The Economy: "Why The US Is Worse Off Than Greece"

"Why The US Is Worse Off Than Greece"

by Tim Hanson

"Little old Greece made news again this week following the announcement of a $145 billion rescue package for the country (courtesy of the EU and IMF). Although this money will see the country through its May 19 debt maturities, the bond market remains skeptical of Greece's long-term solvency. And rather than solve for the market's worries, it seems to have actually exacerbated them. That's because investors, due to the tightened ties between Greece and Europe, now fear contagion - a series of sovereign defaults in countries such as Portugal and Spain that would threaten the economic stability of the entire region.

The plan! The plan! Standing between the present and that looming financial apocalypse is Greece's "Economic Policy Program relating to the Eurogroup and IMF support mechanism." This, more succinctly, is Greece's austerity plan - the measures it needs to put in place to get its debt and deficit under control and remain eligible for EU and IMF loans - and it is aggressive.

Here, however, is the good news. Unlike most government plans (I'm looking at you, U.S. federal budget), Greece's plan is front-loaded and based in realistic assumptions. This isn't to say Greece won't encounter resistance or even that it will ultimately be able to pull it off, but rather that the plan, at the very least, is not doomed from the outset. Greek austerity efforts are forecast to be a whopping 9% of GDP in fiscal 2010 and aim both to cut spending and raise revenue. On the revenue-raising side, Greeks can expect an increased VAT tax, increased sin taxes, a widened tax base on property and luxury items, windfall taxes on profitable businesses, and a major crackdown on tax evasion. It's this last effort that has the potential to move the needle most for the Greek budget. The Greek government at present collects just 4.7% of GDP in personal income tax - a little more than half of other European countries despite comparable tax rates.

In terms of spending cuts, the country is staring down freezes and cuts in public sector salaries, allowances, and pensions as well as restrictions on procurements. For a country that sacrifices up to 8% of its GDP annually to nepotism, cronyism, and bribery, according to Daniel Kaufmann of the Brookings Institution, this could also make a real difference.

In most cases, of course, these plans and projections would be just about worthless. That's because most governments build their financial models from ridiculous assumptions. Take, for example, the U.S. government budget for fiscal 2011. Its 10-year deficit reduction goal is a relatively modest $1.2 trillion, which would cut our annual deficit from 5% to 4% of GDP annually. Yet even this forecast is based on a real GDP growth forecast of 4.3% in 2011, 4.3% in 2012, and 4.2% in 2013. To put this in context, the U.S. has not sustained better than 4% GDP growth for three years since the three-year period ending 1999. You may remember that as the top of the dot-com bubble - a temporary boom that ended as a ridiculous bust. Prior to that, it was the three years ending 1985. In other words, maybe we're due. More likely, the federal budget is far too optimistic. As Christina Romer, head of the White House Council of Economic Advisors, said in a live chat at the time of the budget release, "all forecasts have to be understood to be subject to substantial margins of error."

And yet! Despite this acknowledgment of substantial potential margins of error, our country is staring down serious financial consequences should we not sustain 3.3% annual GDP growth between now and 2020. In fact, according to the sensitivity analysis included in the White House's own budget, we will add more than $3.1 trillion to the national debt should annual GDP growth through 2020 check in at 2.3% - just one percentage point lower. How likely is this to happen? After all, 3.3% real annual GDP growth is roughly the historical U.S. average.

According to a recent paper from the Bank of International Settlements, GDP growth falls one percentage point annually when a country's debt reaches more than 90% of GDP. The U.S. is currently at 87.3%. That number will be over 90% by the end of this year or next, making 2.3% GDP growth over the next decade much more likely than 3.3% GDP growth given that 3.3% was the average when the country was not weighed down by debt. This fact, if you're concerned about fiscal responsibility, should have you headed to the restroom. And it just goes to show how so many well-intentioned government plans are doomed by optimistic, unrealistic assumptions."

- http://www.fool.com/investing/international/2010/05/06/why-the-us-is-worse-off-than-greece.aspx?source=ihpdspmra0000001&lidx=4

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