Does reducing the government's footprint work as advertised? The experience abroad offers clues. In Europe, where public-debt cuts have been government policy for more than a year, the results don't inspire confidence, at least so far.
Consider Greece. The debt-ridden country was saved from defaulting last year on its bonds when the European Union, the International Monetary Fund, and financial institutions supplied a $155 billion bailout in exchange for a strict timetable of spending cuts, tax increases, and sales of government-held assets. But so far, Greece's deleveraging has backfired. The Finance Ministry predicts that the economy might shrink by as much as 5.3 percent in 2011, depressing the tax receipts that the country needs to repair its finances. And its debt is a bigger problem than ever. With its creditors unable to agree on bailout terms, many investors expect Greece to default on its loans.
The rest of Europe's economies have performed better, but not by much. In Britain, more akin to the United States, the Conservative-led government's austerity program hasn't revived the economy. The Institute for Fiscal Studies, a respected London think tank, predicted recently that British living standards will decline by 10 percent over three years, with price increases far outstripping the growth in incomes.
Most other European governments, though less in debt than Greece, have imposed austerity measures of their own. Growth in the 17 countries that use the euro averaged an anemic 0.2 percent during the second quarter of 2011. Germany, the Continent's strongest economy, has grown only half that much. The slump prompted a warning from Christine Lagarde, the IMF's managing director, that "slamming on the brakes too quickly will hurt the economy and worsen job prospects."
Conservative economists may argue that the austerity in these countries hasn't gone on long enough to work its dark magic. Japan's experience, though, is more discouraging still. What the United States experienced in 2008, Japan suffered in 1989. A debt-fueled real-estate binge went bust, leaving banks stuck with loans for land and buildings that were suddenly worth a fraction of the amount borrowed. The stock market fell 48 percent.
Japan's central bank, unlike the Fed, waited 17 months before lowering interest rates and balked at forcing banks to acknowledge their losses on loans or to rebuild capital depleted by bad debts. Nearly three years passed before the government spent money on public works to bolster the economy, and it turned off the spigot before the private sector became self-sustaining. Now, 22 years after the crash, growth is still at a crawl, and the stock market has yet to regain its earlier heights. Prime ministers and their governments have come and gone, none of them able to muster the will and vision to lift the economy from its doldrums. Sound familiar?
The impact of deleveraging in Japan has been more than economic. It has produced a generation of chronically discouraged young workers. When McKinsey & Co. surveyed Japanese ages 18 to 35 last year, only 10 percent deemed themselves ready to compete in the global economy; two-thirds of them doubted that their country could.
This gloom hasn't spread to the United States--yet. The popular culture has remained relentlessly upbeat--comic-book escapism in the movies, nostalgia (à la Mad Men) on TV. A rare new series on this fall's primetime schedule that will tackle the foreclosed futures of the young is, tellingly, a sitcom, CBS's Two Broke Girls. "The tale of our times is mostly being told by our unwillingness to tell it," cultural commentator Jaime O'Neill wrote in the Los Angeles Times.
Like the Depression-era movies that showed butlers in marble foyers, this avoidance suggests how much is at stake. It goes to the heart of American expectations that every generation will enjoy a higher standard of living than the one before it. This expectation isn't dead yet, but it's in danger. Fifty-five percent of respondents to a Gallup Poll last spring thought it unlikely that young people today will live better than their parents. An Associated Press poll found that more than half of 18- to 24-year-olds anticipate having a harder time buying a home and saving for retirement than their parents did.
Their pessimism may be warranted. Unemployment is one of the prices of a deleveraging economy, and young people are paying more than their share: The jobless rate among workers ages 16 to 24 is 18 percent--double the national average. Even the lucky ones who find work can expect that as long as deleveraging--or anything else--stifles growth and keeps the job market fearsome, they'll earn less when they join the labor force, and they'll have fewer opportunities to hop from job to job and from raise to raise. Lower starting salaries and limited mobility will blight their earning power for years to come. Yale University economist Lisa Kahn has found that people entering the workforce during an economic contraction earn about 10 percent less during the first 17 years of their working lives than those who start when there are jobs aplenty. What's more, they tend to stay in each job longer, resulting in incremental wage gains instead of the jumps in salary that often accompany a new position.
Expect any waning of optimism to reshape American politics--and not for the nicer. A recent poll by the Pew Research Center for the People and the Press found Americans almost equally split over whether Washington, to speed the economic recovery, should spend more or cut the deficit. This ambivalence drove the summer's toxic debate over the debt ceiling that further poisoned the tone of U.S. politics.
Deleveraging could also pit the young against their elders. If older Americans, finding their retirement savings depleted, stay in their jobs longer and thereby block younger workers from advancing, resentment between the generations could erupt. So, too, if Washington curbs Social Security benefits or raises the age of eligibility. "We face the real possibility that this century will be marked by harsh generational conflicts over limited resources," says David Yamada, director of the New Workplace Institute at Suffolk University Law School in Boston.
Or possibly young people will just learn that "life isn't what you expected," as Barry Schwartz, a psychology professor at Swarthmore College, put it. He sees a chance that Americans would emerge from a long and deep recession with a worldview like the one that prevailed before World War II, when people accepted straitened circumstances with the confidence that their children would fare better.
After the war, "that stopped being good enough," Schwartz recounted. "Parents started to expect that their own lives would get better." Fulfilling these expectations required a steady rise in incomes that only a thriving economy could provide. Lowering those expectations, after a half-century of seeing them rise, could get ugly indeed.