Shock Therapy and the Debt Crisis: Lessons for the United States

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Argentina has launched another round of “shock therapy” in response to the nation’s debt crisis. Argentina is a serial defaulter, and the most recent default leaves them with no option other than shock therapy. President Milei is finding it very difficult to enact policies such as devaluation of the peso, massive cuts in government spending, and cuts in energy and transportation subsidies. He has also promised to eliminate the central bank and dollarize but has yet to enact these policies.

Pursuing shock therapy in response to the debt crisis in Argentina will be very challenging. Argentina has experienced debt default many times, and using shock therapy to address the debt crisis has proven to be short-lived. For example, in 2015, President Mauricio Macri pursued shock therapy unsuccessfully. His reforms failed in the face of opposition from powerful interest groups who benefitted from deficit-financed government spending. It is not clear that President Milei will be any more successful in pursuing shock therapy in the face of this opposition. 

In the United States, as in Argentina, we face an economic crisis linked to public debt. Over the past two decades, public debt in the United States has grown at an unsustainable rate and is projected to continue to do so in coming decades under current law. The United States no longer has the fiscal space to respond to economic shocks such as the financial crisis of 2008 and the coronavirus pandemic in 2020. Unsustainable growth in public debt means that at some point the United States will be exposed to debt default and financial market instability, not unlike that in Argentina. It is important that the United States act now to avert debt default and the need for shock therapy.

There is an alternative to shock therapy that has proven to be effective in addressing a debt crisis in the long term. The alternative is to enact effective fiscal rules constraining deficits and debt accumulation. The Swiss debt brake has proven to be the most successful of these rules-based approaches to fiscal policy. Three decades ago, Switzerland experienced unsustainable growth in debt. They responded with a debt brake that caps the growth in spending at the long-term rate of growth in the economy. Over a transition period, the Swiss were successful in bringing expenditures into balance with revenues and in stabilizing and reducing debt.

There are several lessons for the United States from the rules-based solution to the debt crisis in Switzerland. The Swiss debt brake is very much a bottom-up approach to reform. Debt brakes were first enacted at the cantonal level and only later at the federal level. The debt brake was incorporated into the Swiss Constitution through a referendum with support from 85 percent of voters. The debt brake provides for a transition period in which expenditures are brought into balance with revenue. The debt brake has automatic triggers, reducing spending when deficits exceed a tolerance level. Deficit spending is permitted in response to emergencies, but the deficits must be offset by surplus revenues in the near term.   

In the United States, the precedent for rules-based fiscal policy is the fiscal rules enacted at the state and local levels. As in the Swiss case, these fiscal rules are incorporated into constitutional and statutory law. For centuries, these fiscal rules have allowed state and local governments to balance their budgets and stabilize debt.

We need a bottom-up approach to fiscal reform in the United States like that in Switzerland. It is time for the states to step up and impose effective fiscal rules at the federal level. The U.S. Constitution does not provide for initiative and referendum; but Article V gives the states, as well as Congress, the power to propose amendments. Private organizations are now working with state legislators to draft resolutions calling for a fiscal responsibility amendment enacted through an Article V amendment convention. There is now a window of opportunity to avoid debt default and shock therapy by enacting rules-based fiscal policy in the United States, but that window is closing fast.

Barry Poulson ([email protected]) is a policy advisor with The Heartland Institute.

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