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The Bankrupting of America.

The Bankrupting of America is an urgent message sent to Americans and the United States government on how the federal budget is impoverishing the nation. In the introduction, the author points out three basic arguments: deficits don't matter, deficits could easily be cured by spending less, deficits could easily be cured by raising taxes. According to the author, America's fiscal deficits do matter a great deal. The crisis is very deep and has been gathering for a long time. Step by step since the 1960s, Presidents and Congresses have taken the decisions that have accumulated huge imbalances. Cutting spending is not easy. The United States has spent a significantly higher proportion of its GNP on the military than its major economic competitors. On the other hand, demographic trends will greatly increase the costs of pension and health care. Raising taxes is not easy either. It would require changing the amount and direction of public spending, the incidence of taxation, and the general balance between public and private sectors.

Chapter 2 defines fiscal deficits and describes their consequences. According to the author, a fiscal deficit is a result of the compromise between Presidents and Congresses because they are unable to reach a consensus on spending and taxes. A fiscal deficit can be financed in three ways: domestic borrowing, foreign borrowing, and creating money. Higher government domestic borrowing can push up interest rates and crowd out the private borrowers. Foreign borrowing might transfer wealth and potential employment abroad causing the "twin deficit:" fiscal deficit and current account deficit. Financing deficits through inflation by creating new money not only monetizes the government's new debt, but by depreciating the value of money, reduces the weight of old debts as well. However, in catching up with increases in money supply, merchants will push up prices, workers will demand higher wages, and the national economy will get caught in an inflationary spiral which will continue to a hyperinflation and a collapse of the currency.

Chapter 3 describes the federal spending since 1950 with an analysis of military and civil spending. Chapter 4 compares the fiscal policies of the United States, France, and Germany. All three countries have had serious fiscal problems. A good part of Europe's larger government outlays are in the form of direct transfers to private households such as education, pension, health care. . . . These transfers help to explain the European public's willingness to accept much higher tax levels. Since World War II, the United States has spent more relative on defense because it has assumed a more ambitious geopolitical role than either France or Germany. In addition, the American outlays for health care are higher than France or Germany due mostly to its inefficiency. During the 1980s, the American economy faced the twin deficit while the German current account was in surplus and the French account was in rough equilibrium. Chapter 5 analyzes taxes and incomes in the United States. America's taxes are the lowest among developed countries. However, American federal outlays fail to provide the taxpayer with public goods at an European level. Moreover, American median family income adjusted for inflation, stagnated after 1973 and shrank rather sharply with the 1980s depression. In any event, raising taxes, under present circumstances, would mean a real decline in America's standard of living.

Chapter 6 presents the way we are financing the deficit. Since World War II, the United States has been the global system's principal leader. On the one hand, a hegemonic power often benefits less from a liberal system than other powers who participate in it. "Free riders," i.e. Japan and European countries, profit and grow relatively stronger as the hegemon grows relatively weaker. On the other hand, the United States has been seizing financial advantage from its international position to sustain the expensive military forces that have kept the liberal global order secure. The Bretton Woods agreement allowed the United States to act as the manager of the world's reserve currency, the United States therefore could make profits by issuing credit in excess of its own reserves. In effect, the United States owned a paper gold mine. The Nixon formula suspended the gold exchange standard and made the dollar's fall inevitable. Chapter 7 analyzes fiscal deficits, public goods, and the real economy. The Reagan formula's combination of big fiscal deficits and tight money mean high real interest rates that squeezed profit margins. It also made for a high dollar that kept import prices down, so that American producers could not raise their prices. American firms shifted their operations abroad, restructured, or went out of business. Productivity and incomes lagged relative to Japan and most Western European countries.

Chapters 8, 9, and 10 can be combined as one chapter to present the author's solution to "rebalancing America." With the collapse of the Soviet Union, America's geopolitical role needs reconsideration. With the establishment of the European Community, the United States will no longer be in the same geopolitical position to command capital from its old allies. Only fundamental changes in policy can dissolve the malign syndrome slowly dragging down the American economy. The United States needs policies to set an environment for American business to surmount the technological and industrial challenges. To reach fiscal balance will certainly require higher taxes, but to get them the federal government will need to spend more on the civil sector in ways that improve the country's productivity. Military spending has to be decreased. We can no longer afford to assume the protector's role while our allies worked in the economic sphere to advance their own competitive position against us. David P. Calleo is Dean Acheson Professor and Director of European Studies at the Nitze School of Advanced International Studies, The Johns Hopkins University. The Bankrupting of America is a significant contribution to the debate on the fiscal deficits. All political candidates, all students of politic science and economics must read this book. I agree with the author that deficits are our serious problems and that we need fundamental changes in our policy to get rid of the structural fiscal deficits. There are, however, some things that need to be clarified.

First, there are "good" deficits and "bad" deficits. Good deficits are the government's planned deficits in order to stimulate the economy during recession through government spending. Deficit spending may also is an automatic stabilizer built into government tax and spending programs. When unemployment rates are high, government tax revenues fall while expenditures for unemployment insurance and other benefits increase.

Second, empirical studies prove that there is no direct correlation between the size of the deficit and interest rates. In fiscal year 1972 net deficit of federal, states, and local governments was $11.1 billion and the prime rate was 5.3%; in FY 1973 the net deficit fell to $5.7 billion but the interest rose to 8.0%; in FY 1974 there was a net surplus of $1.2 billion but the prime rate continued to rise to 10.8%. In FY 1981 the net deficit was $47.2 billion and the prime rate was 18.9%; in the following year the net deficit increased to $95.0 billion but the interest decreased to 14.9%; in FY 1983 the net deficit jumped to $159.2 billion but the interest dropped to 10.8%. The net deficit for FY 1992 is currently estimated at more than $300.0 billion and the prime rate is running at only 6.0%.

Similarly, there is only a very uneven relationship between deficits and CPI. In FY 1978 the net deficit was $30.0 billion and the inflation rate was 9.0%; in FY 1979 the net deficit decreased to $16.3 billion but the inflation increased to 13.3%; in FY 1980 the net deficit rose to $45.6 billion and the inflation decreased to 12.4%; in FY 1981 the net deficit continued to rise to $47.2 billion but the inflation fell to 8.9%. More interesting, in the following fiscal year the net deficit jumped to $95.0 billion and the inflation dropped to only 3.9%.

Third, we should be careful when comparing government revenues, outlays, and deficits between the United States and another country. In the United States, the states and local governments play a very important role in the argument. When comparing the fiscal policies of the United States, France, and Germany, Professor Calleo uses only data for central governments. This is misleading. For instance, the United States federal government spends very little for education because the states and school districts are responsible for education. In 1982, the total number of states and local governments were 82,391 units. In 1985, federal revenues were $805 billion, states revenues were $349 billion, and local governments revenues were $264 billion. In the same year, their expenditures were $925 billion, $269 billion, and $387 billion, respectively. Moreover, the French government outlays included large expenditures for its state run corporations which are mostly absent in the American economy. Finally, I support Calleo's call to reconsider our geopolitical role; we have paid a very high cost for that. However, I do not agree with the author that during the past, the hegemon could "command capital from its allies because of its geopolitical position." We sent our troops to Korea, Japan, and Europe to protect them but their people sometimes went down to the streets to shout at our embassies: "G.I.! Go Home!". We sent our troops to the Persian Gulf to protect the world's oil supply and it was not easy to collect our allies' contributions to the war costs. I do not think our allies have sent their capital to the United States to help the hegemon fiscal deficits. The capital always goes to where paying higher interest with lower risk. America is the most secure and stable investment market in the world. Sometimes, the "Group of Seven" tries to help the United States to stabilize the dollar value. They do that not because of our protector's role but for their own benefits. The American economy is very large and the dollar is the international currency, our economic problems can easily spill out into the world. They try to help us to stop sneezing before they get a cold from us.

TUAN Q. DANG Leviton Manufacturing Co. Inc.
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Author:Dang, Tuan Q.
Publication:American Economist
Article Type:Book Review
Date:Sep 22, 1993
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