The North Atlantic crisis has played out in three acts over the past three years. It started as a financial crisis in late 2008. Markets froze in fear. Financial institutions that had gorged on dodgy derivatives tottered on the edge. Next was an economic crisis. Output fell. Jobs disappeared. The third stage was the fiscal crisis. Fiscal deficits bloated as taxpayers were forced to fund expensive bailouts of financial institutions. Many rich countries are close to insolvency. Others have been able to fund their deficits at low interest rates, but one can never predict when the bond markets will revolt in a buyers’ strike.
The big question: is a political crisis the next stage? The multiple crises in the US and Europe have their roots in politics. The credit boom in the US was an attempt by policymakers to help an average family increase its standard of living despite stagnant incomes. The common currency in Europe is part of an ambitious project to unite the continent, while the welfare state was an honest attempt to consolidate social stability in countries that had terrible memories of mass unemployment, communism and fascism.
Given this, the solutions should also have a strong political element. The political establishments on both sides of the Atlantic have not provided too much reason for hope. The mission to save the European Union has run into the intransigence of German and French leaders. The US has seen an outbreak of partisanship, with both parties doing their best not to cooperate on measures to bring down public debt over the next 10 years or so.
The political gridlock in these countries is now emerging as a risk to the rest of the world. Technocrats have taken charge of governments in Greece and Italy. Economist premiers may be able to calm the bond markets for now, but it is to be seen whether they can muster the political firepower to reform arrangements that led to the crisis in the first place. For instance, can they oversee painful adjustments to make their economies more competitive—leaving the euro, cutting domestic wages, keeping a tight lid on entitlements?
There is already growing anger in many Western countries. Most of it is inchoate. The Occupy Wall Street movement is a good example of genuine but aimless anger about what has happened in the past three years. Western politicians will eventually have to rise to the occasion. The entire world should worry if they continue to let matters drift at a time when there are so many fires raging.
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Illustration by Jayachandran/Mint