How Politicians Are Wrecking the World Economy

The private sector is healing. The political sector is now the problem.

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For the last several years, the big problem has been the economy. Not any more. Politicians are now the problem.

The headline drama masks the damage that elected officials are doing. The American job market is terrible, with most companies reluctant to hire. After a huge, two year run-up, the stock market, composed of publicly traded companies, is in the midst of a dizzying correction. Weak consumer spending is a big drag on the economy. A persistent housing bust, now in its fifth year, has drained Americans of nearly $7 trillion worth of home equity. Those mostly seem like private-sector problems, not public-sector ones.

[See 10 ways to create jobs.]

But the private sector is healing, and for a while, the government aided the convalescent process. Though unpopular, the 2008 bank bailouts prevented a nationwide and perhaps a worldwide bank run that would have caused a long-lasting depression if left unchecked. The 2009 stimulus program, which the Obama administration oversold, nonetheless helped end the recession sooner than it would have ended otherwise. The tax cuts that were part of that stimulus program helped too. So did the tax cuts enacted at the end of 2010. The Federal Reserve, which critics liken to some kind of nefarious star chamber, has kept interest rates low and helped Americans regain some of the wealth lost in the twin housing and stock-market busts that mushroomed in 2008 and 2009.

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There's one huge exception to the improving nature of the economy, however: government debt. It's no longer bad news about jobs or home prices or insolvent banks that is sending the stock market into violent swings. Stock losses are now being driven by worries about excessive sovereign debt in the United States and Europe, political ineptitude in both places, and a daisy chain of related problems. There's nothing new about those debt levels. But politicians in both regions are proving that they're not up to the task of dealing with problems of their own creation. Doing nothing is no longer an option, yet the kind of assertive leadership that's needed is largely absent. Here's how politicians threaten to wreck the economies of both Europe and the United States:

EUROPE

There are five European countries with dangerous levels of debt. Greece, Ireland, and Portugal have already thrown in the towel and accepted costly bailouts backed by other European nations and the International Monetary Fund. But those bailouts are only partly funded, and if more money doesn't materialize over the next few years, one of more of those countries could default on its obligations. "The big problem in Europe is that this crisis has been going on since end of 2009," says Ted Truman of the Peterson Institute for International Economics. "Generally, crises are over these days within 18 months. But the European crisis has one chapter after another."

While those three zombie nations have become a chronic concern, Italy and Spain loom as a bigger problem at the moment. Italy's debt load is higher than America's, and its economy is far less competitive. That has led to a recent spike in interest rates on Italian debt, which in turn is fueling fears that Italy could become insolvent if the rout continues. If it can happen in Italy, it can happen in Spain, which has similar problems. There are no plans to bail out either country, and they're both far too big for a Greek-style rescue. More than anything else, those are the worries that have sent stocks reeling. "The markets remain unimpressed with the European authorities' efforts to combat the region's sovereign debt crisis," writes economist Howard Archer of forecasting firm IHS Global Insight.

[See 11 countries with worse problems than America.]

There are ways to solve these problems—but they require the kinds of tough, unpopular decisions that politicians tend to run from. Worse, the euro zone consists of 17 nations—some rich, some borderline poor—with 17 different finance ministries and widely divergent agendas. That sometimes makes political agreement impossible. "There's no Treasury Secretary or central fiscal authority in Europe," says Jacob Funk Kirkegaard of the Peterson Institute. "Imagine if the National Governors Association had to pull together a bailout of Delaware. If Texas and California had to come up with money for Delaware, the politics of that would be pretty messy, too." That helps explain why Europe keeps coming up with marginal solutions that forestall the problem for a few weeks or months but increasingly fail to reassure financial markets.

Here's a short list of what European leaders need to do: In Italy, scandal-plagued Prime Minister Silvio Berlusconi needs to accelerate an unconvincing "austerity" program, so that government spending cuts and new wage controls go into effect promptly, instead of being put off until 2013 and 2014. Italy also needs some bold new efforts to invigorate its stagnant economy, such as a repeal of protectionist measures that keep wages and prices unnaturally high, and a simplified tax system. As in many other countries (including the United States), Italy's fortunes would improve markedly if its economy grew faster than expected. But that would upend the status quo and cause short-term pain for labor unions and others. So Berlusconi gives tone-deaf speeches insisting that the markets are exaggerating Italy's problems—which unnerves global investors even more, because he seems out of touch.

Spain has considerably less debt than Italy, but it too suffers from an inflexible Old World economy, with unemployment close to 20 percent. Spain has been trying to reassure markets with a slow-but-steady reduction in government spending and a gradual series of steps meant to show that its troubled regional banking sector is solvent. It probably needs to intensify both efforts, while finding ways to liberalize its flat-lining economy and stimulate growth. The ruling party, however, is weak and likely to lose in upcoming November elections. So bold action will probably have to wait there, too.

[See how Greece has outperformed Washington.]

The European Central Bank is Europe's equivalent of the Federal Reserve, and the only institution with any meaningful authority over all 17 euro zone states. But the ECB has been much more timid about intervening in the economy than the Fed. It has raised interests rates instead of lowering them, as part of its hereditary impulse to aggressively combat inflation, and has not embarked on the kind of large bond-buying program that the Fed undertook in two rounds of "quantitative easing." The ECB has also refused to broker a decisive solution to the European debt problem, although it could. The bank could indicate its unwavering support for Italy and Spain, for instance, which might entail buying large amounts of those countries' bonds. Or, it could force European banks to put more capital aside to account for losses that might result from a contagion scenario, which would blunt the impact of a financial crisis.

The leaders of Germany and France, the eurozone's largest economies, could help matters by putting their own weight fully behind one course of action or another. Instead, they've been vacillating, sometimes insisting that bailouts will proceed no matter what, other times suggesting that banks should prepare to accept some losses. Markets hate uncertainty, and Europe's leading nations have been stoking it.

THE UNITED STATES

As most Americans realize, the performance of U.S. politicians in 2011 has been pitiful. Republicans won control of the House of Representatives last fall, and gained seats in the Senate, largely by campaigning for smaller government and spending cuts meant to reduce America's $14 trillion national debt. Their goal may be worthy, but their timing is terrible. This summer's big debt battle showed Washington at its venal worst, as Republicans and Democrats slung mud at each other while threatening a government borrowing freeze that would have thrown the global economy into turmoil. Tea Party Republicans were particularly intransigent, refusing to consider even a dollar's worth of new taxes to bring down the debt, even though solving the problem by spending cuts alone would decimate Medicare, Medicaid, and the defense budget. The British magazine The Economist recently called the GOP stance on taxes "economically illiterate and disgracefully cynical."

[See 6 unwanted outcomes of the debt deal.]

Meanwhile, government has, in fact, been shrinking—and instead of unleashing private-sector growth, as some Republicans fantasize, those cuts have contributed to fears of a double-dip recession. So far this year, government has shed more than 200,000 jobs on net, mostly at the state and local level. Recent job reports would have been considerably better, except the loss of government jobs dragged down the overall numbers. And the recent debt deal will cut about $70 billion in spending over the next year or so, which economists say will have a slightly negative effect on GDP, not a positive one.

Markets probably would have tolerated the ugly debt battle if it produced something significant. But it didn't. The final deal calls for modest spending cuts now, with more to be determined by the end of the year by a "supercommittee" whose plan is supposed to be binding on Congress. Wall Street doubts that it will be, and is also dismayed by the fact that after all the recent brinksmanship, the biggest fights—over Medicare, Medicaid, Social Security, and tax reform—were left for another day. "When investors took a step back and looked at the deal, it became clear that the long-term debt issues have yet to be resolved," investing firm BlackRock explained to clients afterward. "Investors do not like uncertainty, and being faced with additional rounds of contentious debates over debt issues does not bode well for investor sentiment." In other words: Washington, you blew it. [See editorial cartoons about the deficit and debt.]

There are several things Congress and the Obama White House could do to reassure investors: Start focusing on new ways to create jobs. Try something new to stimulate growth. Show a sense of urgency, and compromise to get something done in a hurry. Above all, politicians in Washington need to stow their doctrinaire ideas about the supremacy of low taxes or the sanctity of entitlements and show some awareness of what's going on in the real economy. Then do something about it.

[See how a debt downgrade would harm America.]

But Congress is now on vacation for a month, and many of Europe's leaders are enjoying their own traditional August holiday. They'll all be back sometime in September. The economy will have to wait.

Twitter: @rickjnewman

  • Check out political cartoons about the economy.
  • See photos of the Obamas behind the scenes.
  • Check out editorial cartoons about the deficit and national debt.