Coming home from my Italian vacation this year was an abrupt transition. From the calm waters of southern Sardinia, I was plunged into the global economy’s stormy seas. Financial markets were plummeting, driven by pessimistic growth forecasts in Europe and America. Investors were fleeing for safety pretty much everywhere. Systemic risk—the statistical likelihood of outright economic collapse—was rising. Yields on Italian and Spanish sovereign debt were climbing into the danger zone, threatening to fly out of control. America was on the verge of a technical default on its sovereign debt.
Weeks later, the fear in the markets is only growing worse. It comes in part from a large and still-incomplete market correction. But more than that, the policymaking bodies of Europe and the United States seem paralyzed. On both sides of the Atlantic there are unsettling similarities. In the face of very clear—and admittedly difficult—challenges to restore fiscal stability and stimulate medium- and long-term growth, government response is in various states of gridlock and denial.
In response to Washington’s dysfunction on the debt issue, Standard & Poor’s downgraded America’s credit rating (prematurely, in my view). Nevertheless, the markets have not abandoned U.S. bonds. For one thing, big investors like China have no practical alternative. For another, the risk still isn’t all that high. But trouble is deepening around the world. Equity prices are dropping as growth falls away or is threatened. Employment is stagnant, and policy processes are stuck. Fears of a global downturn are rising; some view it now as a near certainty. Jobs will be a major casualty, especially for the young. Even in the emerging economies, growth seems likely to suffer. Prospects for improvement seem remote.
And why has the focus of the policy debate in Washington borne so little resemblance to what most Americans seem to want? Traveling around the United States on a book tour in May and June, I spoke with many people who wanted nothing more than a coherent bipartisan plan—a plan that would focus on the future, on employment and growth. They recognized that getting there would take sacrifices. Polls suggest that many Americans share that desire. And yet in Washington the legislative process has not produced anything like that kind of consensus.
Some observers argue that Americans are looking for a solution that simply isn’t feasible. Others say the country’s philosophical disagreements over economic priorities are so large that compromise is practically impossible. Both views may contain some truth. But the real sticking point seems to be something other than the economy: the size and role of government. Fiscal stabilization is only the battleground, not the objective. Jobs and economic growth are related only tangentially to the policy debate.
There’s another problem, too, and it’s not confined to the United States. Enabled by a combination of public and private debt, much of the Western world has been living far beyond its means for at least two decades. By now the pattern has embedded itself deep in the expectations of people who have come to see it as normal. But it’s no longer sustainable.
To restore a stable pattern of inclusive growth—the kind that truly lifts all boats—the first step is to reduce the debt loads in these economies, not suddenly but systematically. That alone won’t be enough. Consumption and government services will have to be reset downward, replaced by public and private investment that is funded by domestic saving. The path we’ve been on is blocked; we need to take a few steps backward to be able to go forward again. Nevertheless, this harsh truth has not yet been accepted by governments or electorates. Instead we appear to be clutching at our past standards of living, hoping for a vigorous but delayed cyclical recovery. The unemployed are the ones paying for this strategy.
The world is at a crossroads, with popular expectations diverging from reality. With luck, our policymakers may become more bold and focused, leading toward a more balanced and durable growth pattern. That is the hope. Still, it could go the other way—bickering our way into a relatively stagnant future, fraught with political and social conflict and inequities.