Thinking the Unthinkable by Article 13

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Thinking the Unthinkable Defaulting Governments: How did we get here and where are we going?

Toby Radcliffe Article 13 Associate

ARTICLE 13 ORANGE PAPER

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Thinking the Unthinkable Defaulting Governments: How did we get here and where are we going? By Toby Radcliffe (Article 13 Associate) Introduction How, and why, are our governments struggling with recession and increasingly defaulting? Iceland, Greece, Italy, Spain, Portugal, Ireland. Defaulting on government debts seems commonplace. Only membership of the Eurozone prohibits the rest from doing what Iceland did – a quick, tough restructuring of its economy to deal with the sudden bursting of its economic bubble in 2009. The rest continue to bail out their banks, accept debt write offs, and suffer through economic downturn by defaulting and towing the Euro line. But now it seems that the unthinkable is about to happen: the USA is on the brink of the same issue. It has already been downgraded in 2011 by ratings agency S&P from AAA to AA+, with other major agencies giving a negative warning. Its total debt surpassed its GDP in 2011, staggering upwards at an alarming rate to unprecedented levels as spending grew from 2009 to enormous levels in order to bring about a reversal in the recession following the Global Financial Crisis. The Fiscal Cliff deal made on 1st January 2013 merely bought a couple of months before the real US economic issues must be dealt with – or at least until more time is bought through protracted negotiations and burgeoning interest repayments. But how did we get here, to the edge of the unthinkable? What does it mean in economic terms? Who will pay for the management of the budget deficit and how? Where does sustainability sit in a crisis such as this and what is the bigger pictureWhy are policy decisions around these economic issues so difficult and how can we make better decisions in the future?

Background in US Housing Bubble and Financial Deregulation Through the 1990s and 2000s, the Clinton and then Bush administration had been pushing for the laudable aim of affordable home ownership, especially for African American and Hispanic borrowers, who had traditionally found it difficult and expensive to get a mortgage. This put political pressure on mortgage providers to lower their lending standards, spawning cheap, high multiple mortgages and even the now infamous "NINJA" loans for borrowers with "No Income, no Job or Assets." The mortgage finance company Fannie Mae was also urged to fulfil its mission of helping low income homeowners by buying up risky loans. Combined with low interest rates and questionable lending practices, this political direction helped inflate the sub prime housing bubble. The US authorities did little to prevent the sale of millions of mortgages to people who could never afford them.

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Alongside this, there was a significant change in financial regulation. The Glass Steagall Act of 1933 was repealed in 1999. Until then, this Act had separated the activities of commercial banks (which take deposits) from investment bank (which invest money). That relaxation of the rules enabled commercial lenders, such as Citigroup, to trade instruments such as mortgage backed securities and collateralised debt obligations. These new instruments grew massively with the increasing number of mortgages available and the AAA rating (very low risk) given to them due to their apparent security. House market crash But between 2006 and 2008, contrary to popular and market belief1, home prices began to slide. According to Standard & Poors, as of 2008, home prices were down 20% from their 2006 peaks, and in some hard hit areas, that number was even higher. The subprime mortgage market was especially exposed, experiencing a dramatic bubble and massive subsequent collapse. Subprime mortgages were issued to households with below average credit or income histories and are more risky than traditional "prime" mortgages. Many people who took out subprime mortgages during the housing boom did so with the intention of "flipping" the house for a large gain. This worked well while house prices were soaring. Other subprime borrowers took up mortgages because of initially low payments, but when these reset to true market rates, many homeowners could not afford the new, much higher payments. Not only did the US authorities fail to regulate the mortgage lending market, they also failed to police the market in mortgage backed securities; in theory, the financial services organisations had in place detailed governance and risk management controls aimed at preventing such occurrences, allowing for the ‘light touch’ regulatory approach. This securities market also started to collapse as the now declining housing market led to increasing defaults on mortgage payments as many people found themselves in negative equity. This signalled the end to the overextended lending situation. Other markets, such as credit default swaps, those multi billion dollar bets on other people going bust, also went virtually unregulated and suffered similar collapse. Market participants began avoiding any mortgage related risks. Investors became even more nervous after Bear Stearns was forced to close two hedge funds that had suffered very large losses on mortgage backed securities. As the size and frequency of mortgage related losses began to increase, liquidity started to evaporate for many other types of securitized, fixed income securities, leading to increasing uncertainty about their true value. Investors soon began to question whether financial institutions knew the true extent of the losses on their books due to the liquidity crisis and new mark to market regulations which made companies attempt to account for losses even in illiquid markets. This uncertainty led to sharp declines in the stock prices of many financial firms, and a growing unwillingness to bid for risky assets. As investors attempted to sell in a market with no buyers, prices fell further. Soon, most risky assets were dropping rapidly in price and panic began to creep into the global marketplace. The credit crisis had begun. 1

The mortgage backed securities market was given a AAA rating by ratings agencies suggesting that it was as ‘risk free’ as the US Government http://www.bloomberg.com/apps/news?sid=ah839IWTLP9s&pid=newsarchive http://www.milkeninstitute.org/pdf/Riseandfallexcerpt.pdf

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Recession So how did the Credit Crunch spiral into the Global Financial Crisis? The loss of confidence in 2007 by US investors in the value of sub prime mortgages triggered this liquidity crisis, which in turn, resulted in the US Federal Bank injecting a large amount of capital into financial markets. But by September 2008, the crisis had worsened and stock markets around the globe crashed and became highly volatile. The interconnectedness of global markets meant that contagion spread quickly from the US to many other markets. Consumer confidence hit rock bottom. In many countries, household income fell in real terms and unemployment soared. The collapse of Lehman Brothers in September 2008 marked the beginning of a new phase in the global financial crisis. Governments around the world struggled to rescue giant financial institutions as the fallout from the housing and stock market collapse worsened. Many financial institutions continued to face serious liquidity issues. This also raises the importance of corporate governance in the global financial crisis. Many financial services institutions had not aligned their business strategies with the suitable type of risk management. Incentives structures were also aligned towards profits and not to responsibility: individuals in these institutions were rewarded if a risky business gamble paid off but were protected from the full extent of the financial downside. Corporate governance – in internal controls and matching incentives and risk management – failed to curb the over extension into high risk (and high potential reward) markets2. By September and October of 2008, people began investing heavily in gold, bonds and US dollar or Euro currency as it was seen as a safer alternative to the ailing housing or stock market. In January of 2009 US President Obama proposed federal spending of around $1 trillion in an attempt to improve the state of the financial crisis. Spending The budget deficit has continued to grow apace, with the White House desperately spending to try to avert the financial crisis (as traditional Keynesian economic theory suggests), stimulate growth and maintain some small modicum of GDP growth post crash. Borrowing through 2010, 2011 and 2012 remained high, and taxes relatively low, resulting in 4 years straight of US budget deficit in excess of $1trillion. But in summer 2011, the budget ceiling was reached. The ceiling is a legislated cap to Government borrowing, which requires Congress to agree on an increase to raise the ceiling. However, the Republicans – apparently concerned over the massive budget deficit – held Debt ceiling issue as a hostage, not allowing it to be raised again as the White House requested without concession, leading to a sequestration deal which gave us the so called Fiscal Cliff which would come into force on January 1st 2013 if a suitable compromise was not found to reduce the deficit and deal with the overspend. Fiscal Cliff The Fiscal Cliff ‘crisis’ that the US has been deciding on since summer 2011 – but only just finding an agreement at the 13th hour on 1st January represents a battle of ideals and policy choice that goes far beyond the normal Republican Democrat splits.

http://www.oecd.org/corporate/corporateaffairs/corporategovernanceprinciples/42229620.pdf

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But it is also a red herring, a media induced frenzy suggesting a ‘win’ or ‘lose’ outcome on the 1st January 2013 when a massive recession inducing set of policies would have come into force. But the US House of Representatives had ample time to come to an agreement on a full alternative or – as is what happened – a minor agreement to some tax rises for the wealthiest of Americans and a few other small measures, and all with the ability to retroactively apply such agreements. It is a red herring because it has made American policy for the last few months purely about this self imposed ‘fiscal cliff’ and not about the real issue from which it is derived – the budget deficit. The actual spending cuts and tax increases that will be needed in order to meet any kind of substantial budget deficit decrease will be massive and long term. The cliff deal (plus expected economic growth) is forecast3 to begin to reduce the deficit to more acceptable levels, as a percentage of GDP at least. In 2012, deficit was approximately 7.2% of Gross Domestic Product (GDP), but with the fiscal cliff deal, this will drop to 3% by 2015. It is worth noting that much of the revenue increases seen in this more favourable balance are through projected increases in GDP as well. Note that this merely represents a reduction in borrowing. However, if GDP growth estimates are overenthusiastic, then trouble is very near at hand. The Fiscal cliff deal does not stabilise the total debt:GDP ratio. Politically, according to Forbes4, the agreement leads us to revenues in 10 years reaching about 19.4 % of GDP – at the very high end of what most Republicans say is tolerable. Spending will be at 22%, at the low end of what many Democrats think is acceptable given the aging of the population. It looks like fiscal compromise will be difficult to find. In the meantime, the real impact of the fiscal cliff deal is that every household and every taxpayer is going to see their net pay decline in 2013. Given economic estimates of increased GDP and employment in 2014, something needs to fill the policy gap. Budget Deficit Ceiling The fact is that the US hit the new budget deficit ceiling already, as of January 1st 2013. The Treasury has a month or maybe two of short term measures with which it can stave off bond defaults before the financial markets will really respond to the magnitude of the issue. Now is the time that the new Congress will need to come up with a real and material solution to the budget ceiling problem. But it is highly unlikely that the ceiling will not be raised, at least not for long. Will Congress be able to come to any agreement in the next two months?

http://www.forbes.com/sites/beltway/2013/01/03/the bottom line what the fiscal cliff deal really means for taxes and spending/

http://www.forbes.com/sites/beltway/2013/01/03/the bottom line what the fiscal cliff deal really means for taxes and spending/ Note that these estimates exclude interest; they also assume that the temporary tax provisions (the so

called extenders) and the temporary Medicare physician payment adjustment expire in a year as the law states. If not, or if they are not paid for some other way, long term revenues would be lower and spending quite a bit higher. Similarly, if the automatic spending cuts known as the sequester are repeatedly postponed and not replaced with other spending reductions, the deficit would also balloon.

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What happens if the budget ceiling is not increased? The unspeakable will happen: the US has no more borrowing lines. Business as usual must be suspended – even in the absence of more spending, managing repayments on existing debt requires the US to borrow more5. Without this option, the US will default on interest repayments. Massive spending will have to be negotiated to bring the budget into balance as no further borrowing is permitted. Revenue streams will need to be increased beyond those small tax hikes seen from the Fiscal Cliff deal. It is unthinkable. And that’s what Republicans are counting on – they are holding the Ceiling hostage to leverage concessions from the White House. The U.S. economy is still fragile. Economic growth is still weak, with only marginal improvement since mid 2011, still not having created a significant number of jobs. Unemployment, whilst slowly improving still languishes at a massive 7.8%6. Ahead of the 2011 debate, a group of 235 key US economists7 wrote to Congress that: “Reaching the limit on total outstanding debt could force a dramatic and sudden cut in federal spending that would destroy jobs and threaten the recovery. To remove spending from the economy at such a pivotal moment would be irresponsible.” This situation has not changed substantially. They went on to say “Failure to increase the debt limit sufficiently to accommodate existing U.S. laws and obligations also could undermine trust in the full faith and credit of the United States government, with potentially grave long term consequences. This loss of trust could translate into higher interest rates not only for the federal government, but also for U.S. businesses and consumers, causing all to pay higher prices for credit. Economic growth and jobs would suffer as a result.” So, again, in 2013, if Congress fails to increase the nation's $16.4 trillion debt ceiling, countries who hold America's debt could seriously question the US' ability to make good on its debts and economists predict the US could slip back into recession. The IMF and Standard & Poors have also backed this opinion, warning that the deficit must be brought under control. With institutions like this arguing for a curbing in the deificit, pressure on ratings and on market confidence will be key drivers to conform. If we look at other economies that have been in similar situations, to the US, we can see some warning signs. In 2011, US total debt8 overtook the US GDP for the first time ever9. In real terms this means that the US owes the entire annual output of its economy. In Europe, we see that serial defaulting, recession and high unemployment rates in Italy and Greece. Italy has a total debt to GDP ratio of 120.1% (2011 est.)10 whilst Greece has 170% of GDP (2011)11. The US is quickly moving towards these levels, giving the IMF, economists and ratings agencies cause for worry.

The amount spent on servicing debt in 2011 was $227.1bn and is set to double over the next decade http://www.heritage.org/federalbudget/interest spending 6 http://www.tradingeconomics.com/united states/unemployment rate 7 http://www.epi.org/press/news_from_epi_prominent_economists_call_on_congress_to_raise_debt_limit/ 8 This is total debt, not federal debt as is often reported by US economists; total debt includes debt to other governments and international lenders, making it comparable to those of other nations. 9 http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/04/DEbt%20to%20GDP.jpg 10 http://www.indexmundi.com/italy/public_debt.html 11 http://www.tradingeconomics.com/greece/government debt to gdp

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Other issues to consider are the actual size of the debt. It is unprecedented. Whilst this does not seem so bad when compared to the size of the US economy, relative to other nations, this debt is astronomical. Given the interconnectedness of global economics, trouble in the US will clearly have an impact outside of its borders. Add to that the belief that recessions are short blips in continued and sustained US economic growth, increasing borrowing is seen as justified as economic forecasts assume continuing growth in revenue through economic expansion. But we also believed that the housing market had no downside, assigning triple A ratings to mortgage backed securities – until the bubble burst. Currently the market for US treasuries is still fairly strong, but issues such as dcreasing ratings for the debt might change this – a limited market for US debt would be a serious problem for the economy. Certainly the opening up of other international markets and new players has allowed some of the vast expansion in debt over the last 10 years. International markets own about a third of the current debt. China for example, has gone from owning nearly no US debt to over $1.4 trillion in under 10 years12. But Chinese interest has already started to wane, with the beginning of selling off positions last year, judging the US economy to be less stable than previously. China's official news agency Xinhua warned of more profound problems with the US economy, including the growing debt, stating: “People, or governments, can overspend for some time, but they simply cannot live on borrowed prosperity forever." The US Treasury is clearly aware of these issues as it has recently been trying to buy up foreign debt.

The economic consequences start with the decision making process Even before any decision is or is not made on future budget and spending policy, there will be immediate economic signs to look out for in February to show that a financial crisis is near: Discontinuities in the Treasury bill market. Prices of bonds maturing near the decision date or limit deadline will start to fall, demonstrating that investors are looking for higher interest rates for holding on to them. Spikes in the credit default swaps market. Prices in the credit default swaps (insurance against the US government debt) will rise if the market is pricing in risk of US default (typically within 5 years). A narrower spread between Treasuries and near substitutes. As US government bonds become a riskier bet, investors will look elsewhere, for example Canada, or other credit worthy countries like Switzerland or Germany. During the decision making process, we will see more costs. The 2011 debacle initially cost an estimated $17 million in additional interest payments to investors in the sale of Treasury bills to finance government operations. This occurred because a spike in interest rates in the two weeks prior to the negotiation’s conclusion. As the risk of default mounted, investors responded by reducing their holdings of short term government bonds. To assure the risk of maintaining those holdings, investors raised their asking price by spiking the interest rates on Treasury bills. Immediately post the decision, further Treasury bills were also auctioned, all at higher interest rates thanks to the increased uncertainty – an auction of $23 billion in one month Treasury bills straight 12

http://www.guardian.co.uk/news/datablog/2011/jul/15/us debt how big who owns

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after the sequestration deal was announced yielded 0.14 percent (instead of 0.1% two weeks prior) – this translates to $249 million in additional interest added to the national deficit. At that point, demand for Treasury bills was still high, only just below previous demand despite the increased interest rates. If a decision is made in the next few months, it will likely incur such ‘deliberation costs’.

What are the likely outcomes? Beyond the immediate costs to the US economy, the budget ceiling will be held hostage again to deliver poor compromises on fiscal and spending policy. What will these most likely entail? The Republicans allowed for taxation to increase on income earners above $400k and households above $450k, not agreeing to the Obama suggestion of increases above $200k and £250k respectively. They are unlikely to negotiate further on revenue from America’s wealthy. Budget forecasts now rely on increasing revenue over the next period solely through economic (GDP) growth, which is currently assumed to return to about 3% from 2014, and potential increases in tax on middle class families. The deficit must therefore be reduced through spending cuts. At the top of the list for cuts are the ever increasing and currently unsustainable social programmes. Medicare, Obamacare subsidies, CHIP, Medicaid, Social Security currently use just under 11% GDP and are growing rapidly13. These need massive reform. This is an unsavoury outcome from the liberal point of view – it seems to be a trade off of social welfare in favour of economic growth. Republicans will be calling for spending cuts to large entitlement programs such as Medicare, Medicaid, health insurance subsidies and social security – programs which on one hand run large cash flow deficits but on the other are key to protecting low income families and the elderly. This means that the fragile social support system in the US will be under pressure. The marginalised and vulnerable will suffer first. Then the traditional middle class tax hikes will likely follow. And yet, economic forecasts still show ‘normal’ GDP growth returning from 2014 and unemployment coming down. To achieve this, an ideal budget agreement would have limited near term fiscal restraint while making structural changes to gradually stabilize public debt in the longer term. But the ultimate answer to what will happen lies with our treasured ‘free market’. This market, which is currently starting to weigh up the future of the US economy, might push investment into more rewarding markets – such as China who is actually experiencing real growth. Not only should the market move investment out of the US, but it will limit lending to the US as it becomes riskier. If it doesn’t, the US will see increasing interest payments needed to service new lending, adding to their budget deficit. The market actions over the next few months will be the deciding factor in whether any decisions made in Congress are effective. Confidence is more important in the current economic climate than

http://www.heritage.org

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the actual policy choices; whether the US can say or do anything to promote the reality or illusion of future US growth will be seen in the next few months. Of course, there are options to side step this discussion completely, but these are perhaps more unsavoury in the long term, and simply allow for the debt:GDP ratio to expand more and more. Obama could issue executive order to force the Treasury to increase the ceiling, but this would be highly unconstitutional. The debt limit could be abolished completely, but given the role of the US currency as the world’s reserve currency, not having a limit would be a risky strategy for global stability.

What should the US be doing? The US should have been decreasing the budget deficit steadily over an extended period already. A 1 to 1.5% of GDP decrease in the deficit should be targeted according to the IMF’s chief economist14, large enough to reduce the deficit but not so large to crush growth. It will be up to Congress to see if a balance of realistic taxation and spending cuts can be found. But more radical alternatives might be more efficient in the long term. Let’s learn something from Iceland: they had to react quickly due the small actual size of their economy and their massive relative levels of debt (840% GDP15)(the banking industry grew from nearly nothing to outweighing the rest of the economy in just a few years), and quick it was. They took the hit, restructured the economy, let the banks go under. It seems to have paid off, with Iceland now firmly on the road to recovery. The US and the Eurozone chose to battle against the tide; if everyone had let their banks go under, the relative losses would have been much more palatable. The Icelandic krona plunged, spiking the prices for imports, meaning Icelanders saw an 18% drop in their disposable income in 2009. But if other nations had chosen to let their bad banks go at the same time in 2009, many currencies would have taken a more simultaneous hit which would have made for less of a relative decline in any one currency. Iceland’s pain was mostly front loaded, and their growth in 2012 (est. 3%) is looking brighter than most countries in the debt plagued developed world. Not spending tax revenue on bail outs, they have been able invest in things that will strengthen them long term like education and green technology. They are an example of how it is possible for a country to let the banks take their deserved losses, and still overcome deep economic dislocation without undoing the social fabric. This was the correct response to a speculative bubble burst of this magnitude and massive kneejerk overspend following. They cut it off, defaulted and restructured. Painful? Yes, but honest. Is it too late for the US to do this? Certainly in the eyes of the policymakers. The sunk costs in economic support and buoying the financial markets are now truly massive. But the policy options coming in the next few months might leave some sustainability choices to be made: whether to 14

http://news.morningstar.com/all/dow jones/us markets/201301041828/000626/imfs top economist us should cut deficit by 1 to 15 of gdp cnbc.aspx

http://www.vanityfair.com/politics/features/2009/04/iceland200904#

support greentech through the spending cuts; how to best maintain social support systems in the face of unavoidable cuts. Given the massive profits retained by some sectors despite the recession – namely the oil sector – it might be appropriate to create social obligations for these companies to help support them through the next period. The regressive tax system in the US also needs an overhaul, though in Republican eyes this has already happened with the Fiscal Cliff Deal – another opportunity lost. But where the government may fail to implement an effective policy mix, the corporate sector may find opportunities. Given that public service provision may suffer, community engagement programmes might be able to step into the breach – energy companies might offer widespread fuel poverty programmes, manufacturing companies might grow their traineeship programmes. Pharmaceutical companies might start to think about offering free healthcare clinics in disadvantaged areas. Banks could offer free budgeting and debt managing services to struggling customers. These kinds of opportunities to increase reputation, engage communities and help social cohesion will pay in the long term. Who will take the first mover advantage?

Confounding factors: GDP as a marker of progress Policy makers have hard choices to make. But what really confounds this decision making is that the options they are evaluating are based in terms of GDP with very little in terms of consistent metrics to judge social and environmental impacts of their decisions. Fundamentally, the US – in fact, all governments – should be re evaluating national accounting and setting it in terms of sustainability and wellbeing. The traditional discussion of the debt ceiling and impacts of the fiscal cliff deal – as illustrated above – all revolve around the issues of GDP per capita, GDP growth, relating absolute debt to GDP. Debt is the capital element of the system. Key outcomes (after production) for the economy – employment and job creation – add some social flavour to the economy, but on is so much as counting underlying individuals who can be taxed and contribute to GDP. Debate over spending cuts on social programmes are almost too difficult at least in part because there is no rational way to assess policy options on a level playing field. The debate and discussion over the absolute debt has completely ignored the elephant in the corner – the massive and wholesale loss of environmental capital that has been used to fuel the economic growth. As Prince Charles puts it ”we are spending environmental capital as if it were income”. One comment on this paper’s previous draft made the comment “There's not much point preserving us from deficit if we all perish from a collapsing climate “. This is a valid point. In the long term, US policy could be to significantly increase the debt to allow them to carry on spending. Indeed, climate mitigation efforts in the medium term might actually require much larger spending in order to try to maintain economic growth and actually enhance the growing debt problem. And yet, the budget deficit is still gives cause for worry. Handled badly, further recession (in traditional GDP terms) may be on its way, and the typical impact is directly onto CSR programmes and ‘non essential’ business spending. We have to break this over reliance on economic measures both in terms of national accounting and in terms of company account. The two are implicitly linked – if Governments can implement this change effectively, then business will follow.

And this is one of the key underlying reasons that our economic systems are set up for these market bubbles and crashes: we consistently value economic growth, both nationally and within businesses, in terms of profit and production. The bigger picture is one including economic and social capital, against which the impacts of the US debt and its policy choices must be viewed. Where we currently assume GDP as a measure of progress, and GDP per capita as a proxy for well being and quality of life, this economic output measure was never designed for these roles. It can only measure the output of markets. National income accounts rose to prominence following the Great Depression as policymakers recognised that they knew too little about how the economy was actually performing, making decisions based on only partial information on some facets of the economy16. Whilst revolutionary at the time, representing a milestone in measurement systems, it represented only a move in the right direction. We are still making policy decisions based on only partial information. GDP has come to be interpreted as a broader measure of progress by many policymakers and the public. But the inventors of national accounting clear understood that “the welfare of a nation can, therefore, scarcely be inferred from a measurement of national income”17. Progress is more than increases in income, wealth or production18. Progress should include sustainable development – rather than solely economic development and wellbeing – rather than just GDP per capita – though these terms are both hard to define and encompass many, difficult to measure underlying elements. We know we need to consider environmental resource use. Concerns over environmental capital and revenue are driving demand for additional measures to better understand and inform policy to promote sustainable development. Sustainability requires that at least the current level of wellbeing or quality of life per capita be maintained for future generations. Put another way, sustainability requires the per capita stock of capital, or the productive base for wellbeing, left to the next generation to be as least as large as the stock the current generation itself has inherited19. As sustainability relates to the change in an economy's productive base we require a measure of over (or under) consumption – how much we draw down (or add to) our productive base in generating current wellbeing – not just a measure of current consumption us. To give an example, exploitation of natural resources to fund current consumption will cause GDP to increase through increased consumption, but where natural resources are not replaced with another form of capital of equal value, the productive base available to future generations may be eroded. Note that the productive base available to future generations includes advances in knowledge and technology, which may compensate fully (or more than fully) for the depletion of at least some natural resources. But overall, if the economy's productive base is shrinking, at some point GDP will decline.

http://www.bea.gov/scb/account_articles/general/0100od/maintext.htm Bureau of Economic Analysis (BEA), 2000, 'GDP: one of the great inventions of the 20th Century', Survey of Current Business, January, Washington DC. 17 http://www.foe.co.uk/community/tools/isew/annex1.html 18 http://www.stiglitz sen fitoussi.fr/documents/rapport_anglais.pdf Stiglitz, J E., Sen, A and Fitoussi J P 2009, Report by the Commission on the Measurement of Economic Performance and Social Progress, Commission on the Measurement of Economic Performance and Social Progress. 19 Arrow, K., Dasgupta, P., Goulder, L., Daily, G., Ehrlich, P., Heal, G., Levin, S., Mäler, K G., Schneider, S., Starrett, D., and Walker, B. 2004 'Are we consuming too much', The Journal of Economic Perspectives, vol. 18, No. 3 (Summer, 2004), pp 147 172.

The problem with this is that it could take some time, and in the current national income accounting will bot be recognised until it is too late. A plethora of methods suggesting to adjust, replace of add to GDP have emerged. One popular method relies on the difficult task of converting all stocks economic, environmental and social into a monetary equivalent. It implicitly assumes that different forms of capital are substitutable or shadow prices can be correctly estimated. Another approach looks at variations in each stock separately, with the degree of substitutability a matter for judgment, but with the main focus on ensuring that a particular stock does not fall below a critical threshold. At the extreme, sustainability is achieved where the specific stock does not decline at all, which of course implies complete non substitutability. Measuring stocks in a monetary equivalents show promise seems like an excellent way to include current externalites in natioanl accounting, but estimating shadow prices poses significant problems. Current measures of environmental and social capital are crude at best, and the field needs much more work to be done. In the meantime, some authors suggest that a monetary index of sustainability be complemented by a limited set of physical indicators to monitor the environment20 particularly in the case of irreversible or discontinuous alterations. This seems like a very pragmatic approach as we determine better ways to value the environment. The national accounts need such a systematic valuation of environmental and social capital alongside the financial debt, and balances of environmental and social revenues and expenditures alongside the current revenue from tax and spending. Such an approach would, from a policymaking perspective, allow analysis of the complex inter relationships between economic, environmental and social capital, and ensure policy is directed towards social optimal use. Our indicators need to be better suited to helping measure and address the todayâ&#x20AC;&#x2122;s challenges â&#x20AC;&#x201C; with the remit of guiding policy towards sustainable development as our measure of progress rather than economic growth. This would allow us to look at the budget deficit as part of a wider system of revenue and expediture flows, allowing decision making and investement to be based on the whole picture, rather than just the economic one. Perhaps the most important outcome would be the focusing of attention on material issues such as environmental resource use, climate change impacts and social wellbeing to drive the way in which the budget is managed.

Moving away from our current model The Government remit should not be to operate the economy like a company; it should be to help all of its population live in a safe environment, encourage individuals to make a meaningful contribution to society, foster quality of life growth, protect national resources for future generations and take care of the fringe population who need support. Elections come and go and politicians debate issues framed in economic terms, going back and forth within the structure of the current capitalist dogma. We can see that the current US situation demonstrates that things are not working as they should. The most viable economic option in the short to medium term for them is to

http://www.stiglitz sen fitoussi.fr/documents/rapport_anglais.pdf Stiglitz, J E., Sen, A and Fitoussi J P 2009, Report by the Commission on the Measurement of Economic Performance and Social Progress, Commission on the Measurement of Economic Performance and Social Progress.

Article 13 Orange Paper (2013) Article 13 ÂŠ

overhaul social security, Medicare, Medicaid, etc social support policies, in order to bring excessive spending under control. The alternative, to keep the ever increasing social spending, but follow it with increased borrowing and increased instability of the economy, is equally unpalatable both politically and in terms of being heavily reliant on continued strong long term economic growth. But GDP will eventually have to stop increasing no matter which economic policy mix is followed, no matter how doggedly it is pursued – if environmental capital is depleted below sustainable levels. The underlying driver of macro economics is the unsustainable model of chasing GDP growth against all odds. Our current model generates economic growth through depletion of environmental resources thanks to externalisation of the costs and poor valuation of the capital. We overemphasises and support the upturns in our economy – creating speculative bubbles due to market over liberalisation – which leads us into deeper downturns causing overreaction in protectionist policy and overspending to stimulate failing economies. We track it in terms of GDP and unemployment rates. We continue to discount future costs in favour of short term profits and GDP growth. We should be measuring a host of wellbeing and quality of life indicators, including comprehensively the value of environmental capital in budgets, using taxation to adjust market pricing where externalities are not correctly priced, incentivising economic growth in arenas where social and environmental capital are not depleted whole scale. In this new model, real GDP per capita is not the key target as a measure of progress. Rather than constantly striving to increase this one indicator at the cost of environmental resource and pushing up GDP per capita as the proxy for wellbeing, we track the path towards sustainable development. . This should push policy makers’ decisions towards promoting sustainable business, encourage more even distribution of wealth, and increase quality of life. Economic policy becomes about stewardship, balanced with rational decision making against environmental and social goals, rather than the gold rush mentality that dominates currently. These accounting tools filter down into business, or – perhaps more likely – spread out from just the initial businesses who trailblazed such systems, making corporate activity systematically take account of their externalities as well. The policy choices arising from this framework are the ones that should be implemented with regards to dealing with the US budget deficit and national debt. But in the short term, this is just a pipe dream, with no real road map to get there. All we know is what has come before and hope that we will learn from it. A constant focus on GDP rather than the nation’s sustainabiility progress has lead to market deregulation, poor risk management and unrestricted speculation allowing bubbles to be created and subsequently burst when reality inevitably struck. Spending follows to bail out failing banks and to shore up failing economies has led to excessive budget deficits in many economies; several of whom have already defaulted. Is it now time for the US to walk the same economic tight rope? It seems as if in the short and medium term, the middle class will foot the bill for budget management as is usual in the USA, but at some point the excessive spend on social programmes in the US will be cut back, leaving low income families and increasing numbers of state pensioners pushed further to the fringes of policy. We continue to focus on economic issues at the detriment of environmental capital and ignoring the environmental budget deficit against our natural resource base.