INCRA US Rating Report 2015

Rating: AAA (8.0)

United states

stable outlook

Rule of Law

Economic Fundamentals Public Sector Fiscal Policy

Transparency and Accountability

9.6

Strengths: • World’s largest economy • Diversified, wealthy and highly productive economy • World’s largest and deepest financial markets • Flexible labor markets

8.5

• Rapidly rising energy production

9.1

7.9

Monetary Policy

Social Cohesion 9.2

Capital Markets and Financial Risk

10

8

7.1

6

4

8.0

2

8.3

2

6

• Strong tradition of rule of law 8 7.7

7.6

External Sector

4

10

Future Resources

7.5 7.4

7.0

• Highly developed civil society

Strategic Capacity

Weaknesses: • Debt-to-gross domestic product (GDP) ratio far higher than the historical norm

7.0

• Debt-to-revenue ratio far higher than its peers

Crisis Management

Implementation Adaptability

• Ongoing political gridlock • Income inequality

8.3 Macroeconomic Indicators

Forward-Looking Indicators 7.8

• World’s costliest healthcare system

Summary The United States is by far the largest economy in the world. It remains one of the most competitive, diversified, wealthy and productive nations on earth. However, its recovery from the Great Recession has been slow, and uneven, with many significant differences in growth from quarter to quarter. Nonetheless, the medium-term outlook for annual growth remains between 2.5 and 3.5 percent.

The National Bureau of Economic Research (NBER) dates the Great Recession from December 2007 to June 2009. During that time, US output dropped by an estimated 5.1 percent. With the

1

sudden collapse of the real estate market and its repercussions in the financial markets, US and world financial markets faced the risk of a complete meltdown, especially following the sudden bankruptcy of Lehman Brothers in September 2008.

However, the federal government proved capable of rapidly dealing with the crisis, although not without considerable political melodrama.

In late September 2008, Congress initially rejected a financial market bailout proposal, a rejection that caused a sudden and dramatic drop in US stock markets. But lawmakers quickly reversed themselves and approved $700 billion in funding for the Troubled Asset Relief Program (TARP) in early October 2008. This bailout, when coupled with the actions of an unfettered and imaginative Federal Reserve, averted what could have easily become an even more severe economic downturn, if not an outright depression.

After a sharp rise in unemployment, a steep decline in household wealth caused

by the sudden drop in real estate prices — a decline greater than that witnessed during the Great Depression — and falling stock values, the federal government undertook significant stimulus policies well beyond the initial TARP program.

The rating outlook for the United States is stable. That outlook could change if either the general government debt ratios were to move toward an upward trajectory and/or if political gridlock related to the debt ceiling were to once again put debt repayment at risk.

The Economy As noted above, real GDP growth since the end of the recession remained lackluster until the second quarter of 2014. After negative growth in the first quarter of that year, the economy grew by 4.6 percent (SAAR: Seasonally Adjusted Annual Rate) in the second and 5.0 percent (SAAR) in the third. In the fourth quarter, growth slowed slightly to 2.2 percent. This deceleration in growth was mainly due to higher imports, which

Real GDP Growth (%) 4 3 2 1 0 -1 -2 -3 -4

2008

2009

2010

2011

2012

2013

2014

2015

are usually associated with stronger GDP growth, and a decline in federal government spending. Overall, GDP grew by 2.4 percent in 2014.

GDP growth in the first quarter of 2015 was -0.9 percent. The decline was due to numerous factors, including slower export growth, higher imports, a slowdown in residential investment and lower state and local government spending.

There is a debate among economists regarding interpreting first quarter results: many argue that the seasonal adjustments used for first quarter analysis may be distorted, resulting in overestimating the decline in GDP, since this has happened repeatedly in recent years. The extremely cold weather also seriously affected about two-thirds of the country in the first quarter of 2015 and may help explain part of the sharp decline. Despite very weak GDP results in the beginning of the year, forecasts for US growth for all of 2015 range from 1.5 to 3.0 percent. Growth is expected to accelerate in 2016, putting the economy on a trajectory which is still expected to close the country’s output gap by the end of 2017.

House prices are no longer falling in the United States; in most regions, they are rising. Mortgage rates are still at historically low rates, and the rate of foreclosures has dropped significantly. Housing inventories are down. A turnaround in housing is important because not only does it create a positive wealth effect, but new home construction and/or purchases of existing homes have an important knockon effect on related industries such as appliance manufacturers and household goods suppliers.

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Looking at the components of GDP growth, we find that real private consumption grew by 2.5 percent in 2014, rising more rapidly in each of the four quarters, peaking at seasonally adjusted growth of 4.3 percent in the fourth quarter of 2014. Domestic investment grew by 6 percent. Growth in residential investment, however, which was 13.5 percent in 2012 and 11.0 percent in 2013, slowed significantly in 2014, coming in at just 1.6 percent. Export growth, which outpaced import growth in both 2012 and 2013, fell below import growth in 2014; although exports rose by a comfortable 3.1 percent, imports rose by 3.9 percent. The government sector once again acted as a drag on GDP, as real federal government spending declined by 1.9 percent. However, state and local government spending rose by 0.9 percent, slightly higher than 2013’s growth of 0.5 percent.

Inflation Inflation has remained subdued during this recovery, despite the enormous monetary stimulus injected into the economy by the Federal Reserve. The consumer price index (CPI) actually increased at a slower pace in 2014, when it rose by a mere 0.8 percent compared with a rise of 1.5 percent in 2013. Given that the US economy is performing below capacity, excessive inflationary pressures are not likely to emerge until 2017, when, according to the latest forecast by the Congressional Budget Office (CBO), the US economy will reach full capacity. The CPI for all items declined in April 2015 by 0.2 percent year-over-year (YOY).

However, the main reason for the decline was a sharp drop in energy prices, which decreased by 19.4 percent YOY. Excluding energy and food prices, the CPI rose by

1.8 percent in April YOY. This would put the core inflation rate slightly below the Federal Reserve’s target rate.

What has concerned many observers about the medium-term inflation outlook is the massive amount of monetary stimulus that has been provided through unorthodox measures, in particular through quantitative easing (QE). QE is essentially a form of printing money.

Historically, when governments or their central banks resorted to the so-called printing press, it almost inevitably ended badly, resulting in high inflation and in some cases hyperinflation. There are countless examples of this in the history of Europe and Latin America. However, in most historical cases, QE occurred when an economy was prostrate after military defeat.

The other common scenario is that it was employed in an emerging-market country whose government was unwilling or unable to raise enough revenue to pursue its goals.

As such, more money was chasing the same amount of goods. The result of such actions was soaring inflation.

In the case of the United States, QE has been used because traditional financial market transmission mechanisms have not functioned normally. Putting it another way, the velocity of money has slowed. In most countries where QE was used to excess, capacity constraints, not velocity, were the core problem. In the US case during the recent financial crisis, velocity has been key. Given that the US economy is expected to reach full capacity by the end of 2017, unwinding QE remains a potential risk in the medium term. This is one of the primary reasons why the Federal Reserve is likely to start raising short-term interest rates in 2015 or early 2016 at the latest. This would allow the economy to adjust gradually to a return to a more orthodox monetary policy, which will likely be required as it approaches capacity constraints in 2017.

A major concern is that with monetary policy having been loose for so long, asset prices are potentially vulnerable to a higher interest rate environment. Since

Inflation - CPI (%) 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 -0.5 -1

2008

2009

2010

2011

2012

2013

2014

2015

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we have no experience with the existing unorthodox monetary policy used since 2008, it is difficult to predict the impact on asset prices when the Federal Reserve starts to raise interest rates. Much will depend on the size of such increases. If interest rates increase at a slow pace, then asset price adjustments may not prove too unsettling. However, if the Federal Reserve raises interest rates significantly at some point in the future, as it did in the early 1990s, asset price adjustments might prove disruptive. They will need to be monitored closely going forward.

Labor Markets The US has one of the most flexible labor markets in the developed world. The Great Recession caused a steep increase in unemployment, with the jobless rate peaking at 10.0 percent in October 2009.

That, however, was still slightly below the previous post-World War II peak of 10.8 percent, reached from November to December of 1982. In recent months, the unemployment rate has dropped more quickly than many had expected. Between

January 2013 and December 2014, it fell by 2.4 percentage points, from 8 percent to 5.6 percent. In April 2015, the rate had fallen further to 5.4 percent.

discouraged workers who had simply given up looking for a job. The rest of the 1.4 million had valid family or educational reasons to be outside the labor force.

The number of long-term unemployed, those who have been without work for 27 weeks or more, has fallen significantly both in terms of the actual number of people and the percentage of the unemployed. The number of people unemployed for more than 27 weeks totaled 3.9 million in December 2013.

That number fell by nearly 1.1 million, to 2.8 million, by December 2014. In April 2015, the percentage of long-term unemployed as a percentage of all the unemployed fell to 29 percent, well below its peak of nearly 45.1 percent in September 2011.

The Banking Sector

In April 2015, another 2.1 million people were considered marginally attached to the labor force — which means that they had looked for work over the past 12 months, but not for the past four weeks. Of that 2.1 million, only 756,000 were considered

Unemployment Rate (%) 12 10 8 6 4 2 0

2008

2009

2010

2011

2012

2013

2014

2015

After the near meltdown of the financial system in 2008 following the bankruptcy of Lehman Brothers, the federal government and the Federal Reserve proved that they would not allow the banking sector or systematically important financial services firms to collapse. The $700 billion TARP program provided more than enough funds to support the banking system, as well as the two major mortgage lenders, AIG, Bear Stearns and the automakers. Although we do not yet have the final figures, indications to date suggest that the federal government is instead likely to have made a net profit.

There is much discussion about the moral hazard issues relating to the idea of “too big to fail.� In that regard, it is essential to note the difference between a bank failure and a bank default. Depending on how a bank is wound down or how intervention is structured following its failure, it might still avoid defaulting on deposits or other financial instruments. In recent decades, the US banking industry has become ever more concentrated into fewer and fewer banks. In September 2014, the five then-largest US banks accounted for 44 percent of total bank assets in the country, equaling $6.8 trillion in total assets.

Therefore, despite all the discussion about allowing banks to fail, given the size and importance of the largest US banks, and their systemic significance, it is unlikely that the largest ones will ever be allowed to default, at least on deposits. As such, despite the rhetoric, the US banking

United States | 4

sector should be viewed as a contingent liability of the US government (excluding small local banks, which are often allowed to fail and default). However, at the same time, it is difficult to imagine an economic scenario where the banking sector would be under more stress than it experienced in 2008 and 2009.

The External Sector Exploring the US external sector presents a variety of analytical problems. On the surface, the US regularly runs large current account deficits. To finance these deficits, the US has either borrowed money or sold assets to foreigners. This results in a large net international debt now estimated at more than several trillion dollars. The analytical problem we have is that ongoing current account deficits and a significant net foreign debt should result in a net income outflow in the current account. Yet, despite years of large deficits and the large net debt, the net income flow is always positive. This means that despite a large and growing net debt, US residents still earn more on their foreign investments than foreigners do on their US investments.

Therefore, if one simply looks at the debt stock and changes in the net stock of debt, the US would score low. However, when one attempts to determine the cost of financing this debt, even over many years, it appears that there is none. In fact, as noted above, the United States remains a net recipient of foreign investment income, instead of the other way around. From that perspective, the US external position is quite healthy.

In 2013, net income as recorded in the current account totaled $208 billion, rising to $226.9 billion in 2014.

Analysts have been predicting for decades that the net income flow would eventually turn negative, but so far this has not occurred.

Public Sector and Fiscal Issues During the rating process, we aim to use data that is comparable across countries.

To date, this has not posed an analytical problem. However, in the case of the United States, using general government debt data distorts the analysis.

Current Account Balance to GDP (%) 0 -0.5 -1 -1.5 -2 -2.5

2008

2009

2010

2011

2012

2013

2014

2015

OECD reports indicate that general government statistics, though statistically comparable across countries, analytically exaggerate debt in some instances, particularly in the United States. The simple explanation for this is that the United States handles its pension programs in a different way from most other wealthy countries, and this tends to exaggerate the US debt burden.

The main difference in approach is that US government pension obligations are handled using an unusual accounting practice — at least unusual for national governments — by creating a liability for future pension obligations. For instance, because payroll taxes to fund the pension system are in excess of outgoing pension payments, the excess payments are used to purchase non-marketable US Treasury debt. For public finance purposes, this is an accounting fiction. Most other countries use a variant of pay-as-you-go pension systems. As a result they still have a similar implied liability to future pensioners, but they avoid the creation of additional government debt. From a longterm perspective, there is no difference between the two approaches.

Besides pension-related debt, the US also has a number of other similar trust funds created to sponsor other government activities.

The difference between marketable federal government debt and total federal government debt is significant (31.7 percent of US GDP in 2012).

-3 -3.5 -4 -4.5 -5

Given the accounting fiction, it appeared reasonable to the committee to exclude such trust fund obligations from the US debt numbers when making crosscountry comparisons.

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The United States also poses another interesting challenge when trying to make international comparisons. US general government debt includes debt of state/ provincial and local governments. In most countries, this is not a controversial idea, because to varying degrees national governments are usually seen as responsible, in whole or part, for lower levels of government debt. For instance, in Germany, there are strict and binding constitutional arrangements in place to handle joint liability issues. In Spain in recent years, despite not being constitutionally required to do so, the government felt obliged to step in and provide financial support for provinces in financial difficulty.

In the United States, not only is there no such legal obligation for the federal government to come to the rescue of state and local governments, there is a long history of the federal government not doing so. The one and only exception, federal aid to New York City in 1975, arguably strengthens the general rule.

Given this laissez-faire tradition, some argue that when examining US creditworthiness, state and local government debt should be ignored.

The committee came to a different conclusion for the following reasons.

Although the US federal government is not likely to find itself in a situation where it will rescue problematic state and local governments. But due to the outsized role these governments play in the US, they implicitly affect the ability of the federal government to adjust its own fiscal policy.

In 2014, state and local government debt equaled approximately 16.2 percent of

US GDP. State and local governments provide a vast array of services that are often provided by national governments elsewhere. In the United States, state and local governments also have widely varying tax policies.

Most states and even some cities levy their own income taxes, as do some cities. There are various state and local sales taxes.

Real estate taxes are, as a rule, levied at the local level by cities and towns.

Because state and local income taxes, as well as property taxes, are treated as deductions for federal income tax purposes, and because there are very different tax burdens on individuals depending on the state or locale of residency, changing this system may prove difficult in practice. Regional resistance may prove challenging to surmount. Given the effect of state and local government finances on federal fiscal flexibility, the committee deemed it appropriate for purposes of international comparison to include their debts when calculating overall US government debt.

General Government Debt to GDP (%)

Below is a table providing a time series for the various measures.

As you see, while INCRA-adjusted general government debt for the US was 77.8 percent of GDP in 2010, it had climbed to 86.3 percent in 2013. By the third quarter of 2014, the ratio began its first decline since the Great Recession.

The debate about the deficit centers around the federal government, rather than state and local governments (almost all the states, and many municipalities, have balanced budget requirements). As such, we will discuss the issue in terms of the federal deficit.

The federal deficit as a percent of GDP, after peaking at 9.8 percent in 2009, has been declining steadily since then. In fiscal year (FY) 2014 it had dropped to 2.8 percent. It is forecast to decline further in FY 2015 to 2.6 percent of GDP. According to the CBO, there is a risk that federal deficits, as a percent of GDP, could once again start to rise beginning in FY 2018. The committee expects that increases in deficits in later years will

2010

2011

2012

2013

2014

77.8

78.4

85.2

86.3

84.7

Italy

124.8

120.7

127.0

132.5

136.7

France

81.5

85.0

89.2

92.2

94.5

Germany

74.5

80.3

77.6

79.0

76.4

Japan

210.6

226.5

234.8

243.4

243.2

USA

(Federal government debt held by the public plus state and local government debt/GDP)

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relate to increased entitlement spending.

It appeared reasonable to the committee that some entitlement reform is likely by 2018, and that therefore the projected rise in deficits starting in FY 2018 will likely not occur. If that proves not to be the case, then there might be some slight downward pressure on the rating outlook.

Forward-Looking Indicators (FLI)

of Western Europe have managed. This may portend renewed efforts to lessen inequality, because such efforts have in the past generally been undertaken during periods of economic growth. Second, the issue of economic inequality has become the subject of increasing public discussion and debate. Public concern is a necessary, although not a sufficient, condition for remedial public policies.

The United States scored particularly well in the categories of monetary policy, rule of law and accountability. There is room for improvement in adaptability, implementation and social cohesion.

The 2014 congressional elections provided further evidence of political discontent among the American public. The level of participation was low, candidates of both major parties waged largely negative campaigns, and polls continued to show broad pessimism about the prospects for effective governmental action at the federal level. The ongoing proliferation and compartmentalization of the media makes effective communication by the government increasingly difficult.

The broad audiences that the major television networks and a few influential print publications once commanded have splintered. The multiplication of outlets, in combination with the growing political polarization in the United States, has fostered a tendency for citizens to get their politically relevant information almost exclusively from sources whose political point of view they support.

The inequality gap continues to be a problem in the United States and appears to be growing. However, two recent developments may lead to measures that can reduce economic inequality in the future. First, economic growth has resumed in the United States. It has not reached the level that was considered normal in the post-World War II decades, but the rate exceeds what the countries

Government gridlock remains an issue in the United States; indeed, in 2013 and 2014 that polarization deepened, increasing the difficulty of implementing strategic priorities. While these political issues do not immediately impact the US ability or willingness to repay, as the government has been able to solve imminent crises, “business as usual” politics must change in the coming decade.

While US macroeconomic indicators have improved across the board, the political assessment of the United States has remained largely the same since INCRA last rated the country in 2013. The United States is both willing and able to pay, and we have every reason to believe that this will persist, given the economy’s strong performance in recent years. Deficit as a percentage of GDP is decreasing, low oil prices are boosting consumption, and unemployment has been fairly low for some time now. The country committee discussion emphasized that political inaction and lack of compromise are the clearest threats to the country’s ongoing success.

Rule of Law The US scored highly in the rule of law category. It was recognized that the US legal system is respected, and its laws generally obeyed. For instance, even in the hotly contested legal dispute over the 2000 Presidential election, a verdict by the Supreme Court determining the winner was accepted as binding by all sides. The US scored even more highly regarding the independence of its judiciary. At the Federal level, the judiciary is viewed as highly independent.

Separation of powers was viewed as extremely strong. However, the committee noted that the separation of powers was so strong at the federal level, that although normally a sign of a healthy democracy, in the US case the separation of powers appears to have unintended consequences as witnessed by today’s political gridlock.

Property rights were also scored highly, despite the fact that there was some concern expressed about excessive use of eminent domain.

Transparency and Accountability The US scored highly regarding government transparency and accountability. In the section regarding corruption prevention, the committee noted that the US is generally regarded as suffering from only minor instances of corruption, usually at the local level.

In general, the public does not view corruption as a major issue. In fact, it appears that official corruption in the US is possibly lower than it has ever been in its history.

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There was little doubt among committee members that the US media was independent of government interference.

Although there is a small public broadcasting network, it is usually viewed by the public as among the least biased sources of analysis.

The rest of the media are privately owned.

Also, as elsewhere, the growing use of the internet has democratized news outlets in an unprecedented way.

The US also scored highly regarding civil society participation. Non-governmental organizations are active throughout all aspects of society. Although some would argue that some voluntary organizations are slightly less active than in the past, there appeared little doubt that nongovernmental groups continue to play an active role in US society, affecting such things as tax policy, foreign policy, environmental regulation, education, etc.

Some on the committee even argued that as with the separation of powers indicator, civil society participation in the US may be so high that it slows down the decisionmaking process, and therefore might represent a slight negative. Nonetheless, overall it was still viewed as a key strength for the US.

Social Cohesion We have just examined some of the FLI indicators where the US scored relatively high. Now we will explore several where the US scored somewhat lower.

The US scored poorly in the category of social inclusion. The US has relatively high income and wealth inequality compared to almost all other advanced industrial countries. The US has a less generous welfare system than its peers. It has a heterogeneous population and still has

issues related to its historic racial divide.

Although much progress has been made, racial issues still exist. In addition, as mass immigration is continually changing the country’s demographics, the US will soon face a challenge as it becomes a country where a majority is composed of minorities.

Although the US has found it easier to deal with its immigrants than most of its peers, the very size of the population and rapid demographic change presently underway will nonetheless pose a challenge, made all the more difficult to deal with because of the country’s growing economic inequality.

Between 2002-2007 people in the top one percent of the American income ladder captured two-thirds of the total gains from economic growth, and the top one-tenth of one percent captured fully one-third of the gains.

The US also scored low for trust in its political institutions. Although the committee recognized that the US political system is viewed as among the most stable in the world, public opinion surveys indicate Americans appear to have little faith in Congress. Additionally, American voter participation is significantly lower than in most other advanced industrial countries.

Some interpret this as a signal that many people view their vote as having little direct impact on policies that affect them.

The US scored by far the lowest in the area of conflict management. Since the mid-1990s, the US government has often faced gridlock. The two major political parties have become so polarized that decision-making has often become almost impossible. In the past, most issues could be settled in a bipartisan fashion. That no longer appears to be the case. The debt ceiling controversy of 2011, the fiscal cliff

debate of 2012, the use of sequestration in 2013, and the difficulty in getting cabinet and judicial level appointments approved by the Senate all indicate dysfunction.

Both sides may argue that the other side is to blame, but from a governance perspective, polarization, albeit a relatively new phenomenon, is nonetheless an increasingly significant risk. The US scored lower in this category not only compared to its peers, but also when compared to Brazil.

The US also scored low regarding policy implementation. The divisions within the federal government have become so pronounced that approval for new policy initiatives, regardless of their nature, appears unlikely. As discussed in the committee, in the past, US presidents would often propose an agenda in the annual State of the Union address, and would likely find many of the proposals passed during their term of office. Few would expect that to happen today.

Resource efficiency was another area of weakness. Here the discussion centered on the federal civil service.

It was noted that in the 1930s, civil servants were highly regarded and generally well compensated. Since the 1980s, civil servant compensation at the federal level has generally fallen behind similarly skilled private sector workers.

In addition, the size of the civil service has not kept pace with the demands put upon it by an increasingly technological society. As already noted above, since it takes so long for senior federal nominees to get approved by the Senate, many highly qualified people are simply unwilling to go through the now painful appointment process.

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Adaptability In the two sections related to adaptability, when the committee discussed both policy learning and institutional learning, the US scored low. Again, it related to the increasingly divided nature of the federal government. It was noted that in the past, bipartisan policies could be adopted if viewed in the national interest. Today it appears difficult for the two major parties to agree on defining what is in the national interest. For example, in the past, bi-partisan commissions were frequently appointed to resolve complex issues surrounding Social Security, Medicare or to resolve important tax matters. Today, even when such commissions have been formed, their recommendations have usually been ignored.

Recent Political Developments In November 2012, President Barack Obama was reelected. In addition, Democrats won 53 of the 100 seats in the Senate. Republicans won 45 seats, with two senators who ran as an independent, but who generally caucus with the Democrats.

There are 435 seats in the House of Representatives. Democrats won 201 seats, while Republicans won 234.

In the 2014 mid-term elections, Republicans made significant gains, resulting in their best Congressional performance in nearly 100 years. Republicans now hold 54 Senate seats to 44 seats held by the Democrats and two independents who generally caucus with the Democrats. In the House, Republicans increased their majority to 247 seats compared to 188 seats for the Democrats. Nonetheless, the Republicans still don’t have either a veto-proof majority, nor even a large enough majority in the

Senate to block most filibusters. However, it should be noted that since the Democrats changed some of the filibuster rules in the last Congress, Republicans might do the same in the present Congress.

At the same time, the committee felt that the Republicans were likely to try to avoid another debt ceiling controversy in the near-term, since the Republicans are likely to want to be viewed as a party that can govern effectively.

The Debt Ceiling Unlike other advanced industrial countries, the US has a debt ceiling that acts as the upper limit on how much the Federal government can borrow. It is an anachronism, which dates to a time when the Congress had to pass a bill permitting every US Treasury bond issuance. At the beginning of the 20th century, the process was streamlined by simply putting in place an overall limit. The debt ceiling has been raised on countless occasions ever since. Until 1995-96, it had never been a controversial issue. After all, the ceiling only allowed debt issuance related to programs and spending already approved by Congress.

However, in 1995-96 for the first time, the Congress threatened to not raise the debt ceiling unless President Clinton agreed to a variety of measures. However, instead of agreeing to Republican requests, he slowly shut down the federal government.

Pressure grew on the Republican Congress, who was being blamed by the public for the problem, and the debt ceiling was raised in early 1996. It did not become an issue again until 2011. Political battle lines were drawn after Republicans took control of the House of Representatives following the 2010 election, with a large contingent of so-called Tea Party Republicans, a political group that

advocates reducing the size of the federal government by all means possible.

By late July 2010, the US government was rapidly running out of borrowing authority.

The Treasury had already used many of its traditional quick fixes to get around the ceiling. There were some in the Tea Party caucus who actually argued for not raising the debt ceiling even it meant that the federal government would default on its debts.

Cooler heads prevailed, and at the very last minute a deal was struck to raise the debt ceiling, but not in a clear nor long-lasting way. The new law was signed on August 3, the day the Treasury was scheduled to run out of borrowing authority.

The crisis was averted by creating a socalled Super Committee that was charged with recommending a deficit reduction package of $1.5 trillion before November 2011. (The actual requirements were incredibly complex.) If the committee did not agree on a recommendation, automatic-spending cuts, better known as sequestration, would eventually result beginning January 1, 2013. The rules surrounding sequestration are as equally obtuse as the requirements surrounding the Super Committee. It was thought in 2011, that such a foolish and arbitrary policy that might end in sequestration would never be allowed to happen.

Additional Signs of Dysfunction The Bush tax cuts were set to expire on December 31, 2012. Massive tax increases were scheduled to come into effect on January 1, unless an agreement on a new tax law was reached. Nothing was done until late in the night on January 1, thereby avoiding a sharp tax rise, but only by going to the brink once again.

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Rating Committee Average Scores by Indicator Macroeconomic Indicators

8.3

Capital Markets and Financial Risks

8.3

Economic Fundamentals

8.5

Domestic Credit / GDP (%)

8.8

Real GDP Growth %

8.5

Domestic Credit (% Change)

8.1

GDP per Capita

9.2

Overall Strength of Banking Sector

8.1

Real Exports (% Change)

7.9

External Sector

7.6

Real Imports (% Change)

8.6

Current Account

7.4

Gross Domestic Investment / GDP (%)

8.3

External Debt

7.7

Gross Domestic Savings / GDP (%)

7.4

Inflation-CPI (%)

8.8

Forward Looking Indicators

7.8

Population Growth (% Change)

9.5

Political Economic and Social Stability

8.4

Public Sector / Fiscal Policy

7.9

Rule of Law

9.6

General Government Debt / GDP (%)

7.6

Legal Certainty

9.4

Nominal GDP Growth (Local Currency %)

8.3

Independent Judiciary

9.8

Separation of Powers

9.3

Property Rights

9.9

Transparency / Accountability

9.1

Corruption Prevention

8.3

Independent Media

9.3

Civil Society Participation

9.6

Social Cohesion

7.1

Social Inclusion

7.3

Trust in Institutions

7.0

General Government Debt / General Government Revenue (%) General Government Interest / General Government Revenue (%)

7.3 7.6

General Government Primary Balance / GDP (%)

8.3

General Government Fiscal Balance / GDP (%)

8.3

General Government Revenue / GDP (%)

7.8

General Government Expenditure / GDP (%)

7.7

Monetary Policy

9.2

Accommodative Monetary Policy

9.2

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Societal Mediation

7.6

Implementation

7.0

Conflict Management

6.7

Government Efficiency

6.5

Future Resources

7.7

Resource Efficiency

7.4

Education

7.0

Adaptability

7.0

Research and Innovation

9.1

Policy Learning

6.4

Employment

8.4

Institutional Learning

7.5

Social Security

6.9

Crisis Management

7.4

Environmental Sustainability

7.0

Historical Evidence of Crisis Management

8.4

Steering Capability and Reform Capacities

7.2

Crisis Remediation

7.5

Strategic Capacity

7.5

Signaling Process

7.3

Prioritization

7.0

Timing and Sequencing

7.1

Policy Coordination

7.1

Precautionary Measures

6.9

Stakeholder Involvement

8.2

Automatic Stabilizers

7.5

Political Communication

7.8

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macroeconomic indicators I. Economic Fundamentals

2008

2009

2010

2011

2012

2013

2014

2015

Nominal GDP Growth (%)

1.7

-2.0

3.8

3.7

4.2

3.7

3.7

4.8

Real GDP Growth (%)

0.3

-2.8

2.5

1.6

2.8

1.9

2.4

2.0

Unemployment Rate (%)

5.8

9.3

9.6

8.9

8.1

7.4

5.6

5.3

Real Exports, Goods (% Change)

12.1

-18

21

15.8

4.4

2.2

2.8

Real Imports, Goods (% Change)

7.5

-25.9

22.7

15.4

3.1

-0.4

3.4

Nominal GDP (bn. US$)

14,718

14,418

14,964

15,517

16,163

16,768

17,416

18,286

GDP per Capita (US$)

48,302

46,909

48,313

49,746

51,449

53,000

54,678

57,045

GDP per Capita (PPP basis: US$)

48,330

46,929

48,307

49,731

51,434

52,985

Inflation - CPI (%)

3.8

-0.3

1.6

3.1

2.1

1.5

0.8

1.0

Population Growth Rate (% Change)

1.0

0.9

0.8

0.7

0.7

0.7

Gross Fixed Capital Formation / GDP (%)

21

18.5

18.0

18.2

18.8

18.9

19

19.5

Gross Domestic Savings / GDP (%)

15.7

13.7

15.4

15.1

16.1

16.2

17.1

17.6

II. Public Sector Policy

2008

2009

2010

2011

2012

2013

2014

2015

General Government (GG) Debt / GDP (%)*

91.8

104.9

115.3

120.9

123.7

122.5

124.2

124.3

GG Revenue / GDP (%)

30.2

28.4

28.8

29.1

29.2

30.9

31.4

32.0

GG Expenditure / GDP (%)

37.2

41.9

40.1

39.0

37.8

36.6

36.9

36.3

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GG Financial Balance / GDP (%)

-7.2

-12.8

-12.2

-10.7

-9.0

-5.7

-5.1

-4.3

Primary Balance / GDP (%)

-5.0

-11.6

-9.2

-7.6

-6.3

-3.6

-3.4

-2.2

GG Debt / GG Revenue (%)

241.4

303.0

329.5

340.5

351.2

337.7

336.1

328.3

GG Interest / GG Revenue (%)

15.3

15.6

15.7

16.6

15.6

13.5

2008

2009

2010

2011

2012

2013

2014

2015

-0.3

6

3.2

8.7

5.8

III. Capital Markets & Financial Risk Domestic Credit Growth (YoY) Domestic Credit / GDP (%)

216.8

231.4

227.1

227.2

232.4

240.5

IV. External Sector

2008

2009

2010

2011

2012

2013

2014

2015

-4.7

-2.6

-3.0

-3.0

-2.9

-2.4

-2.5

-2.6

Current Account Balance / GDP (%)

Sources: OECD, World Bank, IMF, Author’s Calculations

*Including unfunded pension liabilities

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About the Bertelsmann Foundation The Bertelsmann Foundation, established in 2008, is the North American arm of the Germany-based Bertelsmann Stiftung. The Foundation is a think tank that spurs debate and discussion on political, economic and social issues and it is committed to promoting the freedom of individuals and societies and international understanding. The Bertelsmann Foundation develops, creates, and implements its own projects and programs. The Bertelsmann Foundation develops “Global Ideas and Transatlantic Action” and we serve as an international window in the US capital, providing a showcase for global best practices and a venue for thought leaders to exchange ideas for confronting society’s greatest challenges.

The INCRA project was launched at the Bertelsmann Foundation’s 2012 Annual Financial Conference, which has developed a reputation for being the go-to event on the sidelines of the International Monetary Fund World Bank Group Spring Meetings. The Bertelsmann Foundation sees INCRA as an important contribution to the debate and discussion on new rules for international financial- and economic-policy governance. Therefore, the Foundation seeks to explore and support all avenues to turn the INCRA concept into reality.

About INCRA The Bertelsmann Foundation developed its INCRA (International Non-profit Credit Rating Agency) proposal following the 2008 financial crisis and the subsequent criticism of the practices of the leading credit rating agencies. The INCRA blueprint presents a new model, both in its institutional setup and its methodology, for developing a credit rating agency to assess sovereign risk in an alternative way. INCRA is based on an operational business model funded by a sustainable endowment.

Since publishing the original model for INCRA the Bertelsmann Foundation has assembled a team of international sovereignratings experts to produce sovereign ratings based on INCRA’s transparent methodology. INCRA has developed a comprehensive new methodology that evaluates a country’s ability and willingness to repay its debt. In its sovereign debt assessments INCRA uses forward-looking indicators in addition to traditional macroeconomic data. These indicators are highly qualitative, mirror a country’s socioeconomic development and include factors like governments’ crisis management and reform capacities as well as investments in education and infrastructure. INCRA defines sovereign ratings as “public goods”, available to all citizens and correspondingly all detailed rating reports are available online for free.

Contact Annette Heuser, Bertelsmann Foundation, (202) 384-1990 annette.heuser@bfna.org Anneliese Humpert, Bertelsmann Foundation, (202) 384-1995 anneliese.humpert@bfna.org Bertelsmann Foundation North America, 1101 New York Ave NW, Suite 901, Washington, DC 20005 www.bfna.org www.incraglobal.org

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