Anyone who has reviewed the hard numbers is aware that the current fiscal path of the United States is completely unsustainable and the surge in government debt and unfunded liabilities will either lead to bankruptcy or long term economic stagnation. In the second, more probably scenario, taxes will be substantially raised and a larger and larger portion of expenditures will be shifted away from discretionary programs (education, infrastructure, technological investment, defense, etc.) towards mandatory domestic spending (entitlements and pensions) and the servicing of debt (interest payments). This will place enormous burdens on an already beleaguered private sector and limit our capacity to invest in education and infrastructure. And almost certainly, the state will rely on inflationary measures to meet impossible financial promises, which history shows is fraught with economic hazards. Or, the nation can establish a sustainable fiscal path by substantially reevaluating and reforming the size, scope and priorities of the state. So, if the need for significant reform is so obvious, why has it not occurred?
Over the long run, balancing the budget, eliminating subsidies and curbing entitlements would result in greater economic health for the nation, but at least in the short run, these measures would increase economic distress, which in a competitive political environment is impossible. Balancing the budget through deep spending cuts and tax hikes would certainly increase unemployment. Much needed reductions in military spending would further increase unemployment by diminishing the demand for goods and services produced by military based industries and decommissioning troops would increase the supply of labor. Ending the war on drugs would save us billions of dollars, but would result in a loss of the relatively high paying jobs that the incarceration industry provides and freed prisons would further expand the supply of labor. Eliminating agricultural subsidies would induce temporary pain for farmers, but would result in a more economically rational market. Gradually reducing subsidies (welfare) for single motherhood would cause distress, but over the long run would result in a reduction of costly social pathologies. Increasing educational subsidies, while decreasing welfare would provide incentives for workers to shift away from economic sector with a surplus of labor (i.e. low wages) towards ones with a high demand for labor (i.e. high wages). Curbing the supply of government subsidized undocumented labor would offer net savings to tax payers, but would impose significant costs on a myriad of industries. Some firms would shift to documented labor, others would invest in automation, while others would wither on the vine.
The most challenging reforms would address the expanded role of the federal reserve, because it would entail challenging deeply entrenched political and economic practices. More than anything allowing for true economic corrections, rather than maintaining a regimen of central planning, economic stimulus and inflation would be an indispensable step in reestablishing a sound economy and currency. For example, rather than seek to bolster the housing market and construction sector, the government could allow for organic market corrections to proceed. This would entail a gradual liquidation of bad debt, the rational reallocation of capital and labor and deflation that would synchronize housing prices with real, sustainable demand. And refusing to bail out moribund (but politically connected) firms, rather than allowing for their liquidation, would cause temporary distress, but re-establish market discipline and curtail nepotism. Contrary to popular narratives, most firms that become bankrupt through ill management do not disappear, but are rather bought up by more competent investors.
The most (seemingly) radical proposal would be to allow for market forces, rather than central planning to determine interests rates. Rather than maintain interests rates below inflation to spur unsustainable spending, market forces would drive up interest rates, providing incentives for a debt ridden public to increase their savings rate. When aggregate savings sufficiently increased the supply of available capital, market forces would drive down interest rates and create incentives for investment. This would simultaneously increase the demand for investment capital (loans), while temporarily limiting the incentives for savings. This would surely induce painful corrections across the economy, but over the long run would spare the American people from disastrous government created bubbles, booms and busts. More than anything, allowing for a shift away from over-consumption and debt towards saving, investing and production, would create a more sound and sustainable economy. For, it has become abundantly evident that a consumer, rather than a producer driven economy is not the path to long term prosperity.
All those who journey down unsustainable paths must sooner or later acquiesce to the need for change. The questions is not if, but rather in what manner will economic reform be pursued. A study of history shows that reform can be undertaken over time in a measured fashion or by shock therapy. In the former, forward thinking leaders directly confront fundamental economic ills and over time enact painful, but needed reform. In this scenario, the government is able to act with foresight, rather than react to increasingly destabilizing economic corrections. The best example is China; starting in 1978, Deng Xiaoping and more forward thinking factions of the communist party assessed that in the long run their economic path was unsustainable and began 30 years of gradual, yet significant economic reform. While the Chinese government merits harsh criticism for its abysmal human rights record, it has presided over a continuous economic boom that has raised the living standards of millions of its citizens and allowed it to become one of the main financiers of the American government's spending binge.
However, in most cases, a nation demonstrates an unwillingness to confront and reform unsustainable economic and fiscal paths. Rather than allow for needed market corrections and austerity measures, the government opts for expanded state intervention in the economy (stimulus measures, manipulation of interest rates, expansion of the money supply, etc.) which at best forestalls the inevitable. Eventually the day of reckoning arrives and the severity of the market distortions and the debt overwhelms the capacity of the state, forcing it to finally enact needed structural reforms. But, unlike its forward thinking compatriots, they do not have the luxury of pursuing proactive, measured reforms, rather they are forced to enact reactive, emergency measures. Owing to the swiftness and severity, such measures can be dubbed "shock therapy." The most prominent example is Chile. In 1973, Chile was ravaged by massive inflation (700%), huge government deficits and a shortage of basic goods and services. The military junta was faced with the choice of pursuing half measures that would at beast result in continued economic sickness or pursue bold economic reform. They chose the latter, they sharply reduced government spending, curtailed the money supply to bring inflation under control, privatized hemorrhaging state enterprises, eliminated subsidies, opened up Chile to foreign trade and investment, etc. This shock therapy resulted in an immediate rise in unemployment, a sharp drop in production and a decline in living standards. But, over time the reforms bore fruit and Chile is now the most stable, prosperous and least corrupt nation in Latin America. In contrast its neighbors that failed to undertake measured reforms or shock therapy now languish in relative economic and social malaise.
The Obama Administration's continued reliance on Keynesian (stimulus) measures leads me to conclude that they lack the insight or will to pursue measured structural reforms. I predict that we will only begin to seriously address our fundamental fiscal ills when our foreign creditors cut us off or substantially raise the cost of borrowing. Or, worse yet, when foreign governments abandon the dollar as the de-facto global currency. At that point we will be forced to react, most likely in the form of wide reaching economic, political and cultural shock therapy. While I dread this prospect, perhaps we have reached the point were only a significant shock will awaken us from our half century of statist somnolence and insatiable sense entitlement.
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