at some point, necessity will force it to balance its budget.

Europe

The 2008-2009 worldwide recession hit Europe hard. The so-called PIG countries (Portugal, Ireland, Greece) were particularly exposed to the recession. Before the recession, Greece and Portugal had each been running large budget deficits even while the economy was performing well. When their economic situations deteriorated, these deficits grew even larger as governments introduced fiscal stimulus programs to ‘prime the pump.’ Greece’s two largest industries, tourism and shipping, each declined 15 per cent as international demand plummeted.

Portugal is similar to Greece with a legacy of structural budget deficits. Ireland’s situation is somewhat different, with a pre-recession budget surplus and a modern and efficient public sector. However, when the worldwide recession began, a massive real-estate bubble in Ireland burst and in the ensuing uncertainty, several over-exposed banks failed. Fearing a spreading banking crisis, the Irish government used public money to support several insolvent banks, leading Ireland’s budget deficit to reach over 30 per cent of GDP in 2010.

All three PIG countries have had their credit ratings downgraded to the point that they no longer have access to the international bond market. In the place of private sector lending, all three have received emergency stabilization loans from the European Commission and the International Monetary Fund (IMF). These stabilization loans have been a contentious domestic issue in several of the more stable European countries including France, Germany and Finland. Under these bailout packages, taxpayers from stable countries are effectively paying the bills of the Portuguese, Irish and Greek governments. This is done in the name of European unity and stability, but, can appear excessive when German taxpayers see that a Greek public servant can retire, with full pension, at age 53.

Euro Consequences

European Commission bailouts are negotiated with individual Eurozone nations and have been conditional on the implementation of wide ranging cuts to entitlement programs such as pensions, unemployment insurance or healthcare spending, the introduction of new taxes to boost revenues, and in some cases, public sector layoffs. IMF loans’ have also not been without strings attached; a major condition of Ireland’s loan package was that the country significantly raise property taxes. As European countries continue to implement controversial budget cuts, we will see a cultural shift sweep through the public sector as countries are forced to make tough decisions on what programs to keep and what to cut, with the hopeful outcome being a necessary return to fiscal sustainability.

United States

Turning to the United States, we have seen the recent conclusion of dramatic negotiations on the raising of the national debt ceiling. The debt ceiling is a constitutionally mandated cap on the aggregate amount the US Federal government is authorized by Congress to borrow.

Since March 1962, the debt ceiling has been raised 74 times, according to the Congressional Research Service. Ten of those times have occurred since 2001. The previous debt ceiling increase was in February 2010, to $14.294 trillion. As deficit financed spending continued, the US Treasury Department began to run short of money and experts predicted that the debt ceiling would need to be raised by the beginning of August 2011. Failure to reach an agreement before the Treasury ran out of money would mean a ‘selective default’ of the United States in which certain obligations would not be paid. This 74^th increase of the debt ceiling was controversial because of the many fiscally conservative Tea Party movement candidates elected to Congress in November 2010. At the same time, the upcoming 2012 Presidential Election served to further politicize negotiations, with Republicans seeking to use it to paint the Obama Whitehouse as “poor economic managers” and “Democrats attempting to raise the debt ceiling to a high enough level that it would not need to be raised until after the Presidential election.”

US Consequences

After weeks of tough negotiations and fiscal brinkmanship, the Budget Control Act of 2011 was enacted on August 2, 2011.  The Act was seen as a second-best outcome for both parties since the budget cuts specific in the Act will not actually reduce overall US debt levels; only slow their existing rate of growth. On August 5, 2011, Standard and Poor’s (S&P) downgraded US debt from “AAA” (highest rating) to “AA+” (highest rating but with qualifications). While the S&P downgrade was almost universally condemned and sent world stock markets plunging, the controversial decision may have provided an important wakeup call to US lawmakers.

There are two components to a nation’s credit worthiness: ability to repay and willingness to repay. There is little doubt that the United States will be able to repay its debts and obligations. The major concern is that US lawmakers lack the political will to take this issue seriously and address the country’s massive structural budget deficit.

James Clark is a second-year Master of Public Policy student at the University of Toronto. His main areas of interest include economic policy and public sector performance management. Before beginning his Masters, James completed an Honours Business Administration Degree at the University of Western Ontario.