SKARBECK: U.S. will someday have to deal with debt

Austerity versus stimulus is the great economic debate of the moment. The loudest voice for stimulus comes from Princeton University economist Paul Krugman, who believes deficits are not harmful in the early stages of recovery and that another jolt of government stimulus is needed to boost our economy.

His antithesis is Harvard’s Niall Ferguson, who claims further stimulus will cause the “bond vigilantes” to eventually sell their bonds and force interest rates higher on the prospects of a more monstrous government deficit.

After years of easy borrowing that helped boost economic growth, governments around the globe are dealing with evil twins—high levels of debt and shrinking revenue to repay. No public official wants to take the path of austerity, but at some point the market can force it upon you, as we have seen in Greece. Many U.S. states, by statute unable to run deficits, are left with the austere-like choices of raising taxes, and cutting programs and personnel.

Raising taxes and cutting costs to reduce debt aren’t the prescription for economic growth. These measures of austerity, if followed, form the outlook of below-trend growth in GDP, or the dire predictions of defaults that some tenured economists and respected investors believe lie ahead of us. Many suggest there is little choice—that the markets are finally imposing the medicine that years ago was predicted to eventually arrive. There have been too many legislative sessions of granting increased health care and pension benefits with no contributions to fund them, too many budgetary tricks that kicked the can on down the road, and too big a pile of debt to dig out from underneath.

Here’s a look at some of the unpalatable choices some states are making in dealing with their deficits. Last November, Jon Corzine, the ex-Goldman Sachs chairman and Democratic governor of New Jersey, was ousted after proposing to raise taxes and cut public worker pay to shrink a $7 billion budget gap. Newly elected Republican Governor Chris Christie—now dealing with a $10.5 billion deficit for 2012—has said he won’t raise taxes. He has instead opted to skip pension funding and cut education.

Illinois Comptroller Daniel Hynes said the state ended its 2010 budget year June 30 “in the worst fiscal position in its history.” The state has sunk by following a blue state policy in social safety nets and a red state aversion to taxes. As one former politician described it, Illinois has not been a tax-and-spend state; its motto has been to “spend and borrow.”

In Maine, state employees do not participate in the Social Security system and instead are vested solely in the state’s pension plan. Now, in an effort to address its ballooning pension costs, the state has prepared a plan to shift state employees into Social Security.

Perhaps the United States will see an outcome similar to Germany, which is experiencing a broad economic recovery. Five years ago, German unemployment was above 13 percent; today, it is down to 7.6 percent. Its export-driven economy is benefiting from Asian demand. German companies managed through their recession with a concept called “short work.” Government incentives allowed companies to reduce worker hours rather than lay off people, and employees were given partial compensation for lost wages. Some workers used their spare hours to increase their education and work skills.

Slower growth appears to be the course for our economy and time seems to be the prescription for a full recovery.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.