A few weeks ago, the International Monetary Fund released a report analyzing the fiscal situation of the world’s largest economies. As I discuss at greater length in a piece over at e21, the IMF finds that the United States is not alone in facing daunting fiscal challenges. For example, the IMF predicts that the United States will have the fifth highest structural primary budget deficit in 2010:
Now you might be wondering what a structural primary budget deficit is. Good question. The “primary” part means that the IMF excludes from the calculation any interest that governments are paying on their outstanding debts. That’s a useful thing to do if you want to focus on the programmatic spending and revenue decisions that governments are currently making. The “structural” part means that the IMF has tried to strip out the effects of the business cycle to identify the underlying posture of government policy. (Because of the weak economy, the IMF estimates that the U.S. primary deficit will be 8.1% of GDP in 2010, much higher than the 3.7% of GDP structural primary deficit.) And just to round out the details, you should also be aware that to make things comparable across countries, the IMF combines all levels of government together, so the U.S. figures include not only the federal government, but also the state and local governments.
With that context, the basic message of my first chart is that the United States has a very large structural primary deficit, but a few countries are even worse off: Japan (which has been running large deficits for years) and Ireland, the United Kingdom, and Spain (which had more severe credit booms and busts than we did, suggesting that the crisis had some structural effects, not just cyclical ones). At the other extreme, Norway is sitting pretty with its oil revenues.
The IMF also estimated how large a fiscal adjustment (i.e., spending reductions and tax increases) each economy would have to undertake to get their government debts back to a reasonable level. The basic idea is that, at a minimum, nations should run small primary surpluses and, in addition, some (including the United States) may need to reduce the size of their debts relative to the economy. Using a quite ambitious debt target (60% of GDP for the gross government debt for most countries), the IMF projects the following adjustments would be necessary:
If you take these results at face value, they suggest that the United States will have to cut spending and increase revenues by a combined 8.8% of GDP between 2010 and 2020, a fiscal adjustment of around 0.9% per year. Imagine having to enact a permanent spending reduction or tax increase of $120 billion per year next year, and then do it again in each of the next nine years. Rather daunting.
One can, of course, quibble with the specific assumptions that IMF has used. For example, getting the gross government debt down to 60% of GDP (about where it was before the financial crisis) may be a bridge too far. But clearly the United States will have a lot of work to do. But hey, things could be worse. We could be Spain, Ireland, the UK, or Japan.
Excellent post — thanks.
Great post, but one question: How does the IMF define “reasonable level” in their second chart? It seems like we’re left saying “OMG, the IMF says our deficit is unreasonable and therefore we have to get it back to their prescribed levels.”
I’m all for it, but I never trusted the IMF all that much especially when terms go undefined.
For most of the countries, the IMF defined reasonable as having the gross government debt get back to 60% of GDP. For the United States, that would mean the gross federal debt (including Social Security trust fund) plus state and local debt at 60% of GDP; that’s about where we were in 2007.
As I hinted above, I think that may well be too ambitious a goal. So the IMF number may overstate what we have to do. But it is interesting to see us compared with other countries on a somewhat comparable basis. (Except, I should note for countries whose finances are in better shape — in those cases, e.g., Norway, the IMF chose lower debt targets.)
FYI, per CBO Long-term Budget Outlook, the “fiscal gap” which “represents the extent to which the government would need to immediately and permanently either raise tax revenues or cut spending—or do both, to some degree—to make the government’s debt the same size (in relation to the economy) at the end of that period as it was at the beginning.” http://www.cbo.gov/ftpdocs/102xx/doc10297/Chapter1.4.1.shtml#1112471 (chart uses CBO’s Alternative Fiscal Scenario, which is more realistic than the Baseline Scenario).
I don’t think the “fiscal gap” factors in dynamic effects, so I assume that if we were to actually fully close the “gap” in a given year (and each year thereafter), GDP and revenues in the would be lower in the short-term and higher in the long-term vs. if we don’t reduce deficits to that degree, assuming that the short-term adverse effect of reduced government spending and reduced after-tax income would outweigh the positive effect of lower interest rates (less “crowding out”).
Donald,
Have you seen any good measures of fiscal gaps by country? If not, maybe you could do them in your spare time. Thanks!
Andrew