Which Country’s Economy Will the U.S. Economy Resemble in 12 Years?
I wish I were writing about vacation options for Americans looking to go abroad given the strong Dollar and an increasingly unlikely “Grexit.” But I am not. Instead, I am exploring the implications of the disturbingly strong parallels between the U.S. economy in 2008-2009, on the one hand, and Sweden’s economy circa 1994 and Greece’s economy circa 1990, on the other hand.
Sweden and Greece represent a modern “A Tale of Two Cities” on a national scale. Although they toed the same starting line in the 1990s, they have run two very different races. Sweden has surged into one of the world’s strongest mature economies. Greece, by contrast, has led the race to the bottom from start to finish, completely self-destructing as an economy in roughly 18 years. The U.S. is about six years into our own debt-driven economic Odyssey. Given that “[t]he history book on the shelf is always repeating itself,” the only question is whether the U.S. is going to look more like Sweden or Greece 12 years from now.
The Starting Line
In 1994, Sweden began to emerge from the worst recession in its history. It had borrowed heavily during the recession and faced an unprecedented debt-to-GDP ratio.
In 1990, Greece was recovering from its 1987 recession and experiencing low and uneven economic growth. Its GDP was flat in 1990. Like Sweden, it had borrowed heavily during its recession, driving its debt-to-GDP ratio to historically high levels.
Does this sound all-too-familiar? In 2008-2009, the U.S. went through the Great Recession. By the time the Recession was technically over, our debt-to-GDP ratio reached heights not seen since WWII and its aftermath.
As the table below illustrates, when the U.S. emerged from the Great Recession, we were in even worse shape than Sweden in 1994 and Greece in 1990, and our debt level was already unhealthy according to one leading economic measure.
Figure 1: Unhealthy Debt-to-GDP Ratios in 3 Economies Source: www.tradingeconomics.com.
5 Years Later
Since 2009, our trajectory has closely mirrored Greece’s, rather than Sweden’s. The chart below shows that the U.S. and Greece continued to borrow heavily after their debt-to-GDP ratios eclipsed 70%, whereas Sweden focused on reducing the relative size of its debt. As a result, the U.S. is now carrying a dangerously high level of debt that is undermining our growth:
Figure 2: Post-Recession Debt-to-GDP Ratios Source: www.tradingeconomics.com
Where Are They Now?
Sweden has become one of the world’s leading mature economies. Its current debt-to-GDP ratio is a very healthy 44%. It grew at a 3% annualized rate in Q2 2015. It has averaged 2.56% growth since 1994 and, during that time, it has experienced four sustained intervals of 4%+ growth. Over this period, its average wages have risen substantially, from $28K/year in USDs to more than $40K/year (adjusted for inflation). Although its current unemployment rate is 8.5%, its average rate over the past decades has been 5.9%.
How did Sweden achieve this enviable track record? Broadly speaking, it focused on reducing government spending, reforming its tax system, and increasing competition. In particular, Sweden reduced its entitlement spending, substantially reduced its income tax rates while indexing other taxes to inflation, expanded its earned income tax credit, and increased flexibility in its labor markets. It also steadfastly rejected the use of borrowed funds to engage in stimulus spending. Today, Sweden is viewed as one of the leading lights in the world’s mature economies.
Greece is reeling and probably has not reached rock bottom. Its economy has collapsed. Its current debt-to-GDP ratio is 177%. It has been in an almost continuous recession since 2008, when its debt-to-GDP ratio hit 105%. Although its economy has grown at an average rate of 1% rate since 1996, that growth was achieved almost entirely through deficit spending, and that chicken has now come home to roost with a vengeance. Even with its positive average yearly growth since 1996, average wages have been virtually flat during that period. Moreover, its unemployment rate has averaged over 14% during that time, and stands at 25% today. The economic collapse has, predictably, produced social unrest and mass emigration. Today, Greece is in a self-reinforcing downward spiral from which it may not be able to escape.
Where will the U.S. be in 12 Years?
When people compare the U.S. and Greece today, it is not because we are both cradles of western democracy. Rather, it is because we are two of the six most indebted nations in the world.
Since the Great Recession, our debt level has exploded at a faster pace than Greece’s exploded during the 1990s. We are now just a few percentage points away from the debt-to-GDP ratio that Greece attained when its economy began collapsing, and we’ll get there in no more than 2 years. Despite all its borrowing, Greece has achieved very little average growth. Similarly, since the Great Recession, the U.S. GDP Growth Rate has stubbornly hovered around 2%, notwithstanding our incessantly increasing debt. Debt did not produce a rise in average wages in Greece. The same is true here. For 60% of earners in the U.S., wages have not increased for decades. When it comes to macro-economics, it literally is “Greek to us.”
It took Greece 18 years to self-destruct after its debt-to-GDP ratio hit 70%. Since we appear to be on roughly the same schedule, this means we have about 12 years to get our economic act together as a country. Will we?
The central lesson from the Sweden and Greek experiences is that the U.S. must break its addiction to debt. We spent 35 years reducing our debt level after WWII, only to see it rise through the mid-1990s, fall briefly, and then begin its rapid rise to its current atmospheric level. ABBA
succinctly described the U.S.’s tortured love affair with debt when they sang:
“I’ve been angry and sad about the things that you do I can’t count all the times that I’ve told you, we’re through And when you go, when you slam the door I think you know that you won’t be away too long You know that I’m not that strong.”
We need to be strong and take our medicine while there is still time. We have an $18 trillion debt that has been increasing by almost $1 trillion every year since 2000. At some point, perhaps in the next 12 years (as recent history suggests), our debt level will become unsustainable, even for an economy as large and dynamic as ours. And when this happens, the consequences will be catastrophic, as the Greek drama unfolding before our eyes demonstrates.
We need it. And more. The other central lesson from the Sweden experience is that we need pro-growth policies and reforms in the U.S. We must increase our GDP Growth Rate, which has many salutary impacts, including increasing tax receipts. We cannot restore our debt to sustainable levels, even if we actually reduce our aggregate debt, without also achieving meaningful growth. If we hold our debt constant at $18 trillion (i.e., consistently balanced our budget), and our roughly $18 trillion dollar economy grew at 2.5% annually (roughly Sweden’s performance for the past 18 years), it would take over 20 years to achieve a much healthier debt-to-GDP ratio of 60%. If we cut our annual deficit to $250 billion (roughly a 50% reduction from current levels) and grew at 3.5% a year, it would take us 6 years to get our debt-to-GDP ratio below 90%. In short, we have to do even better than Sweden in generating growth because we are trying to dig out of a much deeper hole.
This focus on growth does not mean that we need to sell our soul as a country. Sweden did not pursue growth at all costs, and we need not do so either. Sweden’s budget reform was shaped by five values: competition; openness; efficiency; social welfare; and environmental protection. In the U.S., we could adopt our own similar list if (hold your breath) the political parties would focus on the values that unite rather than divide America.
It Could Happen
It’s unlikely that the parties will collaborate on deficit reduction and pro-growth policies, but it could happen. There have been episodes where the parties have forged sustainable agreements on major policy issues for the long-term benefit of the U.S., such as the policy of Containment and the entitlement reforms enacted under President Reagan.
Unfortunately, it is just as likely that the U.S. will turn into a much larger Greece.
Now, I know many of you are saying: “Wait just a minute. There is no way we will ever turn into Greece. We have a real economy — Silicon Valley, Boeing, GE, Caterpillar, Berkshire Hathaway. We work. People pay taxes. We are the center of global finance. We have the world’s reserve currency. Everyone wants to live here. Our politicians are terrible, sure, but you can always count on the U.S. to do the right thing after trying everything else first.”
These are all accurate observations as of today. But I’ll also point out that some version of these statements was previously uttered by each of the Romans, the French, the Spanish, and most recently, the Brits. And the world changes, often unpredictably, in the blink of an historical eye:
- Did anyone in Britain predict the imminent (in historical terms) collapse of the British Empire shortly after the victory over Germany in WWI?
- In the 1980s, did anyone predict Japan’s imminent slide into not one, but two consecutive “lost decades”?
- Did anyone predict the rise of al Qaeda and catastrophic terrorist attacks on U.S. soil when Jimmy Carter was sworn in? When the Beirut barracks were bombed? When the Berlin Wall fell?
- Who understood the eventual importance and omnipresence of the Internet when President Nixon resigned? When President Reagan proposed SDI? When President Bush kicked Iraq out of Kuwait?
We should not be overly sanguine that our politicians will have the foresight and resolve to get us off the debt-driven bullet train that is hurtling us toward the Greek station. Nor should we simply assert that “it cannot happen here” because we are the greatest country on earth. In fact, there is a very famous book written about countries that previously said “it cannot happen here.” It is called “The Rise and Fall of the Great Powers”
by Paul Kennedy. If you haven’t dusted it off recently, you’ve got about 12 years to read it before Mr. Kennedy has to add a new chapter.