FORBES- Luis Rubio
How times change! Years ago, the quip that financial market operators chuckled over was that “Latin American countries are geometric because they have angular problems that are discussed at roundtables by large numbers of square people.” In recent months the same can be said of the U.S.
The financial situation of that country is pathetic and highly dangerous and, nonetheless, its population as well as its politicians act as if there were no problem at all: The reason there is no sense of urgency is that its debt is denominated in its own currency (the dollar), thus they are not confronting an imminent devaluation. In Mexico’s case, between the seventies and the nineties, the fiscal disequilibria in which we incurred translated into acute devaluations that exerted the effect of raising the value of the debt suddenly and disproportionately.
Under infinitely less serious conditions, Mexico had no alternative: the crisis obliged us to carry out an adjustment that would restore stability. With a high debt denominated in dollars, the devaluations led to economic collapse. Achieving the stabilization of expectations from the end of the nineties was no small feat, even though it would not be sufficient for a strong recovery. The Americans have not lived through a crisis of that nature, which has allowed them the (dubious) privilege of thinking that they can steer clear of a deep fiscal correction.
Financial disequilibria are unsustainable because they absorb the society’s resources that, were there none, would be devoted to consumption and investment. More importantly, sooner or later the creditors of the debt will refuse to continue financing the deficit, which will trigger a severe rise in interest rates and defaults or other responses, which could include exchange controls. While it perhaps would last longer than what happened in Mexico, the disequilibria will eventually force an adjustment and will cause a downturn in economic activity. Under distinct circumstances, that is what is happening in Europe. Eventually it will happen in the U.S.
Despite this obviousness, the discussion in the U.S., where in recent weeks they’ve been playing hide-and-seek about the matter, is concentrated on what Walter Russell Mead calls “ideal models” that suffer from the lack of any realism whatsoever. For this observer, the Republicans live in the era of the end of the XIX Century –low taxes, high growth, limited governmental participation in the economy- while the Democrats inhabit the world of the fifties of the past century: growing social programs with a demographic pyramid capable of financing them. For Mead both are out of sync with today’s world in which the expenditure is excessive and the retired population grows rapidly, all artificially financed by the Federal Reserve.
Perhaps the most important question would be why, under similar circumstance (at least conceptually), Mexico had to carry out monumental adjustments, while the Americans haven’t? Just for illustration, in the eighties, Mexico’s entire governmental expenditure diminished by nearly 12 percentage points with respect to the GDP: a brutal adjustment in public finances. It’s not that Mexican politicians or the expenditure’s beneficiaries were happy about it: the reason for its happening was that there was no alternative. It was adjustment or chaos.
But that’s not how it’s perceived in the developed nations that today exhibit disequilibria even greater than those characterizing Latin American nations in the eighties. The privilege of not confronting an immediate crisis has led the politicians of those nations (and their populations) to think that the party can last forever and that there is no cost or consequences for incurring enormous deficits or reaching debt levels higher than their total GDP. That notion that there are alternatives and that the public expenditure can continue to rise is so generalized that it should scare us all. As Any Rand noted at some point, “You can avoid reality, but you cannot avoid the consequences of avoiding reality.”
And just what could these consequences be? The first and most obvious is that the longer society’s resources are re-routed to finance the deficit (identical whether via taxes or greater debt) the less (or negative) the economic growth and the greater the unemployment. In societies with growing populations of retirees this may not be perceived, at least at the short term, as very alarming, but in younger societies, such as those of Spain and Greece, the impact is dramatic and can be appreciated in unemployment rates of over 50% among the young.
Perhaps the worst implication of phenomena such as the “fiscal cliff” or the “sequester” is not an immediate economic matter, but rather the fact that governments have ended up crippled by the enormous amount and power of the myriad interest groups that prey on the budget, that pay no direct taxes, and that expect attention exclusively to their interests. That is, the grand theme is that of governability: how to solve basic problems in the face of such powerful interests.
Evidently there are solutions to fiscal problems that are currently exhibited by developed nations. In technical terms it is not difficult to envision the areas on which the adjustments could be concentrated, nor would it be difficult to identify the costs of budgetary cuts or changes in taxes with respect to others. But, as depicted by the case of the VAT in Mexico, the matter is not economic but rather political. The sole reason that Mexico’s public expenditure was able to be cut so drastically in the eighties was that the circumstances –the reigning economic chaos- made it inevitable.
And even so Mexican politicians did not learn: it took an additional decade –and another mega-crisis, this one in 1994, for the need for macroeconomic stability to be accepted as a requisite condition for economic functioning. Evidently, the stability of fiscal checks and balances cannot be an end in itself, but our experience demonstrates it to be a conditio sine qua non.
I’d never thought that governability –in this case depicted in the fiscal ambit- derives from factors that make it inevitable to act. Mexico has demonstrated an enormous capacity for response when it has no options. The problem of the developed countries is that they think that they do have them.
@lrubiof