- - Thursday, February 5, 2009

ANALYSIS/OPINION:

The best way to pull out of the recession is to keep America competitive in the global marketplace. Competition, both domestically and from abroad, keeps prices low for American consumers and businesses. It also makes us attractive to foreign investors.

The U.S. economy depends on foreigners to finance a significant portion of our budget deficits. If we let them, foreign investment and international trade can play a huge role in keeping the economy growing. But if foreigners stop buying U.S. debt or investing in our economy, or if we embark on trade wars, we could see a long period of economic stagnation and decline.

Our national debt is going through the roof. The Congressional Budget Office forecasts America’s 2009 budget deficits could reach $1.8 trillion (and that’s not even counting the price tag of the stimulus bill or other new spending). They could average $1.2 trillion a year for 2011-19. Publicly traded debt surpassed $6 trillion at the end of 2008 and, in four years, could soar from 40 percent to 60 percent of gross domestic product (GDP). A decade later it could rise to 100 percent.

All of this sends exactly the wrong message about America’s creditworthiness to foreign investors. Richard Berner, chief U.S. economist at Morgan Stanley, has said that America’s creditworthiness is already deteriorating because of debt. A year ago, when the fiscal situation was much better, credit rating agency Moody’s warned that, unless spending patterns changed, it might “have to look very seriously at whether the U.S. is still a triple-A credit.”

The outlook could get much worse if foreign investors sour on the U.S. economy. The Office of Management and Budget reports that, over the past seven years, foreign investors have financed about 75 percent of our budget deficits. If our credit rating goes down, they may take their money elsewhere. The unwillingness of foreign investors to buy hundreds of billions more in U.S. bonds could force the Federal Reserve to raise interest rates to entice bond purchasers. That would raise the cost of borrowing for everyone.

America´s competitiveness could be harmed by tax increases, too. As the Heritage Foundation/Wall Street Journal 2009 Index of Economic Freedom shows, we already pay taxes higher than the global average. According to KPMG, America´s corporate and indirect tax rate of 40 percent is higher than that of such welfare states as Canada (33.5 percent), France (33.3 percent) and Germany (29.5 percent). Putting aside Japan, America´s top tax rate is the worst among our 30 largest trading partners, which account for 90 percent of U.S. trade. It puts the U.S. economy at a distinct competitive disadvantage.

The evil twin of high taxes is expanding government spending, and here our performance is deteriorating as well. In the U.S., government (federal, state and local combined) consumes about 37 percent of our economic output. Compare that to China, which claims its government consumes only 30 percent of its economy. It’s shocking that, a communist government can boast of consuming less GDP than the U.S. government.

The U.S. scores better than most countries on trade, but that could change. In adding a “Buy American” rider to the stimulus bill, the House signaled a retrenchment from free trade. It set off alarm bells around the globe. Fortunately, President Obama appears to be backing away from that dangerous detour. Protectionism here could force other countries to retaliate and spark another round of protectionist measures in Washington. The last time something like that happened was in 1930, and we know what followed.

All of this does not bode well for the U.S. economy. A brew of debt, taxes and protectionism poisons economic growth. Each reinforces the toxic effects of the other. Economic downturns lead to more government debt, which, in turn, “crowds out” private borrowing, which lengthens and deepens the economic slowdown. The result could be stagflation on steroids, where high inflation co-exists with slow economic growth in a downward spiral of economic misery.

The message should be clear: High taxes, protectionism and debt caused by massive government spending threaten America´s competitiveness and growth. Mr. Obama, beware.

The best recipe for pulling America out of the recession is no secret. It´s a strategy to keep America competitive through: Real tax cuts that lower top tax rates on individuals and businesses (not give-backs or short-term credits that do nothing for the economy), reforming entitlements and putting the brakes on discretionary government spending.

If Washington needs more convincing, it need only talk to other countries whose progress toward prosperity is well documented in the Index of Economic Freedom

Kim Holmes, a former assistant secretary of state, is a vice president at the Heritage Foundation (Heritage.org) and author of ” Liberty´s Best Hope: American Leadership for the 21st Century.”