If you want to feel really good about the state of politics in Washington, look to Athens. Over the past few days, hooded extremists marched in the streets, and demonstrators waved E.U. flags with swastikas on them. Yet the Greek Parliament waited until the stroke of midnight on deadline day to hold a no-confidence vote on the current government in order to give legislators "more time" to discuss the issues. What's to discuss? The country is broke and couldn't grow its way out of a paper bag. Still, even bleary-eyed politicians know when their kebab is skewered. Confidence was granted, mostly because it was a necessary first step in securing the next tranche of bailout funds from the IMF and E.U.
Given that the Hellenic Republic has been in default for more than half the years since it became a modern nation in 1832, it's amazing that anyone still thinks all this will end happily and is willing to put money on it. More interesting is what the Greek crisis portends for the U.S. After all, while the countries' economies are vastly different, they face the same fundamental problem: How do you keep your economy growing and tackle seriously high unemployment when you are also entering an age of financial austerity in which citizens are being asked to give up everything from pensions to health care to basic public services?
It's the key economic question facing rich countries everywhere. Government borrowing is at record levels, and each day brings a new sovereign-debt worry. Ratings agency Fitch just joined Moody's in promising to reduce the U.S.'s triple-A credit rating if it doesn't raise the debt ceiling. Yet there's still a belief that governments can cut spending wholesale and expect consumers to pick up the slack. This is magical thinking. A major new study by the Boston Consulting Group found that consumers around the world are as anxious about the state of the economy as they were during the depths of the global recession in 2009. In the U.S., 90% say they will maintain or reduce spending this year, not increase it.
In this environment, how does any economy grow? Not by slashing the federal budget, as Republicans are suggesting. "The cuts have to be gradual, or there's a danger that the entire economy falls off the edge," says Julian Jessop, chief international economist for Capital Economics. Already, the brinkmanship over the debt ceiling has led the credit-default-swap market to wager that the U.S. has only slightly less chance of defaulting over the next year than Russia.
What about slashing taxes to spur consumer spending? There's actually little evidence it works. Even cutting the U.S. payroll tax, one of the most direct ways to fill consumers' pockets, has been less effective than policymakers thought, in part because rising prices for food and gas have eaten up those small income gains. Tax simplification, though, could have a big effect. Even a country as dysfunctional as Russia has brought its tax take to historic highs by replacing its old convoluted system with a flat income tax rate of 13%.
Will productivity increases help us expand the economy while we are cutting the budget deficit? It depends. Over the long term, new technology drives economic growth by creating entirely new industries (like, say, cell-phone manufacturing) as well as ancillary businesses that service them. But here's the catch: that growth spreads widely through society only if educational improvements keep pace with technological advancement. When public education falls behind, workers don't have the skills to do high-tech jobs. In their book The Race Between Education and Technology, Harvard academics Claudia Goldin and Larry Katz show that education kept pace with technology until the 1970s. Then the link was broken, resulting in lots of lower-skilled workers and a few highly paid, highly educated ones, which is one of the causes of rising income inequality in the U.S. That's yet another reason that educational reform isn't a luxury but a necessity for growth.
Going after growth in the right way is the difference between a lost decade and a new era. After the Great Depression, the American economy shrank. But it also restructured, reformed and rejuvenated itself. Twenty years on, it was nearly double the size it had been at the time of the crisis. In Japan, by contrast, more than two decades of can-kicking have resulted in an economy that's only 25% bigger than it was when its bubble burst in 1989. Greece is showing right now that you can't wish away fundamental economic problems. You need a clear plan to address them. Let's hope that Washington doesn't wait till midnight to get the message.