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Raghuram Rajan
Raghuram Rajan
Raghuram Rajan is professor of Finance at the Booth School of Business, University of Chicago.
Washington and the art of the possible
Debt-deal proves politicians should be lauded for being loyal to their constituents, not lambasted for being untimely.
Last Modified: 10 Aug 2011 10:10
President Obama and Speaker Boehner debated heavily before finally coming to a compromise [EPA]

These days, the United States media are full of ordinary Americans venting their rage at the incompetence and immaturity of their politicians. Even though the US government's debt limit was raised in the nick of time, the process was - and remains - fraught with risk. Why, the public asks, can't politicians sit down together like sensible adults and come up with a timely agreement that commands broad consensus? If we can balance our household budgets, they ask irately, why can't our political leaders?

The reality, though, is that US politicians reflect the views of the American electorate – views that are fundamentally inconsistent. The absence of broad consensus is no wonder. Indeed, the last-minute agreement to raise the debt ceiling is proof that the politicians did what they were sent to Washington to do: represent their constituencies and only compromise in the interests of the country as a whole.

The key question is whether the political gridlock exposed by the debt-ceiling debate will worsen in the run-up to the 2012 presidential and congressional elections - if not beyond. That is possible, but we should not overlook cause for hope in what America's politicians just accomplished.

Income and age

Let's start with why the electorate is so polarised. There are two key divisive factors: income and age. Income inequality has been growing in the US over the last three decades, largely because the labour market has increasingly demanded skills that the education system has been unable to supply. The everyday consequence for the middle class is a stagnant paycheck and growing employment insecurity, as the old economy of well-paying low-skilled jobs with good benefits withers away.

Until the financial crisis, the easy availability of credit, especially against home equity, enabled the middle class to sustain higher consumption despite stagnant incomes. With the collapse of the housing bubble, many people lost their jobs and health insurance, risked losing their homes, and suddenly had little reason for economic optimism. The response from America's Democratic Party, which has traditionally represented this constituency, was to promise affordable universal health care and more education spending, while also protecting government jobs and entitlement programs.

When added up, such spending is unaffordable, especially with current federal revenues at just 15 per cent of GDP. The solution for many Democrats is to raise revenues by taxing the rich. But the rich are not the idle rich of the past; they are the working rich. To balance the budget only by taxing the rich will require a significant increase in income taxes, to the point that it would lower incentives for work and entrepreneurial activity considerably.

This is not to say that taxes on the rich cannot be increased at all; but such increases cannot be the primary way of balancing the budget. Republicans, trying to give voice to many working Americans' ambient uneasiness with rising government expenditures, as well as to the growing anger of the working rich, find it easier to defend a principle than a particular constituency. Hence their mantra: no additional taxes.

The neat divide based on income is muddled by the elderly. It is understandable that older Americans who have few savings want to protect their Social Security and Medicare benefits. However, even elderly Tea Party Republicans, who are typically against big government, defend these programmes because they view them as a form of property right, paid for when they worked.

In truth, rising life expectancy and growing health-care costs mean that today's elderly have contributed only a fraction of what they expect to receive from Social Security and Medicare. The government made a mistake in the past by not raising taxes to finance these programs or reducing the benefits that they promised. Unless the growth of these entitlement programs is curbed now, today's young will pay dearly for that mistake, in the form of higher taxes now and lower benefits when they are old.

But the elderly are politically active and powerful. Not only do many defend their entitlements strongly; some oppose growth in other types of public spending for fear that it will weaken the government's ability to pay for the benefits that they believe they are owed.

The roots of America's fiscal impasse

These then are the roots of America's fiscal impasse, which has produced passionate constituencies viscerally opposed to compromise. Any political deal significantly before the debt-ceiling deadline would have exposed politicians to charges of betrayal from their constituents. And, given that President Barack Obama would ultimately be held responsible for a default, he needed the deal more than the Republicans did. So he had to coerce his party into accepting a deal full of spending cuts and devoid of tax increases.

Will the deal deliver what it promises? A bipartisan committee has to propose $1.5 trillion in deficit reduction by the end of this year, and Congress must either accept that proposal, or see immediate, politically painful expenditure cuts, which would include defense spending - an area that America's Republicans care about strongly.

If this structure works as advertised, Congress will be forced to reach a compromise, which can be sold once again by politicians to their polarised constituencies as being necessary to avoid a worse outcome. This time, Obama's Democrats will be on a level playing field, because both parties will be held equally responsible for a failure to reach a deal.

Ultimately, the big necessary decisions on curbing entitlement growth and reforming the tax code will probably have to wait until after the next election, giving the divided electorate an opportunity to reflect on its own inconsistency and send a clearer message. In the meantime, US politicians might have done just about enough to convince debt markets that America's credit is still good. For that, Americans - and others around the world - should stop pillorying them and give them their due credit.

Raghuram Rajan, a former chief economist of the IMF, is Professor of Finance at the University of Chicago's Booth School of Business and author of Fault Lines: How Hidden Fractures Still Threaten the World Economy, the Financial Times Business Book of the Year.

A version of this article was previously published on the Project Syndicate.

The views expressed in this article are the author's own and do not necessarily represent al Jazeera's editorial policy.

 

Source:
Project Syndicate
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