America is hardly the first industrialized nation to lose its coveted AAA status from a credit rating agency. Others lost their highest appraisal of creditworthiness and managed to regain it but only after years of strenuous fiscal consolidation. What lessons can be drawn from their experience?
Standard and Poor’s is the only major credit rater that has downgraded American debt from AAA to AA+ so far. Moody’s affirmed the nation’s AAA rating but with a negative outlook. Fitch has also warned that as America’s national debt mounts, its bond rating may come under scrutiny. All champion massive deficit reduction over the next decade and believe that some $4 trillion in spending cuts or tax increases is necessary to achieve balance in the medium term.
Once a country loses its top credit rating, it takes years to get it back. Australia needed as many as eighteen years to regain its AAA status. Canada, on the other hand, pulled it off in less than a decade.
After losing its AAA credit rating in the early 1990s, Ottawa embarked on deficit reduction effort that included budget cuts and tax hikes in a ratio of roughly seven to one. The books were balanced within six years and today, Canada is among the economically freest countries in the world. Its regulations on businesses are efficient and transparent while there are virtually no barriers to international trade and few restrictions on foreign investment.
Canada’s public debt at the end of last year equaled 34 percent of gross domestic product or $519 billion. Even this year, it’s not projected to exceed the $563 billion of debt that Canada had amassed in 1997. For comparison, America’s national debt is approaching $14.6 trillion which is almost the size of the entire economy.
Another country that saw its creditworthiness called into question during the 1990s was Finland. In the decade preceding their downturn, the Finns had assumed huge private debts which eventually led to a disastrous decline in stock market value and housing prices. Finland’s economy contracted by 13 percent and nearly one out of five workers lost their jobs.
Politicians struggled to cut spending as powerful trade unions opposed necessary labor market reforms. Finland quickly racked up a public debt equaling 60 percent of GDP before regulations on businesses and investment were finally streamlined and several state enterprises sold off.
Government spending is still high while dismissing a worker can be costly and burdensome but Finland did manage to reduce its debt burden to 45 percent of GDP last year when the state’s budget was almost in balance.
Even if Canada and Finland managed to regain competitiveness and a top credit rating, their experiences are unlikely to be repeated in the United States. Fiscal consolidation in both nations required a political consensus. Opposition parties largely agreed with the need to slash spending and increase revenue simultaneously.
Democrats in the United States by contrast are reluctant to reduce government expenditures whereas Republicans are opposed to raising taxes. Both parties fear that it might undercut a still lackluster economic recovery.
The world economy today is in a far more fragile shape than it was during the 1990s when the United States actually ran a budget surplus. Canada and Finland were able to boost trade when they removed regulatory impediments and lowered tariffs. American legislators can help commerce by enacting pending free-trade agreements but their nation would still maintain a large trade deficit with the rest of the world. Canada and Finland were able to profit from growth elsewhere. Countries in Europe and East Asia have depended on the United States for growth instead. To win back its AAA rating, Washington will have to enact reforms at home.