As members of Congress spar over whether to raise the U.S. debt ceiling, they might consider the efforts of other governments to manage their own debt problems. Some have been successful — some not — but all their experiences are instructive, with lessons for Washington.
Take Canada. Back in 1993, it was burdened by a government debt comparable to almost 70 percent of the country's gross domestic product (GDP). Government overspending had left the country with a big budget deficit. Moody's Investor Service put Canada on a "credit watch" because of the high debt-to-GDP ratio. In an editorial, The Wall Street Journal mocked the Canadian dollar as "the peso of the north," while another Journal article suggested that Canada was on its way to becoming a third-world country.
"Both were exaggerations," says David Henderson, a Canadian-born economist now teaching at the Naval Postgraduate School. "But it was scary to a lot of Canadians."
In response to the growing outcry, the Canadian government, led by the Liberal Party, took action. Spending was slashed. Government assets were privatized. Some taxes were raised.
The effort was successful. As of last year, the debt-to-GDP ratio in Canada stood at just 34 percent. The Canadian economy is growing, and the unemployment rate is almost two points below the U.S. level.
Canada's lesson for the U.S.: When faced with a debt problem, act promptly and decisively to confront it.
Timely government action, of course, may be easier in a country with a parliamentary system like Canada's. Because the prime minister also serves as the leader of the ruling party, there is no divided government such as exists currently in Washington.
"The downside of a parliamentary system is you can get a lot of bad policy quickly," says Henderson, "[but] the upside is, you can get a lot of good policy quickly."
Stay Ahead Of The Problem
Another country struggling with a big debt problem is the United Kingdom. The conservative-led government that took office there last year promptly cut spending and increased taxes in an effort to bring its debt under control and reduce its deficit. International rating agencies were pleased, and the country kept its AAA credit status.
"The good part of the U.K. story is that they tried to get ahead of the problem and undertake some austerity before the financial markets started pushing up their interest rates," notes Simon Johnson, a senior fellow at the Peterson Institute for International Economics.
Another lesson for the United States: It's much better to be ahead of the problem than to fall behind it.
The case of Spain illustrates what happens when that principle is ignored.
"The big mistake Spain made was just to dawdle over the structure of reforms for months and months and months and months," says Gayle Allard, an economist at the Instituto de Empresa in Madrid.
The Spanish experience, as opposed to Canada's and Britain's, shows clearly that dawdling and political squabbling will hurt a country with a debt overhang. Investors in financial markets conclude the government is not serious about getting the deficit under control. The credit rating agencies downgrade the government's debt. It becomes harder to get banks to loan the government money.
"Once markets turn against you, it's too late," says Allard. "Your interest rates are up and you've got higher borrowing costs."
The higher a government's borrowing cost, the harder it becomes to make interest payments and reduce the debt. That's part of Spain's problem now.
But it's not all. The Spanish economy has gotten smaller. This is a debt issue for Spain, because a country's debt weighs much more heavily when its economy is not growing. The richer a country, the more debt it can handle. The more its economy shrinks, the more its debt becomes a burden and the harder it becomes to repay it. This is why the key measure of a country's debt burden is its debt-to-GDP ratio.
"You want to get it down by a combination of reducing debt but also growing GDP," advises Kemal Dervis, a former economics minister in Turkey and now a senior fellow at the Brookings Institution. Dervis and other pro-growth economists argue that countries faced with high debt-to-GDP ratios sometimes put too much emphasis on reducing debt and too little on boosting economic growth in such a way as to make the debt more manageable.
"The name of the game for fiscal sanity is economic growth," says Irwin Stelzer, director of economic policy studies at the Hudson Institute. "You can't just slice your way and cut and cut and cut without stimulating economic growth."
India, a country that just a few years ago was burdened by heavy debt, is well on its way to growing out of the problem, thanks to a booming economy. Spain, on the other hand, is falling behind, in spite of aggressive efforts to cut government spending.
Britain could soon face a similar problem, if the spending cuts and tax increases take so much money out of the economy that growth will be hampered.
"I do believe that Britain has a serious debt problem and so I'm sure that [austerity] efforts are required," says Dervis, "but one has to look at both the growth side and the debt side simultaneously."
Indeed, Britain, could prove to be another test case for the proposition that debt reduction efforts in some cases actually make it harder for a country to grow its way out of a debt hole.
"The jury is still out," says Simon Johnson of the Peterson Institute. "It remains to be seen what happens to the economy, what kind of adjustment they get."
In sum, here are some lessons gleaned from debt reduction efforts around the world:
- Act swiftly and boldly, if possible.
- Stay ahead of the markets, lest they turn on you.
- Aim not only to shrink the deficit, but also to grow the economy simultaneously.
And remember that economics is never separated from politics. If you really want to impress the markets and insure a good credit rating for your country, build broad political support for whatever program you want to implement.