Wealthy Europe and America, crown jewels of mixed capitalist democracies, are drowning in deficits and debt, owing to bloated welfare states that are now in place (Europe) or in the making (the United States). As Europe struggles to prevent financial contagion and America struggles to reduce its record deficits, their dangerous debt levels threaten future living standards and strain domestic and international political institutions.
The ratings agencies are threatening additional downgrades; others envision an eventual breakup of the euro and/or demise of the dollar as the global reserve currency. The economists Ken Rogoff and Carmen Reinhart estimate that public debt/GDP ratios of 90 percent are associated with sharply diminished growth prospects. Greece's debt ratio is over 120 percent, Italy's is around 100 percent, and the U.S. is at 74 percent, up from 40 percent a few years ago — and rapidly approaching 90 percent.
The International Monetary Fund estimates that each 10-point increase in the debt ratio lowers economic growth by 0.2 percentage points. Thus, increases of 40 to 50 percent of GDP risk cutting long-run growth in half in parts of Western Europe, and by one-third in America — a devastating reduction in gains in living standards over the course of a generation. Worse yet, the burden of banking losses that will sooner or later be socialized, and that of future unfunded public pension and health costs, are often understated in official debt figures.