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Why Europeans and Americans Are Addicted to Budget Brinkmanship

From the Peterson Institute by Jacob Funk Kirkegaard:

The common refrain echoing through American politics, especially from Republicans, is that the United States must avoid, at all costs, becoming another Europe. How ironic, then, that thanks to Republicans, American and European politics have come to rely on the same sort of budget, borrowing, and fiscal brinkmanship.

On the US side, the system is so gridlocked that basic political decisions—like passing a government budget reflecting  preferences of the governing majority—cannot  be made without artificial deadlines and “cliffs.”  The so-called fiscal cliff on December 31—the  combination of legislated tax increases and automatic spending cuts  intended to coerce an agreement—produced a lame budget deal that merely set up  new debt ceiling and budget resolution cliffs in the coming months, guaranteeing that once again Congressional antagonists will race  against the clock to  avert a mutually assured destructive outcome.

As pointed out here many times, however, the political processes (and the Bismarckian sausage making) in the euro area and the United States are strikingly similar. Both seem incapable of reaching agreement without the imminent fear of disaster. The Economist has even warned that US political leaders are “building Brussels on the Potomac.” As usual though, London’s “St. James’s Street siren” is far too harsh in its assessment of the euro area in this comparison, while failing to adequately fault the policymaking incompetence of its Anglo-Saxon brethren.

The fundamental differences between the problems facing the euro area and the United States require different political strategies, of course. The euro area has an institutional design problem necessitating unprecedented handovers of national sovereignty by euro member states. Post-Westphalian states even in Europe do not like to part with national sovereignty. It is thus unsurprising that acute market pressure and the threat of imminent economic disaster (in the form of euro and/or financial sector collapse) has been instrumental in forcing the euro area’s many late night agreements since early 2010. Redefining state sovereignty in the euro area (now without control over the domestic banking system and unable to engage in sovereign fiscal decisions) was never going to be easy.

By contrast, in the United States, the medium-term fiscal emergency (as opposed to containing long-term health and retirement costs) is over returning to a non-war economy with tax rates at roughly historical levels. Europe’s problems are far bigger than those in the United States. While Europe must strip its members of critical parts of their national sovereignty, Congress needs merely to pass credible budgets. The fact that a political strategy of brinkmanship with built-in artificial cliffs is necessary to achieve such basic governance in Washington is testament to the American capital’s political dysfunction. Market volatility and crises may be necessary for the drive to unify a continent from the bottom up in Europe. But one cannot successfully run a country if shock therapy is required to accomplish basic government tasks. But at least the recent European experiences in policymaking at the brink of disaster do provide some clues to how events will unfold in Washington in the coming months.

To understand the essence of political brinkmanship—a political strategy of deliberately pushing a dangerous situation to the edge of disaster in order to compel concessions—the best place to start is nuclear deterrence strategy and in particular Nobel Prize winner Thomas Schelling’s 1966 classic Arms and Influence. Here Schelling describes brinkmanship as “manipulating the shared risk of war…. exploiting the danger that somebody may inadvertently go over the brink, dragging the other with him.” In the euro area since 2010, Armageddon has loomed in the form of a collapse of the euro/euro area financial system. The risk in Washington in the coming months is obviously not war. Rather it is the threat of recession in 2013 (had the fiscal cliff not been avoided), a US sovereign default (if the debt ceiling is not raised), or a US federal government shutdown.  

Schelling describes the need for a crisis to focus policymakers’ minds this way:

The essence of the crisis is its unpredictability. The “crisis” that is confidently believed to involve no danger of things getting out of hand is no crisis; no matter how energetic the activity, as long as things are believed to be safe there is no crisis. And a “crisis” that is known to entail disaster or large losses, or great changes of some sort that are completely foreseeable, is also no crisis; it is over as soon as it begins, there is no suspense. It is the essence of a crisis that the participants are not fully in control of events

In the risk terms defined by the economist Frank Knight, the essence of brinkmanship is uncertainty, which unlike quantifiable “risk” has no probability distribution. The fear of something terrible forces policymakers to take out insurance against such an outcome.

In the euro area, acute market pressure has instilled urgency into European policymakers’ deliberations. Not so in the United States, where—except for the devastating fall in the stock market after the first initial rejection by Congress of the TARP (Temporary Asset Relief Program) in October 2008 (which worked wonders as Congress passed TARP four days later)—financial markets have generally  ignored Washington’s political paralysis. Instead markets have generously and faithfully rewarded America’s supposedly far superior political institutions and general growth prospects with record low government borrowing costs. To please investors, the United States merely has to seem better than the alternative asset classes in the euro area and Japan. Without bond vigilantes putting a gun to their heads, Congressional lawmakers have been forced to load their own guns and create their own artificial crises.  

I lament the necessity of using markets to coerce euro area political leaders into surrendering political sovereignty. But I am optimistic that a similar strategy will succeed in Washington.

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