Global Policy Forum

By Victor Keegan

The United States economy is looking more and more like a welcoming landscape obscured by three dangerous mountains. President George Bush inherited two of them - the consumer debt mountain and the trade deficit mountain - but he has built a third with his own hands, using only government debt.

So far, it has to be admitted, the US economy has done remarkably well in the face of such formidable obstacles.

In the first three quarters of 2002, gross domestic product expanded by 3% - not bad for an economy that has been through a dot.com collapse, a corporate governance crisis, the events of September 11 and an increasing threat of war. Mr Bush is hoping that his tax cuts will give consumer spending another boost, meaning the economy can continue to defy gravity for a while longer.

It may well do - but as the deficits get larger, the danger of a sudden implosion will become greater. It is not possible to allow the trade deficit, which is already more than 5% of GDP, to keep expanding forever. Sooner or later, investor confidence will be punctured and international money - which has been financing the deficit - will flow out like a tidal wave. Ditto for consumer debt.

In these circumstances, Mr Bush's budget was the right medicine given to the wrong patient.

Yes, there is a case for a Keynesian demand stimulus to keep economic activity up during a period of turbulence. But the Bush bullion is going not to poor people who would actually spend it, nor even to public works that would benefit everyone. It is going to rich people who are likely to add it to their savings.

Half the package is going to finance the abolition of taxation on dividends. This will not benefit poorer shareholders whose main equity wealth is in retirement funds already exempted from taxation, but rich people who are buying shares as individuals.

As a means of economic stimulation, this deserves to be called voodoo economics - except that George Bush senior probably has intellectual property rights over the phrase. Don't think that all this is something that does not affect us over here - it does, in two ways.

Firstly, if the dividend proposals get through a Republican-dominated Congress, they will almost certainly lead to demands for the similar tax treatment of dividends here to restore a "level playing field" regarding investment.

If this happens, the chancellor will have to raise taxes elsewhere to pay for income foregone from untaxed dividends.

Secondly, and most importantly, the US - by far the biggest economy in the world - is still the locomotive of world recovery. If it sinks into recession because consumers stop spending or international investors take fright, the rest of the world will be reeling under the effects.

Why? Because Europe's main source of extra growth at the moment is the US trade deficit - the fact that millions of Americans are buying imports.

This is reckless from the point of view of the long-term health of the US economy, but to Europeans it is like Red Cross parcels being handed out at a time when domestic demand is so weak. The simple truth is that we are all in this together. The US trade deficit is becoming so huge that the country will not be able to trade out of it, even if a lower dollar restores some lost competitiveness.

What it needs urgently is for Europe to take up the locomotive role and expand its own economy to provide a market for exports from the US and the rest of the world.

There is no other economic bloc able to take on this role. China is still too small and Japan - the third biggest economy after the US and Europe - is desperately trying to stave off deflation after ten years of economic stagnation.

If Europe does not start to exploit its own underlying economic strength, it too could follow Japan into the economic doldrums.

The EU has been so distracted by the demands of its new currency that it has failed to get its act together on even more important matters.

Maybe it should have learned how to walk before it started running with the euro.

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