INCRA - USA Expert Report

UNITED STATES OF AMERICA

RATING REPORT

INCRA

AN INTERNATIONAL NON-PROFIT CREDIT RATING AGENCY

FOREWORD With this report, we want to make an additional contribution to one of the most pressing challenges of the global financial world: how to conduct sovereign ratings. For almost two years now, the Bertelsmann Foundation has been committed to improving major shortcomings of the sector from two angles. The first relates to the institutional and legal framework. The second is aimed at increasing the transparency and overall quality of sovereign ratings.

FOREWORD

In spring 2012 the Bertelsmann Foundation launched its first report that answered both of these key questions. In that report, we developed an institutional framework and governance structure for the first International Non-profit Credit Rating Agency, called INCRA. Additionally, we developed a comprehensive set of forward-looking, qualitative indicators to be used to improve the quality of sovereign ratings. These indicators complement the traditional macroeconomic ones.

In the second phase, we put our indicators to the test by simulating a sovereign rating process for five countries: Brazil, France, Germany, Italy and Japan.

Given the tremendous amount of interest expressed during the first two rounds, we have produced a third report. In an effort to further demonstrate the viability of our INCRA model, we decided to rate the most powerful and one of the most complex countries in the world: the US. We gathered a team of economists and political scientists from around the world, albeit with US expertise, to join our rating committee to assess the US today and over the next three to five years.

The simulation of a US rating took place with one key question at its center: What is the ability and willingness of the US government to repay its debt on a timely basis?

The overall engagement in our INCRA project demonstrates that we define ourselves not only as a think tank, but also as a “do tank.” In today’s world, the Bertelsmann Foundation believes that an important part of our mandate, as a responsible actor and representative of civil society, is not only to propose innovative social change, but also to support its realization.

With this in mind, the Bertelsmann Foundation will continue its efforts to broadly communicate and help implement the INCRA model.

Aart de Geus Annette Heuser President and CEO Executive Director Bertelsmann Stiftung Bertelsmann Foundation Gütersloh, Germany Washington, DC, USA April 2013

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TABLE OF CONTENTS 1

Introduction

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US Rating Radar

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U N I T E OF D SCONTENTS TAT E S O F A M E R I C A TABLE

Foreword

US Rating Report by Vincent Truglia, International Economist and Publisher of clearandcandid.com and former Head, Sovereign Risk Unit, Moody’s Investors Service US Macroeconomic Data

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US Forward Looking Indicator Report by Michael Mandelbaum, Christian A. Herter Professor and Director of American Foreign Policy at The Johns Hopkins School of Advanced International Studies

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Conclusion

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INCRA Ratings Scale

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Macroeconomic Indicators Codebook

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INTRODUCTION

Why INCRA Makes a Difference The 2008 financial crisis served as a catalyst to bring the shortcomings of the financial sector to the attention of the broader public. In particular, the operations and results of credit rating agencies were put under the microscope. CRAs specialize in the professional provision of credit ratings to overcome information asymmetries between investors and debt issuers.1 They are knowledgeable intermediaries that facilitate the exchange of capital between supply-side and demand-side actors. They inform investors about the likelihood of receiving all principal and interest payments, as scheduled, for a given security. In other words, they answer the question: What is the probability of default?

From our point of view, the issue of sovereign risk assessment needs to be addressed from two angles: • The legal and organizational framework: Do we need alternative institutions to the traditional for-profit CRAs? Who is responsible for conducting research?

• The quality of the analysis provided: Is the current set of indicators used by CRAs to evaluate a country’s willingness and ability to repay debt sufficient? Do we need a more comprehensive set of indicators that will also increase the predictability of a government’s financial performance?

Our proposed agency, INCRA, would be a non-profit, international network of offices and utilize a new legal framework based on an endowment solution to guarantee a sustainable long-term existence. Financially supported

by a broad coalition of funders, from governments to corporate players, non-governmental organizations (NGOs) to foundations and private donors, it would be an independent entity. INCRA would be based on a robust governance model that would minimize and buffer potential conflicts of interest. Specifically, a Stakeholder Council would separate the funders from agency operations. The agency would have offices in Europe, the US, Latin America and Asia.

I N T RO D U C T ION

This US Rating Report is a follow-up to the country ratings of Brazil, France, Germany, Italy and Japan which we published last fall, based on the methodology in our report “A Blueprint for INCRA: An International Non-Profit Credit Rating Agency,” released in April 2012. INCRA presents a new model, both in its institutional setup and its methodology, for developing a credit rating agency (CRA) to assess sovereign risk. The INCRA proposal emphasizes a governance structure that would allow the institution not only to be a non-profit, but also to avoid potential conflicts of interest, as well as reflect the needs of the international financial system. The new set of indicators for assessing sovereign risk proposed by INCRA was put to a test in our initial sample ratings report. In rating the US, INCRA’s methodology has been applied as rigorously as before to rate the world’s premier economy.

In order to evaluate a country’s ability and willingness to repay its debts, a more comprehensive set of indicators is needed.

INCRA would conduct its sovereign risk assessments based on a set of macroeconomic and forward-looking indicators (FLI) that would provide the basis for highquality analysis. These FLI aim to capture a meaningful picture of a country’s long-term socioeconomic and political prospects, and therefore potential political and/or social constraints on a government’s ability and willingness to repay debt.

INCRA would pay tribute to the fact that the financial world needs greater buy-in and participation from many different actors in society, including governments and NGOs. It would also reflect the realities of an increasingly globalized financial world, where the quality of sovereign ratings is crucial not only for Europe and the US but also for emerging economies such as China and Brazil.

The Value-Added of a US Rating The INCRA team welcomed the challenge of rating the US, which has the world’s largest national economy. As one of the most powerful countries in the world, the US has successfully overcome the immediate aftermath of the 2008 financial crisis, but is now facing new political challenges of increasing partisanship and political gridlock. As Europe continues to grapple with the immediate issues of its own debt crisis, the US is beginning to assess how to move forward in a post-crisis economy. Therefore, now is an ideal time to take a look at the state of the US. As noted above, we have utilized the INCRA methodology developed in our original blueprint, trying to maintain a systematic approach that ensures comparability and consistency with the five previous sample ratings.

Combined with the previous five sample ratings, with the US rating we want to demonstrate that INCRA can: • produce sovereign ratings that are based on a comprehensive set of macroeconomic indicators,

1 Coffee, John C. (2011). “Ratings Reform: The Good, the Bad, and the Ugly.” Harvard Business Law Review, Volume I and Katz, Jonathan; Salinas, Emanuel & Stephanou, Constantinos (2009). “Credit Rating Agencies. No Easy Solutions.” World Bank Group Crisis Response.

Retrieved from http://rru.worldbank.org/documents/CrisisResponse/Note8.pdf.

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which are quantitative by nature, as well as FLI, which are qualitative reflections of the socioeconomic developments within a country.

• significantly increase the transparency and understandability of a sovereign rating. Our team has created a “rating radar” that presents a snapshot overview of a country’s major strengths and weaknesses. We also provide all the background material that has been used in determining our sovereign ratings. Additionally, we provide a clear overview of the methodology and process that we followed in producing each sample rating.

We cannot stress enough the point that ratings are opinions that can and should be challenged. Yet though they may be subjective, that does not mean that they do not add value. In spite of all the criticism that sovereign ratings in particular have received in the past, they continue to serve a major purpose: aggregating information regarding the credit quality of borrowers, in our case sovereign entities. Ratings are a subjective assessment of the ability of countries to meet their debt obligations. The overall information sovereign ratings provide may prove relevant in helping to provide a foundation for other financial actors to assess credit risks.

The Underlying Methodology and the Process In our first INCRA report, we presented a detailed overview of the comprehensive set of criteria that informs our sovereign risk assessments. Definitions and applications of these two sets of quantitative and qualitative indicators have been further developed in two codebooks, included in the previous sample ratings and at the end of this report.

The codebooks have served as a basis for each “country committee” that we assembled for each country we rated. On each committee, we had a balanced number of economists, political scientists and other social scientists.

The US country committee followed the same procedures as the previous ones, applying the same indicators in the codebooks and discussing differing opinions as well as the indicators that are most important in the medium and long term. The steps each country committee took were as follows: 1. A selected country expert produced a country report based on the FLI codebook.

2. At the same time, the macroeconomic data for the country was assembled from sources such as the Organization for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF), as well as national sources.

3. Each country committee call started with an extensive discussion of the macroeconomic indicators and a 6

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presentation of the expert’s report based on the FLI, followed by a discussion among all members of the committee. After they had reviewed all aspects of the country and weighed all the arguments, each member was asked to give his/her scores for macroeconomic and FLI performance. The scores ranged on a scale from 1 (very bad) to 10 (very good). If a score on one indicator had a spread that was higher than four points, the committee revisited it to discuss the discrepancy.

Where it was not possible to bridge the varying expert opinions, the differences are made clear in the rating report. Each committee had a minimum of five and a maximum of nine voting members, each with an equal vote.

4. The experts’ opinions are reflected in each rating report, produced and finalized by a team of two designated sovereign risk experts. Country experts also reviewed each rating report.

5. Afterward, the scores were added up and weighted according to a weight scheme that assigns different weights depending on a country’s per capita income, divided into high-income, middle-income and lowincome countries. For example, INCRA proposes for high-income countries such as the US to weight macroeconomic indicators 40%, while FLI would be weighted 60%.

6. Finally, the overall scores were aggregated and the averages calculated to produce a rating.

The presented sample ratings are global, not regional, meaning they do not simply compare a country’s performance with that of its regional peers, but rather with global peers. This global approach allowed us to produce consistent ratings to be used to compare the probability of timely repayment of principal and interest across countries. It was of particular importance for us to guarantee the comparability of the US report with its European counterparts, Germany, France and Italy, that we had rated in the earlier phase.

The Results In 2011, some European countries faced credit rating downgrades for the first time in recent history 2—as well as the US for the first time ever. In light of these downgrades and their critical timing, the acceptance, transparency and legitimacy of sovereign ratings have been called into question.3 Although there might be some marginal impacts on funding costs, such costs are not usually significant at the upper end of the rating scale.

However, many view sovereign downgrades, first and foremost, as insults to a country’s national performance and its overall status.

Rather than settling for defining sovereign ratings as accessible to and understood only by a select few, we prefer to redefine them as a public good. Sovereign ratings that affect the future of countries and their citizens need to be non-rivalrous and non-excludable,4 meaning everyone has the same right and access to “consume” them. CRAs are the main actors in the field of analyzing sovereign risk.

The future borrowing power and financial well-being of entire countries often rely on the ratings they are given.

In the US report, as in the five previous rating reports, we have tried to be as transparent as possible about our process. INCRA gives the US a AA+, with a stable rating outlook. The US is not an exception—quite the contrary, our US rating result confirms a worldwide trend. Since the financial crisis broke in 2008, the pool of government bonds with triple-A status by the three major privatesector CRAs has declined more than 60 percent. There can be no doubt that the era of AAA sovereign ratings is over for the time being. So instead of complaining about downgrades, governments and citizens alike should think of them as constructive blueprints for domestic reform. We hope that our US report sets an example of how a sovereign rating of a highly complex country, where decision-making processes are either constantly in flux or in gridlock, can still be provided in a comprehensive, consistent and transparent way.

INTRODUCTION

In this report and the reports preceding it, we have addressed the questions of how to more transparently rate a highly sensitive and critical asset class such as sovereign bonds and how to produce the highest-quality ratings.

Increasing the quality is important, because if ratings continue to fail to mirror financial realities, they will become less relevant over time. We already have initial indications of this in that following recent downgrades of some European governments, investor reaction was much more muted than expected. Some argue that this may be explained as a result of investors having already taken into account the risk of downgrades and therefore concluding that some ratings were already too positive.

there is no particular correlation between rating changes for highly-rated sovereign debt and local interest rates on that debt.

From a rating perspective, at the very upper rating levels, there should be little chance of an actual default on a security rated AAA, AA or A. A downgrade might reflect heightened credit risk throughout the global economy.

Under those circumstances, even if a government is judged to have a marginally higher credit risk than before, there may be reasons for investors to want to buy even more of those government securities.

If a government is suffering from a decline in revenue, to remedy that, a government might increase taxes. If there is excessive government spending, spending cutbacks might occur. Both policy changes would usually be judged a credit negative for other issuers in a country. In addition, especially for large, wealthy countries, such as the US, Japan, Germany and France, government bonds are usually the most liquid security in financial markets. In a period of uncertainty, liquidity has an extra value. Therefore,

2 Downgraded countries include: France, Austria, Slovenia, Slovakia, Spain, Malta, Italy and Cyprus. See: Tymkiw, C. and Rooney, B. (2012). “9 Eurozone nations downgraded by S&P.” CNNMoney. Retrieved from http://money.cnn.com/2012/01/13/markets/sandp_europe_ downgrade/index.htm.

3 Tichy, Gunther. (2011). “Credit Rating Agencies: Part of the Solution or Part of the Problem?” Intereconomics, Volume 6, Number 5.

Retrieved from: http://www.ceps.eu/content/intereconomics-vol-46-no-5-septemberoctober-2011-0. Article critical of the CRAs for reacting too late and not having transparent criteria for sovereign debt ratings.

4 Stiglitz, Joseph. (1999). “Knowledge as a Global Public Good.” Global Public Goods: International Cooperation in the 21st Century. Inge Kaul, Isabelle Grunberg, Marc A. Stern (eds.), United Nations Development Programme, New York: Oxford University Press. Retrieved from: http://cgt.columbia.edu/files/papers/1999_Knowledge_as_Global_Public_Good_stiglitz.pdf and Holcombe, Randall G. (1997). “A Theory of the Theory of Public Goods.” The Review of Austrian Economics Volume 10, Number 1. Retrieved from: https://mises.org/journals/rae/pdf/ R101_1.PDF.

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UNITED STATES OF AMERICA RATING: AA+, Stable Outlook

Macroeconomic Indicators

Forward Looking Indicators

8.2

7.6 Rule of Law

Economic Fundamentals Public Sector Fiscal Policy

Transparency Accountability

9.4

8.4

8.9

7.5

Monetary Policy

Social Cohesion 9.3

Capital Markets Financial Risks

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7.8 AA+

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8.2

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Future Resources

7.5

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External Sector

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7.6

Strategic Capacity

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7.3

6.7

Crisis Management

Implementation Adaptability

Pros:

Cons:

• World’s largest economy for years to come

• Debt/gross domestic product (GDP) ratio far higher than the historical norm

• Diversified, wealthy and highly productive economy, in particular in the vital services sector • World’s largest and deepest financial markets

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• Debt/revenue ratio far higher than its peers

• Flexible labor markets

• Losses in share of world manufacturing trade greater than those of its peers

• Rapidly rising domestic energy production

• Ongoing political gridlock

• Highly developed civil society

• Growing income inequality

• Strong tradition of rule of law

• World’s costliest healthcare system

Summary The United States is still by far the largest economy in the world. Despite losses in its share of world manufacturing trade, it remains one of the most competitive, diversified, wealthy and productive nations on earth. Its recovery from the recent Great Recession has been slow, but steady. Some academic economists argue that recovery from a financial/banking-induced crisis is usually slower than recovery from recessions caused by other factors.

However, when viewed against the depth and breadth of the 2008 financial/banking crisis, the US demonstrated a greater resiliency than most of its peers.

In late September 2008, Congress initially rejected a financial market bailout proposal. This rejection caused a sudden and dramatic drop in US stock markets. Congress quickly reversed itself and in early October 2008 approved $700 billion in funding for the Troubled Asset Relief Program (TARP). This bailout, when coupled with the actions of an unfettered and imaginative Federal Reserve, appears to have 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 witnessed during the Great Depression — and dropping stock prices, the federal government undertook significant stimulus policies well beyond the initial TARP program. In 2009, Congress passed a stimulus program estimated to have cost about $790 billion by 2012. It was three-pronged, with 1) tax cuts; 2) increased direct federal spending on unemployment benefits and education; and 3) job creation through federally funded projects and/or loans.

In December 2010, the federal government also temporarily extended the so-called Bush tax cuts. This extension and a few added features, including a temporary cut in the payroll tax, added $860 billion more in stimulus.

As we will see, for most macroeconomic indicators the US compares well with its peers, except those related to general government debt. However, the US’s general government debt ratios were not the primary drivers of its rating, since overall the US still scored at an AAA level regarding purely

Because of this, and because sovereign ratings are meant to be forward-looking as opposed to a snapshot of a single point in time, the committee overwhelmingly voted for scores consistent with a AA+ rating. It should also be noted that some members of the committee produced scores more consistent with AA. Since the reasons for the rating outcome are more closely related to long-term issues, the rating carries a stable outlook. That outlook could change if the general government debt ratios were to rise and/or political gridlock becomes even worse. Since the committee found the question of gridlock particularly relevant, it should be noted that it expects it to eventually be overcome or institutionalized in a way supporting a AA+ rating with a stable outlook. However, if the gridlock worsens or becomes more disruptive going forward, the outlook and/ or the rating would likely change.

U N I T E D S TAT E S O F A M E R I C A

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. As a result of the sudden collapse of the real estate market, 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, albeit with more political melodrama than was probably necessary.

macroeconomic indicators. Rather, the committee found the US scoring lower on a number of forward-looking indicators (FLI), especially those related to political gridlock and growing income and social inequality.

The Economy As noted above, real GDP growth since the end of the recession has remained lackluster. After real GDP growth of three percent in 2010, the economy grew by a modest 1.7 percent in 2011, with a two percent rise in 2012. Most forecasts for 2013 call for GDP to grow by between 2.3 and 3.3 percent. Growth is expected to be strong in the first quarter because of the rebuilding efforts related to Hurricane Sandy. It is expected to slow moderately in the second quarter and continue at a more moderate level for the second half of 2013. It appears that the short-term boost to the construction sector from hurricane rebuilding may be outweighing the headwinds coming from fiscal policy. This seems to explain the somewhat unexpected outperformance of the economy in the first quarter. Once the effects of reconstruction drop off, more fundamental factors will likely prevail in moving the economy forward.

For instance, in January, payroll or Social Security taxes rose from 4.2 percent to 6.2 percent. This will bring in an extra $100 billion in revenue. Sequestration, or binding cuts in federal spending, will cost the economy about $42 billion in fiscal year (FY) 2013, which ends in September.

The remaining $42 billion of sequestration cuts will not hit the economy until FY 2014 and beyond. According to the Congressional Budget Office (CBO), without the fiscal tightening already in place, growth would be about 1.5 percent higher in 2013. That implies that without sequestration, real GDP in 2013 would be expanding between 3.8 and 4.8 percent, thus achieving growth rates not seen since the 1990s.

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Despite the fiscal headwinds and the drop-off in hurricane reconstruction spending, some forecasters are more optimistic about medium-term growth prospects going forward because the US housing market seems to have begun to rebound. House prices are no longer falling.

In most regions they are rising, albeit still remaining far below their pre-crisis levels. Mortgage rates are still at historically low rates, and the rate of foreclosures has fallen significantly. Housing inventories are down.

A turnaround in housing is important for the direction of the economic outlook because not only does it create a positive wealth effect, but new home construction and/ or existing-home purchases have an important knock-on effect on industries closely related to housing, such as appliance manufacturers and household goods suppliers.

Growth in 2014 is expected to be similar to 2013 and could remain in the range of 3 to 3.5 percent over the next several years. To put this into context, during the five-year period 1996–2000, real GDP grew on average by 4.2 percent a year. During the five years prior to the start of the Great Recession, annual GDP growth averaged 2.5 percent. Therefore, overall growth over the next several years is expected to outpace the pre-recession average, but not be quite as good as witnessed in the latter 1990s.

Looking at the components of GDP growth, we find that last year real private consumption grew by 1.9 percent.

Domestic investment grew by 9.8 percent, with residential investment rising by a comfortable 12.1 percent, following a string of years of decline. Export growth again outpaced import growth, with exports rising by 3.4 percent and imports by only 2.4 percent. The government sector once again acted as a drag on GDP, as real federal government spending declined by 2.2 percent. State and local government spending also again declined, but at a slower pace, 1.4 percent compared with a decline of 3.4 percent in 2011. The drag on GDP growth caused by the governmental sector predates sequestration, which began in March 2013.

Inflation Inflation has remained subdued during this recovery, despite the enormous monetary stimulus the Federal Reserve injected into the economy. So far, the stimulus has not fueled inflation expectations. These expectations are essential as they influence key drivers of inflation, such as wage-price pressures and excessive investment in fixed assets, The CPI, excluding volatile food and energy prices, rose by only 0.8 percent in 2010, 2.2 percent in 2011 and 1.9 percent in 2012. Given that the US economy is performing below capacity, excessive inflationary pressures are not likely to emerge for several years.

What has concerned many observers about the medium-

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term inflation outlook is the massive amount of monetary stimulus that has been provided through unorthodox measures, in particular quantitative easing (QE). QE is basically a form of printing money. Historically, when governments or their central banks resorted to the socalled printing press, it almost inevitably ended badly, resulting in high inflation and even, in some cases, hyperinflation. There are countless examples of this in Europe and Latin America. However, in all the historical cases, QE occurred when an economy was prostrate after military defeat, or was employed in an emerging-market country where the 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 inflation.

In the case of the US, QE has been used because the usual financial market transmission mechanisms have not functioned normally. Putting it another way, the velocity of money has fallen. In most countries where QE was used to excess, capacity constraints, not velocity, were the core problem. In the case of the US, velocity is key. Will a day arrive when velocity naturally picks up and inflationary expectations accelerate? Yes, but there is no evidence that it is imminent. Nonetheless, unwinding QE remains a potential risk in the medium term.

Labor Markets The US has one of the most flexible labor markets in the developed world. The Great Recession caused a steep increase in joblessness, with the unemployment rate peaking at 10 percent in October 2009. Although this was below the previous post-World War II peak of 10.8 percent reached in November–December 1982, the unemployment rate has not dropped as quickly as in past recoveries. By February 2013, the rate had fallen to 7.7 percent.

The number of long-term unemployed, those who have been without work for 27 weeks or more, remained unchanged at about 4.8 million, or 3.1 percent of the labor force. This group accounted for 40.2 percent of total unemployment. This is estimated to be about three times higher than the rate recorded in the early part of the last decade. There is a debate as to the causes of this major change in employment, but it is too soon to know for sure whether it will remain an ongoing problem or will slowly ease as the overall unemployment rate drops further.

Another 2.6 million people were considered marginally attached to the labor force: that is, they had looked for work over the past 12 months, but not for the last four weeks. Of that 2.6 million, only 885,000 were considered discouraged workers, or those who had simply given up looking for jobs.

The rest of the 1.5 million had valid family or educational reasons to be outside the labor force.

The CBO estimates that sequestration will result in 775,000

fewer jobs than if sequestration had been avoided. That is equal to about 0.5 percent of the labor force.

The Banking Sector 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 both would make sure that the banking sector and related financial services firms that were systemically important would not collapse. The $700 billion TARP program provided more than enough funds to support the banking system, as well as the two major mortgage lenders, plus AIG, Bear Stearns and the automakers. Although we do not yet have the final figures, given what has happened to date, the federal government will likely not have lost any money as a result of the bank bailout program.

There is much discussion about resisting too-big-to-fail moral hazard issues. We should keep in mind the difference between a bank failure and a bank default. Depending on how a bank is wound down or how regulators intervene following its failure, a bank might still avoid defaulting on deposits or other financial instruments. The reality is that in recent decades the US banking industry has become ever more concentrated into fewer and fewer banks. In 2011, according to the Dallas Fed, the largest five US banks had 52 percent of banking assets. The next 95 largest banks accounted for 32 percent of all bank assets.

Therefore, despite all the discussion about allowing banks to fail, given the size of most US banks and their systemic importance it is unlikely that the largest ones will ever be allowed to default, at least not on deposits. As such, despite the rhetoric, the US banking sector should be viewed as a contingent liability of the federal government.

However, at the same time, it is difficult to imagine an economic scenario in which the banking sector would be under more stress than already experienced in 2008–2009.

As noted above, the long-term cost to the US government of that bailout will prove to be minimal, if anything at all.

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 government has either borrowed money or sold assets

U N I T E D S TAT E S O F A M E R I C A

The real estate crisis negatively affected labor force mobility in the US. Unlike that of many other countries, the US labor pool is quite mobile. However, as house prices fell, many workers lost their ability to sell their homes and move to other regions to pursue new job opportunities.

Furthermore, some might argue that support from the government to individuals to service mortgage debt may have reduced the incentive to move. As the housing market returns to health, labor mobility should once again return to historic norms.

to foreigners. This results in a large net international debt now estimated at over several trillion dollars. The analytical problem 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. Put differently, the net foreign equity position of the US is still positive and will likely become even more positive with the recovery of international stock markets and other asset markets.

Therefore, if one simply looks at the debt stock and net changes in it, the US would score low. However, when looking at the cost of financing this debt, even over many years, it appears to be cost-free. In fact, as noted above, the US remains a net recipient of foreign investment income, instead of the other way around. Looked at it from that perspective, the US external position is quite healthy.

In 2011, net income as recorded in the current account totaled $227 billion, and in 2012 it was $199 billion.

Analysts have been predicting that the net income flow would eventually turn negative — but for decades, despite those predictions, it has not.

The US Dollar as a Reserve Currency There was a vibrant debate within the committee on the impact of the special role the dollar plays in international financial markets. The traditional terminology used, reserve currency, has had a changing meaning over the years.

From the end of World War II until 1971, the international foreign exchange regime was based indirectly on gold.

Indirectly is meant in the sense that the willingness of the US to exchange dollars for gold, at a fixed price, was the centerpiece of the system. In that era, the US was truly a unique currency (unique in that few other large nations had enough gold to fully support their currencies). In 1971, the US formally broke the relationship between the dollar and gold. From then on, the meaning of reserve currency changed. Any currency that was widely accepted for use in international transactions could appropriately be labeled a reserve currency.

Since 1971, the dollar has remained the world’s preeminent currency. Many argue that as such, the US continues to have an advantage in that foreigners may have a desire and/or need to hold dollars in excess of normal requirements. This is seen as an important explanation of why despite large current account deficits over many years, the demand for the dollar remains strong, allowing long-term US interest rates to remain lower than they otherwise would be.

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For those who accept this argument — probably representing the vast majority of analysts — the role of the US dollar as the world’s major reserve currency is an important strength for the US and its government’s ability to fund itself, and therefore for the country’s credit rating.

By implication, if there is a threat to that reserve status, it should have a negative impact on the rating.

There was a minority view on the committee that argued because the dollar is a fiat currency, the Federal Reserve has always had theoretical control over the entire yield curve. However, until the adoption of unorthodox monetary policies by the Federal Reserve beginning in 2008, yield curve flattening remained theoretical. Since 2008, however, flattening has occurred with a vengeance.

This appears to show that when necessary, the Federal Reserve can and will intervene heavily even in longdated securities. The implication of this, it was argued, is that even if foreign owners of US financial assets were to sell those assets suddenly, Federal Reserve action might completely mitigate or even reverse the effect on US interest rates. The only impact such asset sales would then have would be on the exchange rate of the country attempting to dispose of its US assets. As such, a minority on the committee felt that reserve currency status is less important today to the US than Federal Reserve willingness to undertake unorthodox monetary policies.

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

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

During the rating process, we have tried to use data that is comparable across countries. To date, this has not posed an analytical problem. However, in the case of the US, using general government debt data distorts the analysis.

In the US, 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 it not stepping in when states or municipalities are in financial distress. The one and only exception, federal aid to New York City after it defaulted in 1975, arguably proves the general rule. Given this laissez-faire tradition, some argue that when examining US creditworthiness, state and local government debt should be ignored.

OECD reports indicate that general debt statistics, while statistically comparable across countries, analytically exaggerate debt in some instances, particularly in the US. To put it simply, since the US handles its pension programs in a different way from most other wealthy countries, when using general government debt, this tends to exaggerate the US debt burden.

The committee concluded differently 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, the fact that these levels of governments play an outsized role in the US implicitly affects the ability of the federal government to adjust its own fiscal policy.

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 tax revenue is used to purchase nonmarketable US Treasury debt. Basically, for public finance purposes, this is an accounting fiction. Most other countries use a variant of pay-as-you-go pension systems, so they still have a similar implied liability to future pensioners but avoid the creation of additional government debt. From a long-term perspective, there is no difference between the two approaches.

In 2012, state and local government debt accounted for 19 percent of US GDP. These levels of government provide a vast array of services that elsewhere are often provided by national governments. US state and local governments also have widely varying tax policies.

Public Sector and Fiscal Issues

12

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).

Most states, plus some cities, have local income taxes.

There are various state and local sales taxes. Local real estate taxes are the rule. Because these are important deductions for federal income tax purposes, and because there are very different tax burdens on individuals depending on their state or locale of residency, changing these deductions may prove difficult in practice given regional resistance. Since state and local government

General Government Debt General Government Debt/GDP (%)

2008

2009

2010

2011

2012

US*

58.3

73.5

82.3

87.2

93.2

Italy

105.8

116.1

118.7

120.1

125.8

France

68.2

79.0

82.3

85.2

87.2

Germany

66.9

74.7

83.5

81.2

82.2

Japan

191.8

210.2

215.3

229.8

235.8

U N I T E D S TAT E S O F A M E R I C A

*This row represents US general government debt/GDP (%), as our committee has defined it. This excludes trust fund obligations, but includes state and local government debt

finances affect federal fiscal flexibility, the committee deemed it appropriate for purposes of international comparison to include their debts when calculating the US equivalent of general government debt.

In the table above the figures for the US use federal government held by the public plus state and local government debt as the US equivalent of general government debt. The IMF/OECD definition of government debt is used for the four other countries. As can be seen, while US “general government debt” for analytic purposes was 58.3 percent of GDP in 2008, it had climbed to 93.2 percent in 2012. The US debt ratio was better than that of its peers in 2008. By 2012, it was worse than Germany’s and slightly worse than France’s.

The debate about the deficit centers around the federal government, rather than state and local governments, many of which have balanced-budget requirements. As such, we will discuss the issue in terms of the federal deficit.

Using CBO projections, we find that the federal deficit declines from 5.3 percent of GDP in FY 2013, to 3.7 percent in FY 2014, to 2.4 percent in FY 2015. It should be emphasized that these are projections, not forecasts.

They assume that existing laws will remain in place and the overall economic environment will follow an expected pattern. Nonetheless, they are valuable in that given the present political environment in Washington, it doesn’t seem likely that there will be any major new spending programs, and/or revenue measures that would significantly change the already embedded pattern of declining deficits. Therefore, the overall debt/GDP ratio should stabilize and start declining as early as FY 2014 – FY 2015.

According to the CBO, there is a risk that federal deficits, as a percent of GDP, could once again start rising beginning in FY 2018. The committee expects that increases in deficits in later years will relate to increased entitlement

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

Forward-Looking Indicators Rule of law The US scored highly in the rule of law category. It was recognized that the US legal system is both 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 regarding who won 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. There were some minor concerns raised in the committee because in some states, local judges are elected. Despite this, committee members felt that because lower court rulings are easily appealed, they could still view the judiciary as a highly independent branch of government.

Separation of powers was viewed as extremely strong.

However, the committee noted that it 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 prevention of corruption, the committee noted that the US is generally

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regarded as suffering from only minor instances of corrupt behavior, 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.

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

Although there is a small public broadcasting network, the majority of the public views it 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 high regarding civil society participation. Nongovernmental 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 and education. 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 decision-making process, and therefore might represent a slight negative.

Nonetheless, overall it was still viewed as a key strength for the US.

Social cohesion As noted earlier, the US rating was constrained by its overall scores for forward-looking indicators. 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 regarding social inclusion. The country has relatively high income and wealth inequality compared to almost all other advanced industrial countries. It has a less generous welfare system than its peers, and a heterogeneous population with persistent issues related to its historic racial divide. Although much progress has been made, problems of racism 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 with a majority composed of minorities. Although the country has found it easier to deal with immigration than most of its peers, the very size and rapidity of the demographic change presently underway will nonetheless be difficult to deal with, all the more so because of the country’s growing economic inequality.

Between 2002 and 2007, people in the top 1 percent of the American income ladder captured two-thirds of the total gains from economic growth, and the top one-tenth of 1 percent captured fully one-third of the gains.

14

The US also scored low on 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. Also, voter participation in the US 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 federal 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. Each side may argue that it is the other’s fault, 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 with its European peers, but also compared with Brazil.

The US also scored low regarding policy implementation.

The divisions within the federal government have become so pronounced that getting through new policy initiatives of any sort appears unlikely. As discussed in the committee, in the past when a US president proposed an agenda in the annual State of the Union address, he would likely find many of the proposals passed during his 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 that of 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. In addition, as already noted above, since it takes so long for the Senate to approve senior federal nominees, many highly qualified people are just not willing to go through the now painful appointment process.

Adaptability In the two sections related to adaptability, when the committee discussed both policy learning and institutional learning, the US scored low. Again, this 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.

actually argued for not raising the debt ceiling even if 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 Aug. 3, 2010, the day the Treasury was scheduled to run out of borrowing authority.

Recent Political Developments

The crisis was averted by creating a so-called “supercommittee” that was charged with recommending a deficit reduction package of $1.5 trillion before November 2011. (The actual requirements to avoid sequestration were incredibly complex.) If the committee could not agree on a recommendation, automatic-spending cuts, better known as sequestration, were to take effect in March 2013. The rules surrounding sequestration are as equally obtuse as the requirements surrounding the supercommittee. It was thought in 2011, that such a foolish and arbitrary policy that might end in sequestration would never be allowed to happen. Yet lo and behold, sequestration is now the law of the land. This has produced the odd result that governmental dysfunction in this special case actually improved the capacity of the federal government to meet its financial obligations because it lowered spending. At the same time, the fact that dysfunction prevailed raises concerns that future outcomes might not be as beneficial.

In November 2012, President Barack Obama was reelected.

In addition, Democrats ended up with a 53-seat majority in the 100-seat Senate, along with two independents who caucus with them. Republicans now have 45 Senate seats.

There are 435 seats in the House of Representatives, and Republicans retained control of the chamber by winning 234 of them, while Democrats won 201.

The election resulted in a divided Congress, in which either party can block the other party’s bills. The US has often had divided government at the federal level, and it has usually worked relatively well. However, since 2010, when Congress once again became divided, there has been little bipartisan agreement, at least unless the government was faced with an imminent crisis.

U N I T E D S TAT E S O F A M E R I C A

Today it appears difficult for the two major parties to agree on defining what is in the national interest. For example, in the past, bipartisan commissions were frequently appointed to resolve complex issues surrounding Social Security or Medicare or to resolve important tax matters.

Today, even when such commissions are formed, their recommendations are usually ignored.

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. This is an anachronism that 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. In 1995–96 for the first time, Congress threatened to not raise the debt ceiling unless President Bill Clinton agreed to a variety of measures. However, instead of agreeing to Republican requests, he slowly shut down the federal government.

As pressure grew on the Republican Congress, which the public was blaming for the standoff, eventually the debt ceiling was raised in early 1996. It did not become an issue again until 2011. Republicans took control of the House of Representatives following the 2010 election. A large contingent of them are supporters of the so-called Tea Party, which advocates reducing the size of the federal government by all means possible, and as a result political battle lines were drawn.

Additional Signs of Dysfunction The Bush tax cuts were set to expire on Dec. 31, 2012, meaning that massive effective tax increases were scheduled to kick in on Jan. 1, unless an agreement on a new tax law was reached. Nothing was done until the early hours of Jan. 1, and lawmakers thereby avoided a sharp tax increase, but only by going to the brink once again.

For now, the federal government is operating on a continuing resolution. That basically means there is no budget, except what has already been approved. By July–August 2013, the US will once again bump up against another debt ceiling limit. The issues with the debt ceiling remain the same as they were in 2011. The rating committee noted that Congress will most likely pass a debt ceiling increase in time, and that some sort of bipartisan agreement may eventually be reached on the budget. However, the committee also noted that this is not the type of governance associated with an AAA rating.

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

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Country Committee Average Scores

16

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MACROECONOMIC INDICATORS

8.2

FORWARD LOOKING INDICATORS

7.6

Economic Fundamentals

8.4

Political Economic and Social Stability

8.2

Real GDP Growth %

8.3

Rule of Law

9.4

GDP Per Capita

9.2

Legal Certainty

9.0

Real Exports (% Change)

7.7

Independent Judiciary

9.8

Real Imports (% Change)

8.8

Separation of Powers

9.0

Gross Domestic Investment/GDP (%)

8.0

Property Rights

9.8

Gross Domestic Savings/ GDP (%)

7.3

Transparency / Accountability

8.9

Inflation-CPI (%)

8.6

Corruption Prevention

8.2

Population Growth (% Change)

9.1

Independent Media

8.9

Public Sector / Fiscal Policy

7.5

Civil Society Participation

9.6

General Government Debt/GDP (%)

7.0

Social Cohesion

7.4

Nominal GDP Growth (Local Currency %)

8.0

Social Inclusion

7.1

General Govt Debt/General Govt Revenue (%)

6.9

Trust in Institutions

6.9

General Govt Interest/General Govt Revenue (%)

7.6

Societal Mediation

7.1

General Govt Primary Balance/GDP (%)

8.0

Conflict Management

6.3

General Govt Fiscal Balance/GDP (%)

7.7

Future Resources

7.5

General Govt Revenue/GDP (%)

7.4

Education

6.8

General Govt Expenditure/GDP (%)

7.6

Research and Innovation

9.3

Monetary Policy

9.3

Employment

7.9

Accommodative Monetary Policy

9.3

Social Security

7.0

Capital Markets and Financial Risks

8.2

Environmental Sustainability

6.7

Domestic Credit/GDP (%)

8.7

Steering Capability and Reform Capacities

7.1

Domestic Credit (% Change)

7.9

Strategic Capacity

7.6

Overall Strength of Banking Sector

7.9

Prioritization

6.8

External Sector

7.5

Policy Coordination

6.9

Current Account

7.5

Stakeholder Involvement

8.6

External Debt

7.4

Political Communication

8.1

6.8

Government Efficiency

6.4

Resource Efficiency

7.1

Adaptability

6.7

Policy Learning

6.4

Institutional Learning

7.0

Crisis Management

7.3

Historical Evidence of Crisis Management

8.4

Crisis Remediation

7.2

Signaling Process

7.2

Timing and Sequencing

6.8

Precautionary Measures

6.9

Automatic Stabilizers

7.2

U N I T E D S TAT E S O F A M E R I C A

Implementation

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UNITED STATES MACROECONOMIC INDICATORS I. Economic Fundamentals

2008

2009

2010

2011

2012f

Nominal GDP Growth (Local Currency %)

1.9

-2.2

3.8

4.0

4.1

Real GDP Growth (%)

-0.3

-3.1

2.4

1.8

2.2

Real Exports (% Change)*

6.3

-12.0

14.3

7.2

5.3

Real Imports (% Change)*

-3.8

-15.6

14.9

5.2

3.3

14,291.5

13,973.6

14,498.9

15,075.7

15,653.4

GDP per capita (US$)

46,901

45,674

47,024

48,327

49,802

GDP per capita (PPP basis: US$)

46,901

45,674

47,024

48,327

49,802

Inflation-CPI (%)

3.8

-0.3

1.6

3.1

2.0

Population Growth (% Change)

0.9

0.9

0.8

0.7

0.9

Gross Domestic Investment/GDP (%)

18.1

14.7

15.8

15.9

16.4

Gross Domestic Savings/GDP (%)

12.8

10.5

11.6

11.6

12.8

Nominal GDP (bn US$)

*Exports/Imports include goods only

18

18

II. Public Sector Policy

2009

2010

2011

2012f

General Government (GG) Debt/GDP (%)

76.1

89.6

98.6

102.9

107.2

GG Revenue/GDP (%)

32.5

30.9

31.7

31.4

32.0

GG Expenditure/GDP (%)

39.2

44.2

42.9

41.4

40.6

GG Financial Balance/GDP (%)

-6.6

-11.9

-11.4

-10.2

-8.5

Primary Balance/GDP

-4.6

-7.9

-7.6

-6.4

-5.3

234.1

290.0

311.0

327.7

335.0

8.4

8.0

8.3

8.9

2008

2009

2010

2011

2012f

5.3

-1.3

-1.1

6.7

3.5

Domestic Credit /GDP (%)

224.4

234.4

233.3

234.9

IV. External Sector

2008

2009

2010

2011

2012f

-4.7

-2.7

-3.0

-3.1

-3.1

GG Debt/GG Revenue (%) GG Interest/GG Revenue (%)

U S M A C R O E C O N O M I C I N D I C AT O R S

2008

III. Monetary Policy IV. Capital Markets & Financial Risk Domestic Credit (% Change)

Current Account Balance/GDP (%)

Data sources: Banque de France Annual Reports; IMF’s Article IV 2012; OECD Annual Reports.

f = forecast

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Macroeconomic Data Sources: Nominal GDP Growth OECD Economic Outlook, Volume 2012 Issue 2, Statistical Annex, Table 2 http://www.oecd.org/eco/economicoutlookanalysisandforecasts/economicoutlookannextables.htm Real GDP Growth OECD Economic Outlook, Volume 2012 Issue 2, Statistical Annex, Table 1 http://www.oecd.org/eco/economicoutlookanalysisandforecasts/economicoutlookannextables.htm Real Exports (% Change) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?pr.x=58&pr.y=5&sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&c=11 1&s=TMG_RPCH%2CTXG_RPCH&grp=0&a= Real Imports (% Change) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?pr.x=58&pr.y=5&sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&c=11 1&s=TMG_RPCH%2CTXG_RPCH&grp=0&a= Nominal GDP (US$) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?pr.x=62&pr.y=5&sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&c=1 11&s=NGDPD&grp=0&a= GDP per capita (US$ and PPP) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/weorept.aspx?sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&pr1.x=40&pr1.y=11&c =134%2C111&s=NGDPDPC&grp=0&a= Inflation-CPI (%) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&pr1.x=55&pr1.y=6&c =111&s=PCPI%2CPCPIPCH%2CPCPIE%2CPCPIEPCH&grp=0&a Population Growth (% Change) OECD Country Statistical Profiles: United States 2011-2012 http://www.oecd-ilibrary.org/docserver/download/191100301e1t003.pdf?expires=1366146923&id=id&accname=freeContent&checksum=04D8694C429E3C8B 184326A806555D8B Gross Domestic Investment/GDP (%) IMF Article IV Reports 2010, 2011, 2012 http://www.imf.org/external/pubs/ft/scr/2010/cr10249.pdf http://www.imf.org/external/pubs/ft/scr/2011/cr11201.pdf http://www.imf.org/external/pubs/ft/scr/2012/cr12213.pdf Gross Domestic Savings/GDP (%) OECD Economic Outlook, Volume 2012 Issue 2, Statistical Annex, Table 24 http://www.oecd.org/eco/economicoutlookanalysisandforecasts/economicoutlookannextables.htm General Government (GG) Debt/GDP (%) General Government Revenue/GDP (%) General Government Expenditure/GDP (%) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&pr1.x=70&pr1. y=7&c=111&s=GGR_NGDP%2CGGX_NGDP%2CGGXWDG_NGDP%2CBCA_NGDPD&grp=0&a= General Government Financial Balance/GDP (%) OECD Economic Outlook, Volume 2012 Issue 2, Statistical Annex, Table 27 http://www.oecd.org/eco/economicoutlookanalysisandforecasts/economicoutlookannextables.htm Primary Balance/GDP (%) OECD Economic Outlook, Volume 2012 Issue 2, Statistical Annex, Table 30 http://www.oecd.org/eco/economicoutlookanalysisandforecasts/economicoutlookannextables.htm GG Debt/GG Revenue (%) IMF World Economic Outlook Database, October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?sy=2008&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&pr1.x=70&pr1. y=7&c=111&s=GGR_NGDP%2CGGX_NGDP%2CGGXWDG_NGDP%2CBCA_NGDPD&grp=0&a GG Interest/GG Revenue (%) OECD.StatExtracts: Government deficit/surplus, revenue, expenditure and main aggregates http://stats.oecd.org/ Domestic Credit (% Change) Principal Global Indicators: Domestic Credit http://www.principalglobalindicators.org/default.aspx Domestic Credit/GDP (%) World Bank World Development Indicators 2012 http://databank.worldbank.org/ddp/html-jsp/QuickViewReport.jsp?RowAxis=WDI_Ctry~&ColAxis=WDI_Time~&PageAxis=WDI_Series~&PageAxisCaption= Series~&RowAxisCaption=Country~&ColAxisCaption=Time~&NEW_REPORT_SCALE=1&NEW_REPORT_PRECISION=0&newReport=yes&IS_REPORT_IN_ REFRESH_MODE=true&IS_CODE_REQUIRED=0&COMMA_SEP=true

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20

COUNTRY REPORT FOR THE UNITED STATES

by Michael Mandelbaum, Christian A. Herter Professor and Director of American Foreign Policy at The Johns Hopkins School of Advanced International Studies

I. POLITICAL, ECONOMIC AND SOCIAL STABILITY – FACTORS FOR FUTURE GROWTH AND FINANCIAL RELIABILITY 1. Rule of Law To what extent do government and administration act on the basis of and in accordance with legal provisions or culturally accepted norms to provide legal or practical certainty?

Government and administration act predictably, on the basis of and in accordance with legal provisions. Legal regulations are consistent and transparent, ensuring legal certainty.

10 9

Government and administration rarely make unpredictable decisions. Legal regulations are consistent, but leave a large scope of discretion to the government or administration.

8 7 6

Government and administration sometimes make unpredictable decisions that go beyond given legal bases or do not conform to existing legal regulations.

Some legal regulations are inconsistent and contradictory.

5

Government and administration often make unpredictable decisions that lack a legal basis or ignore existing legal regulations. Legal regulations are inconsistent, full of loopholes and contradict each other.

2

US FLI CODEBOOK

Political and Institutional Stability The rule of law is firmly embedded in American society, politics and economic life. The courts at all levels— local, state, and national—function effectively, although this effectiveness varies across jurisdictions, and their verdicts are respected and obeyed. A vivid illustration of the broad and deep acceptance of the rule of law and the legitimacy of courts was the U.S. Supreme Court’s 2000 decision, in the case of Bush v. Gore, that decided the presidential election of that year in favor of the Republican candidate, George W. Bush. Although the court’s action was unprecedented and the legal reasoning underlying it the subject of widespread criticism, there was no hint of a serious challenge to the decision by the losing side. While judges in some states and localities are elected rather than appointed, this has not thus far compromised the rule of law in the United States by politicizing the judiciary, as it has in other countries. The strength of the rule of law has made an important contribution to American economic growth since the 19th century, making it possible to do business across a large continent among parties who do not know each other. This feature of American life has helped make the country, from the 19th century to the present, an attractive destination for investment from abroad.

4 3

1

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To what extent do independent courts control whether government and administration act in conformity with the law?

Independent courts effectively review executive action and ensure that the government and administration act in conformity with the law.

10 9 8

Independent courts usually manage to control whether the government and administration act in conformity with the law.

7 6 5 4

Courts are independent, but often fail to ensure legal compliance.

3 2

Courts are biased for or against the incumbent government and lack effective control.

22

22

1

Courts in the United States have the power to monitor government actions and overturn them if they are found to be in violation of basic—that is, constitutional— doctrines. This power was affirmed early in the country’s history by the Supreme Court’s 1803 decision in Marbury v. Madison, which established what came to be known as the power of judicial review. This power operates at the state level as well. The legal sector of American society is fully independent and well developed, with an elaborate system of legal training centered on law schools that students attend for three years after receiving undergraduate degrees, and with provisions for continuing legal education provided by local professional groups of lawyers known as bar associations. While the prestige of lawyers has fallen in recent decades, the standing of judges and courts remains high.

To what extent is there a working separation of powers (checks and balances)?

There is a clear separation of powers with mutual checks and balances.

10 9

One branch, generally the executive, has an ongoing and either informally or formally confirmed monopoly on power, which may include the colonization of other powers, even though they are institutionally differentiated.

8 7 6 5 4 3 2

There is no separation of powers, neither de jure nor de facto.

1

It is not uncommon in the American system for power to be divided between the two major political parties, the Republicans and the Democrats, with one controlling the executive branch and the other the legislative (for example, for much of the 1970s and 1980s the Republicans held the presidency while the Democrats controlled both houses of the legislative branch) or with one controlling one chamber of the legislative branch and the other the other chamber (in 2013, the Democrats control the Senate and the Republicans the House of Representatives). These patterns are often found in state government as well. Such divisions did not, in the past, paralyze the working of the government. Indeed, some studies have suggested that “divided government” of this kind can actually be more productive in passing legislation than when power is consolidated in the hands of a single party.

US FLI CODEBOOK

The separation of powers generally is in place and functioning. Partial or temporary restrictions of checks and balances occur, but a restoration of balance is sought.

The separation of powers is perhaps more fully established, and has a longer history, in the United States than in any other country. It is a fundamental principle of the nation’s federal Constitution, which went into effect in 1789 and stipulates a division of power among the executive branch, headed by the president, the legislative branch, which consists of the House of Representatives and the Senate, and the judiciary. This pattern is generally repeated in state and local governments.

The actual balance of effective power between the executive and legislative branches has shifted over time.

The executive became relatively more powerful from the 19th century to the 20th with the expansion of the functions of government, almost all of which the executive branch supervises. In particular, at the national level the executive branch tends to dominate the conduct of foreign policy. Nonetheless, the legislative branch remains robust at all levels of government, and the judiciary retains its independence in its more limited sphere of enforcing and interpreting rather than creating and administering the law.

In recent years the separation of powers that is basic to the American system of government has come under criticism for providing, in effect, too much of a good thing: fragmenting power in a way that makes it difficult for the government to act decisively. It has come to be seen in some quarters not so much as what its designers intended it to be—a check against despotism—than as a formula for gridlock in the conduct of the public’s business.

INCRA USA Ratings Report

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To what extent do government authorities ensure welldefined property rights and regulate the acquisition, benefits, use, and sale of property?

Property rights and regulations on acquisition, benefits, use, and sale are well defined and enforced. Property rights are limited, solely and rarely, by overriding rights of constitutionally defined public interest.

10 9 8

Property rights and regulations on acquisition, benefits, use, and sale are well defined, but occasionally there are problems with implementation and enforcement under the rule of law.

Property rights and regulations on acquisition, benefits, use, and sale are defined formally in law, but they are not implemented and enforced consistently nor safeguarded adequately by law against arbitrary state intervention or illegal infringements.

7 6 5 4 3 2

Property rights and regulations on acquisition, benefits, use, and sale are not defined in law. Private property is not protected.

24

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1

Following the British tradition that the United States inherited, property rights have been well established and effectively protected from the country’s beginnings.

Americans typically have more extensive personal holdings of two important forms of property—equities and real estate—than the citizens of other advanced industrial democracies. There is nothing comparable in American history to the expropriation and nationalization of private firms, and indeed entire industries, that has occasionally taken place in Europe.

A few recent episodes have caused concern about the solidity of property rights. The Supreme Court’s decision in Kelo v. New London, which upheld the right of a municipal government to transfer land from one private owner to another for the purpose of economic development, drew opposition on the grounds that it excessively expanded the government’s power over private property. The federal government’s rescue of the automaker General Motors during the financial crisis of 2008–2009 attracted criticism for imposing losses on, and thus not adequately protecting the interests and therefore the property rights of, people holding the company’s bonds. In general, however, and especially in contrast to its status in other countries, the right to property in the United States remains firmly established.

2. Transparency / Accountability Corruption prevention: To what extent are public officials prevented from abusing their position for private interests?

Legal, political, and public integrity mechanisms effectively prevent public officeholders from abusing their positions.

10 9 8 7 6 5

Some integrity mechanisms function, but do not effectively prevent public officeholders from abusing their positions.

4 3

Public officeholders can exploit their offices for private gain as they see fit without fear of legal consequences or adverse publicity.

2 1

US FLI CODEBOOK

Most integrity mechanisms function effectively and provide disincentives for public officeholders willing to abuse their positions.

The United States probably has less overt corruption today than at any time in its history. Major scandals involving bribery at the federal level occurred in the 1870s and the 1920s, and as recently as 1973 a sitting vice president, Spiro T. Agnew, was forced to resign from the office because of illegal payments he had received in his previous position as governor of Maryland. Most corruption has taken place at the local level, often in big cities, many of them in the northeastern part of the country. While corruption has certainly not disappeared, it is not a major feature of American political life. In 2011, Transparency International ranked the United States the 25th least corrupt country out of 189.

Of greater concern is the legal use of money in politics and governance, through lobbying for private economic interests and donations to defray the expenses of political campaigning. The sums involved in both have increased substantially in recent decades. In 1974, for example, the amount of money spent on all campaigns for the House of Representatives and the Senate came to $75 million. In 2010, the figure was $879 million. In 1976, the major-party presidential candidates spent, together, about $300 million. In 2008, they spent $2.8 billion.

Campaigns have become increasingly expensive, among other reasons, because of the soaring costs of purchasing time on television for airing political commercials. Some observers of American politics fear, and others firmly believe, that monied interests are increasingly able to influence—and distort—public policy through lobbying and campaign contributions. Legislative efforts to limit campaign contributions have been set back by Supreme Court rulings, notably in the 2010 case Citizens United v. Federal Elections Commission, that some types of limits violate constitutionally protected rights.

Another potential source of improper influence, the hiring of former government officials by private firms with economic interests affected by agencies or departments where the officials formerly worked, is regulated by statute.

However, the prohibitions are weak and the “revolving door” between government departments and parts of the private sector over which they have substantial power certainly has not come to an end.

INCRA USA Ratings Report

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To what extent are the media independent from government?

Public and private media are independent from government influence; their independence is institutionally protected and respected by the incumbent government.

10

9

The incumbent government largely respects the independence of media, but the regulation of public and/or private media does not provide sufficient protection against potential government influence.

8

7

6

26

26

The incumbent government seeks to ensure its political objectives indirectly by influencing the personnel policies, organizational framework, or financial resources of public media, and/or the licensing regime/market access for private media.

5

Major media outlets are frequently influenced by the incumbent government promoting its partisan political objectives.

To ensure pro-government media reporting, governmental actors exert direct political pressure and violate existing rules of media regulation.

2

4

3

1

The very first amendment to the U.S. Constitution, adopted at its ratification, guarantees stalwart protection of freedom of the press. The press’s independence has been reaffirmed by a number of important court cases, notably the 1971 decision in the Pentagon Papers case, which vindicated the right of two major newspapers, The New York Times and The Washington Post, to publish government documents involving national security that they were not authorized to have.

The media in the United States are almost entirely privately owned; the country has never had a governmentsponsored broadcasting outlet remotely as important as, for example, Britain’s BBC. And the new technologies of electronic communication have, mainly through the Internet, multiplied the already numerous American media outlets.

One possible adverse consequence of the digital revolution in the American mass media is the weakening of previously large, profitable, and powerful print outlets such as The Times and The Post, to the point that they lack the resources to conduct the kinds of investigations into governmental malfeasance that have in the past served as a check on corruption. Another adverse consequence, already being felt in the view of some, is the aggravation of the polarization of American politics as digital outlets cater to and reinforce strongly partisan political views.

To what extent does the government enable the participation of civil society in the political process?

The political leadership actively enables civil society participation. It assigns an important role to civil society actors in deliberating and determining policies.

10 9 8 7 6

The political leadership neglects civil society participation. It frequently ignores civil society actors and formulates its policy autonomously.

5 4 3

The political leadership obstructs civil society participation. It suppresses civil society organizations and excludes their representatives from the policy process.

2

U N IFLI US TED CODEBOOK S TAT E S O F A M E R I C A

The political leadership permits civil society participation. It takes into account and accommodates the interests of most civil society actors.

Civil society—that is, nongovernmental groups of all kinds—is as strong in the United States as in any country in the world. The same first amendment to the Constitution that assures a free press also guarantees freedom of association, and thus enshrines the role of civil society in the highest law of the land. The prominence of nongovernmental groups was noted by the Frenchman Alexis de Tocqueville in his influential 19th-century book about American society, Democracy in America, first published in two volumes in 1835 and 1840. Their importance persists, although by some accounts—notably the 2000 book “Bowling Alone” by Robert Putnam—they have come to play a less active role in American society recently than they did in the past. In general, however, on virtually every issue from tax and trade policy to environmental regulations to the organization of the system of education to foreign policy, elements of civil society pervade the policymaking process. The government could not cut off their influence if it tried; if it did try it would be violating the Constitution; and it does not try. Indeed, it has sometimes been suggested that the strength of civil society in the United States, and the close involvement of its many component parts in policymaking, are handicaps because the groups are so numerous and so active politically that they render the process of making and carrying out policy less orderly and predictable than is optimal.

1

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Socioeconomic Criteria – Preconditions for Social Stability and Future Growth 3. Social Cohesion To what extent is exclusion and decoupling from society effectively prevented?

Policies very effectively enable societal inclusion and ensure equal opportunities.

10 9

For the most part, policies enable societal inclusion effectively and ensure equal opportunities.

8 7 6

For the most part, policies fail to prevent societal exclusion effectively and to ensure equal opportunities.

5 4 3 2

Policies exacerbate unequal opportunities and exclusion from society.

1

With 15.1 percent of its population living below the poverty line, the United States has a higher incidence of poverty than most other similar countries. This relatively high rate of poverty has several causes. They include a somewhat less generous welfare state than in other advanced industrial democracies, arising in part from the belief that the availability of economic opportunity is more important than economic equality, and a historically more heterogeneous population than in comparable countries.

This heterogeneity stems from the fact that America has been, since its inception, a nation of immigrants; and those immigrants have come from different parts of the world: first primarily from northern Europe, then, at the end of the 19th century, from southern and eastern Europe, and in the second half of the 20th century increasingly from Latin America and Asia. Historically, the United States has relied on the institutions of civil society, and particularly on the private economy and the public school system, rather than on the government, to absorb and assimilate its immigrants.

28

Americans of African descent have had a special status: Their ancestors were brought forcibly to the country as slaves. Even after the slaves were emancipated at the end of the Civil War, the southern U.S. states had an official policy of racial segregation, depriving African-Americans of full political rights and of the social and economic opportunities available to other citizens. Since the late 1960s government and social institutions have made a concerted effort to cope with the adverse consequences of that inheritance, largely through measures intended to broaden opportunity. The effort has had achieved some notable successes. African-Americans are more fully integrated into American society than was the case before legal segregation was abolished and the official efforts at inclusion began. A large and growing AfricanAmerican middle class now exists. On the other hand, on many measures of well-being—income, total wealth, and life expectancy, for example—African-Americans continue to lag behind the rest of the country. Efforts at inclusion since the 1960s have extended to other groups as well, particularly people of Hispanic background, who also tend to lag behind the majority on these indices, and to women—who are, in fact, a slight majority rather than a minority of the American population.

America’s Gini coefficient—a measure of inequality—is 41st out of 136 countries in the world, but it is higher than that of any Western European country, and the trend is toward even greater inequality. Between 2002 and 2007, people in the top 1 percent of the American income ladder captured two-thirds of the total gains from economic growth, and the top one-tenth of 1 percent captured fully one-third of the gains. The U.S. government has taken steps designed to reduce inequality, most notably a progressively structured federal income tax code and the Earned Income Tax Credit, which benefits poorer taxpayers, but these have not arrested or reversed the ongoing trend.

How strong is the citizens’ approval of political institutions and procedures?

Please base your assessment on public opinion survey data, addressing the following factors:

Approval of political institutions and procedures is very high.

10 9

7 6 5

Approval of political institutions and procedures is fairly low.

4 3 2

Approval of political institutions and procedures is very low.

1

On the other hand, the main political institutions, especially the U.S. Congress, have shockingly low approval ratings. In one recent survey, only 14 percent of the respondents approved of the performance of Congress. President Obama earned a higher score, just over 50 percent, but presidential approval ratings have occasionally fallen to the low thirties in recent decades.

Congress’s low approval ratings present a paradox. Since the public elects its members, the low esteem in which the institution is held would seem logically to produce a rapid rate of turnover in its membership. Yet incumbents are routinely reelected. Americans dislike the institution of Congress but often approve of their own individual representative to it.

US FLI CODEBOOK

8 Approval of political institutions and procedures is fairly high.

Citizens’ assessment of politics and government in the United States presents a mixed picture. On the one hand, the overall political system commands wide and deep support. The Constitution is the subject of respect, rising in some cases almost to reverence, among Americans.

Democracy is widely regarded as without question the most desirable form of government. The term “regime change” is virtually never applied by Americans to their own country.

Another sign of dissatisfaction with the political system as it currently operates, as distinct from its basic design, is the growing number of Americans who do not identify with either of the two major political parties but instead consider themselves political independents. According to a survey taken at the end of 2012, fully 38 percent of the electorate considered themselves independents, with 33 percent identifying as Democrats and only 23.9 percent as Republicans.

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To what extent is there a network of cooperative associations to mediate between society and the political system?

There is a broad range of interest groups that reflect competing societal interests, tend to balance one another, and are cooperative.

10 9

30

30

There is an average range of interest groups, which reflect most societal interests. However, a few strong interests dominate, producing a latent risk of pooling conflicts.

8

There is a narrow range of interest groups, in which important societal interests are underrepresented. Only a few players dominate, and there is a risk of polarization.

5

Interest groups are present only in isolated social segments, are on the whole poorly balanced and cooperate little. A large number of societal interests remain unrepresented.

2

7 6

4 3

1

The 20th-century American humorist Will Rogers once said that “the trouble with the House of Representatives is that it is so damned representative.” Social interests of every kind are well represented in the American system at the national, state and local levels. Three concerns about their role and their impact have arisen in recent years. One is that on economic issues, business interests have increased their ability to influence legislation at the expense of consumers, who tend to be far less well organized, and labor, whose union organizations represent a steadily dwindling fraction of American workers. This is perhaps one reason that corporate profits currently constitute the highest proportion of U.S. GDP, and wages the lowest, since the 1930s. (To complicate this issue, an increasing proportion of organized workers are employed by the government rather than the private sector, and their gains in benefits, often imposing financial obligations on the states and municipalities that employ them, can lead to higher taxes or bigger deficits or both.) The second concern is that societal interests can offset one another in such a way as to paralyze the policymaking process, to the detriment of the wider society. The third concern is that cooperative associations are retarding economic growth.

The economist Mancur Olson identified the tendency, which is particularly pronounced in democracies, to form what he called “distributional coalitions”—interest groups that use their political power to divert society’s resources to themselves at the expense of the general well-being.

This process, in the view of some observers, is harming the economic performance of the United States.

To what extent is the government able to moderate domestic economic, political, and social conflicts?

The government depolarizes conflicts and expands consensus across the dividing lines.

10 9 8

The government prevents conflicts from escalating.

7

5 The government does not prevent conflicts from escalating.

4 3

The government exacerbates existing conflicts for populist or separatist purposes.

2 1

In recent years, however, the political system has become more sharply polarized. The two major parties are now farther apart ideologically, according to studies by political scientists, than at any time in a hundred years and perhaps since the 1850s—the contentious decade that led to the Civil War. For this there are several reasons: the increasing ideological homogeneity of the two parties, with northern liberals having left the Republican ranks while southern conservatives abandoned the Democrats; the rise of social issues such as abortion and gay rights, which, unlike economic issues, do not lend themselves to compromise; and the computer-aided construction of legislative districts, known as gerrymandering, to guarantee the election of a candidate from one of the two parties. In such districts, the primary election to choose the parties’ candidates is the decisive contest—and one in which, because only party activists tend to participate, the candidate with the most extreme views stands the greatest chance of winning. There is some evidence, notably in the work of the political scientist Morris Fiorina, that the electorate as a whole is not as sharply polarized as are the two parties, which means that the political system does not fully represent the country as a whole. But the present state of the parties makes compromise on major initiatives to address pressing problems, above all the deficit and the reform of immigration laws, very difficult.

US FLI CODEBOOK

6

Historically the American government has done well at moderating social conflict—with the monumental exception of the country’s Civil War from 1861 to 1865. Since then the two-party system, with its capacity for absorbing and representing new forces and new ideas,; the habits of democracy, which include cooperation and compromise, and the country’s underlying consensus about basic political values, have kept the conflicts inevitable in any society, especially one as large, diverse and dynamic as that of the United States, within reasonable bounds.

Another major conflict looms on the horizon: one between generations. As the American population ages, the cost of the major social support programs for retired people— Social Security and Medicare—will increase sharply.

Meanwhile, the ratio of active workers, who will have to pay more and more for these programs, to retirees, who are the beneficiaries, will decline. In these circumstances, with the economic interests of the two groups increasingly at odds, the generations may well come into sharp political conflict. The way to avoid or mitigate such a conflict is to reform the programs to make them less costly, but the polarization of the political system has thus far prevented this.

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4. Future Resources To what extent does education policy deliver highquality, efficient, and equitable education and training?

Education policy effectively delivers highquality, efficient, and equitable education and training.

10 9

Education policy largely delivers highquality, efficient, and equitable education and training.

8 7 6

Education policy partly delivers highquality, efficient, and equitable education and training.

5 4 3

Education policy largely fails to deliver high-quality, efficient, and equitable education and training.

2 1

The quality of the American system of education varies dramatically. Post-secondary education is by most accounts the best in the world, but at the primary and secondary levels the United States delivers education that is by global standards mediocre. Higher education is a great American success story. Of the 20 best universities in the world according to a survey by the Times of London’s Higher Education Supplement, 15 are located in the United States. (Four others are in Britain.) The best students from all over the world aspire to do postgraduate studies in these American institutions, especially in the sciences, mathematics and engineering. Even here, however, the picture is not entirely rosy. Many of the best postgraduate students come from abroad, but U.S. immigration laws make it increasingly difficult for them to stay in the country and contribute to society and the economy, as so many immigrants have done in the past.

And the nation’s political polarization has blocked reform of the immigration laws to correct this. Moreover, rising costs make access to higher education, which Americans want to be universal, increasingly difficult. Students have to take on increasingly heavy burdens of debt to attend these institutions, which discourages attendance and imposes hardship afterwards. And the percentage of the population actually completing a post-secondary degree, once the highest in the world, has fallen in recent years to the point that America now ranks only 12th in the world on this dimension of educational achievement.

U.S. primary and secondary schools fare less well in international comparisons. In the 2008 Program for International Student Assessment (PISA) tests of students from many countries, American scores in science and technology were at about the OECD average, and in mathematics were below the average. In no discipline did the United States excel. Since the 1970s, per-pupil expenditure in the United States has more or less doubled in real terms without producing better-educated students as defined by scores on standardized tests. More than a quarter of American students fail to complete high school.

The reform of primary and secondary education is widely recognized as a major need, and a number of efforts are under way: upgrading the performance of teachers for one, and broadening the choices available to students beyond publicly supported schools for another. Both are controversial, however; neither is being implemented on a national scale, and neither has thus far produced dramatic improvement where it has been undertaken. The need for such improvement is key because in the future, even more than in the past, educational attainment will be a predictor of income and lifetime earnings. Those without academic credentials will lag behind the rest of society. If the United States cannot upgrade its primary and secondary education, the country’s degree of income inequality will continue to increase.

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To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products and services?

Research and innovation policy effectively supports innovations that foster the creation of new products and services and enhance productivity.

Research and innovation policy partly supports innovations that foster the creation of new products and services and enhance productivity.

Research and innovation policy largely fails to support innovations that foster the creation of new products and services and enhance productivity.

9 8 7 6 5 4 3 2 1

U N IFLI US TED CODEBOOK S TAT E S O F A M E R I C A

Research and innovation policy largely supports innovations that foster the creation of new products and services and enhance productivity.

10

The United States does well—probably better than any other country—at generating innovations and translating them into new and commercially valuable products and processes. This has been true from the founding of the republic. From its earliest days, America was a nation of tinkerers, innovators, and entrepreneurs. In the 20th century, its universities and many private companies became sources of ideas and technologies, with students and others translating the fruits of university-based research into commercially viable products and services.

Military-related research and the nation’s space program also contributed in this way. A community of U.S. venture capitalists provides money for new enterprises, and the country’s bankruptcy laws and its comparatively greater tolerance for business failures than in other countries encourage people to take the risks involved in launching new ventures. The outstanding product, and example, of this “ecology of innovation” is Silicon Valley in northern California. Even in this area of great strength for the United States, however, there are worrying signs. Major high-tech firms, for example, are moving research and development facilities out of the United States. The American share of total global patents is falling. Federal funding for basic research, an integral part of the process of innovation, is likely to decline in the years ahead. Still, on balance, and in comparison with others, the country scores very high here.

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How successful is a government in reducing unemployment and in increasing employment?

Successful strategies ensure unemployment is not a serious threat and levels of employment are high.

10 9

Labor market and employment policies have been more or less successful with regard to the objective of reducing unemployment and increasing employment.

8

Strategies to reducing unemployment and increasing employment have shown little effect.

5

Labor market and employment policies have been unsuccessful and unemployment has risen and employment has declined.

34

34

7 6

4 3 2 1

Historically the United States has had a lower unemployment rate than the countries of Western Europe, the result of more flexible labor markets that were themselves the products of fewer regulations and weaker unions than in Europe. Americans’ greater geographic mobility also played an important role here: Workers moved frequently from one part of the country to another to change jobs. Unemployment has remained higher than normal in the wake of the recession of 2007–2009, in part no doubt because of the severity of that downturn but also very likely for reasons that go beyond it. Even with high unemployment, by some estimates more than 3 million jobs were going unfilled for lack of qualified applicants.

Improved training and retraining programs may turn out to be necessary in the future, as they have not been in the past, to return to the relatively high levels of employment that have been historically normal in the United States.

To what extent are social security schemes based on principles of fiscal sustainability?

Social security schemes are fiscally sustainable.

10

Social security systems meet most standards of fiscal sustainability.

7

Social security schemes are fiscally unsustainable.

6 5 4 3 2 1

US FLI CODEBOOK

Social security schemes meet only some standards of fiscal sustainability.

9 8

America’s major programs in this area—Social Security and Medicare—which are known as entitlements because each is available by right to all Americans age 65 or older, are not sustainable over the long term under current conditions. The retirement of the country’s largest-ever age cohort, the 78 million “baby boomers” born between 1946 and 1964, will vastly increase the amount of money needed to fulfill the terms of these programs. This will create economically ruinous and politically untenable obligations. By one estimate, the entitlement programs’ share of consumption of U.S. GDP, which is now about 10 percent, will rise to more than 18 percent by 2050. By another rough estimate, the difference between the total cost of paying for the boomers’ retirement over several decades under the current rules and the amount of money the government can expect to collect for this purpose at present rates is no less than $52 trillion. The most potent driver of cost increases will be Medicare, and because Medicare is such a large and rapidly growing program, the problem of paying for U.S. entitlement programs is closely related to another one: the high cost of medical care of all kinds. The United States spends about 18 percent of its GDP on health care, which is one-and-one half times to twice as much as the other advanced industrial democracies. France, for example, spends only 12 percent of its GDP for this purpose, but the French population as a whole is no less healthy than the American one.

The solvency of the nation’s entitlement programs, and in some measure of the country as a whole, therefore requires finding ways of controlling health care costs. There is no national consensus on how this should, or even can, be done. The Affordable Care Act of 2010, commonly known as Obamacare, includes provisions for cost reduction, but their effectiveness will not be tested until later this decade, when the law has been in effect for several years.

As their costs rise, and even if the growth of health care costs in general can be restrained, both Social Security and Medicare will have to be reformed to keep them economically and politically viable. While it is widely accepted among those who study these programs that changes will be needed in both benefits and costs to bring them under control, little progress has been made in devising and implementing such changes. The idea of entitlement reform is a highly contentious and politically divisive matter. The country has begun to debate it but is not, as of this writing, close to an agreement on the appropriate steps to be taken.

INCRA USA Ratings Report

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To what extent are environmental concerns effectively taken into account in both macro- and microeconomic terms?

Environmental concerns are effectively taken into account and are carefully balanced with growth efforts.Environmental regulation and incentives are in place and enforced.

10 9

Environmental concerns are effectively taken into account but are occasionally subordinated to growth efforts.

Environmental regulation and incentives are in place, but their enforcement at times is deficient.

Environmental concerns receive only sporadic consideration and are often subordinated to growth efforts.

Environmental regulation is weak and hardly enforced.

Environmental concerns receive no consideration and are entirely subordinated to growth efforts. There is no environmental regulation.

36

36

8 7 6 5 4 3 2 1

The United States has had an active and effective environmental movement since the 1960s, which helped to establish the Environmental Protection Agency (EPA) in 1970. That agency has grown in power and reach; likewise, state and even local governments have their own environmental laws and agencies to enforce them. As a result, over the four decades since the establishment of the EPA, what might be called “local pollution” in the United States—the smog in urban areas, for example, and the pollution in rivers—has abated considerably.

To deal with the most important environmental problem of global scope, however—global warming—the United States has adopted few formal measures. A substantial fraction of the American public, and part of the country’s political establishment, simply does not believe that the planet’s temperature is rising with unusual rapidity, or that, if it is, this will cause severe environmental, economic, social and political damage if unchecked.

The United States did not ratify the 1997 Kyoto Protocol, the international treaty aimed at reducing emissions to combat climate change. Complicated legislation called the American Clean Energy and Security Act, designed to reduce the country’s use of carbon-based fuels, was approved by the House of Representatives in 2009 but did not pass in the Senate. Once a leader in research and development of renewable fuels, the United States now trails behind other countries. It does have a number of government initiatives designed to achieve that goal, such as programs that encourage the use of ethanol or subsidies for solar power and manufacturers of electric automobiles. These programs have attracted criticism and political opposition and have done little to reduce American, let alone global, dependence on globalwarming-producing fossil fuels. Improvement in energy efficiency in industrial and consumer activity over the past several decades has reduced the amount of carbonbased fuel usage per unit of economic output—but because overall national output has grown, so have total U.S. carbon emissions. Because of widespread skepticism about the very existence of man-made climate change, as well as because of the historically deeply rooted resistance to taxation of all kinds (which is a sentiment far stronger in the United States than in Europe) the United States has not even seriously considered the measure that would most efficiently increase innovation, production, and consumption of non-fossil fuels: a tax on carbon.

II. STEERING CAPABILITY AND REFORM CAPACITIES 5. Strategic Capacity Prioritization: To what extent does the government set and maintain strategic priorities?

10 9

The government sets strategic priorities, but sometimes postpones them in favor of short-term political benefits. It shows deficits in prioritizing and organizing its policy measures accordingly.

8

The government claims to be setting strategic priorities, but replaces them regularly with short-term interests of political bargaining and office seeking.

Policy measures are rarely prioritized and organized.

5

The government does not set strategic priorities. It relies on ad hoc measures, lacks guiding concepts, and reaps the maximum short- term political benefit.

7 6

4 3 2 1

US FLI CODEBOOK

The government sets strategic priorities and maintains them over extended periods of time. It has the capacity to prioritize and organize its policy measures accordingly.

The U.S. government has ready access to expertise of all kinds: through government bodies organized for this purpose, such as the President’s Council of Advisors on Science and Technology, through expert testimony to congressional committees, through informal consultation by the bureaucracy at all levels, and by virtue of the fact that it is far easier to enter the government laterally—to recruit expertise from outside the permanent bureaucracy— in the United States than in other countries. America has on several occasions demonstrated its capacity for setting and keeping to strategic priorities. Perhaps the most notable example is its 45-year policy of containing the Soviet Union, maintained through nine presidential administrations, four Democratic and five Republican.

Still, consistency in the pursuit of major goals does face several obstacles in the United States. One is the division of power between the executive and legislative branches, which can and do embrace different goals and check each other in pursuit of them. Another is the fact that all of the members of one chamber of the federal legislative branch, the House of Representatives, must stand for election every two years, a shorter term of office than is found in any other advanced industrial society, which makes them subject to short-term pressures and incentives. A third is the unusually sharp polarization, in the second decade of the 21st century, between the two major political parties, making it difficult to find broad goals that both will support. A fourth is the fact that, in contrast to Europe, planning is not a highly regarded governmental activity in the United States. While most Western European governments have, or have had since 1945, official bodies to engage in indicative planning (not to be confused with the comprehensive and mandatory planning of communist economic systems), the United States does not.

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Policy coordination: To what extent can the government coordinate conflicting objectives into a coherent policy?

The government coordinates conflicting objectives effectively and acts in a coherent manner.

10 9

The government tries to coordinate conflicting objectives, but with limited success. Friction, redundancies, and gaps in task assignments are significant.

8 7 6

The government mostly fails to coordinate between conflicting objectives. Different parts of the government tend to compete among each other, and some policies have counterproductive effects on other policies.

The government fails to coordinate between conflicting objectives. Its policies thwart and damage each other. The executive is fragmented into rival fiefdoms that counteract each other.

38

5 4 3 2 1

The size of and division of power within the American government presents a challenge to policy coordination.

Over the past half century, power within the executive branch has gravitated away from the various departments and agencies and to the White House, although the business of government is so extensive and complex that departments retain considerable independence, especially on matters that are not highly political visible.

Within the White House, both formal bodies, such as the National Security Council, and ad hoc arrangements have been created for the purpose of coordination.

Still, the sheer scope of the government—as well as the power of Congress, which the White House emphatically does not control even when members of the president’s party are in the majority in both houses and which has important powers of its own (notably the power of the purse)—limit the degree of coherence that the making and implementation of policy can achieve in the United States.

Stakeholder Involvement: To what extent does the government consult with major economic and social interest groups to support its policy?

The government successfully motivates economic and social actors to support its policy.

10 9 8 7 6 5

The government consults with economic and social actors.

4 3

US FLI CODEBOOK

The government facilitates the acceptance of its policy among economic and social actors.

Both the executive and especially the legislative branches consult extensively with major social and economic groups. Because of the historical strength of civil society in the United States and because economic, social and political interests are well organized, the government very seldom takes an initiative involving domestic matters without extensive consultation. The 2010 health care law is an example; the Obama administration conferred with all organized parties with a stake in the legislation.

Of course, not all groups are equally well organized, and the growing prominence of money in campaigning and governing may give wealthy groups increasing influence, tilting the political playing field in their favor. (It is also possible, however, that technology will tend to equalize political influence by providing groups lacking money with new channels of influence.) The common criticism of government is not that it fails to consult adequately with those affected by the policies it enacts, but rather the reverse: that consultations can become so elaborate and prolonged that they prevent effective action.

2 The government hardly consults with any economic and social actors.

1

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Political Communication: To what extent does the government actively and coherently communicate and justify the rationale for and goals of its policies to the public?

The government effectively coordinates its communication efforts and it coherently communicates and justifies the goals of its policies to the public.

10 9

The government seeks to coordinate its communication efforts. Contradictory statements are rare, but do occur sometimes. In most cases, the government is able to coherently communicate and justify the goals of its policy to the public.

The government has problems in effectively coordinating its communication efforts. Statements occasionally contradict each other. The government is only partly able to coherently communicate and justify the goals of its policies to the public.

8 7 6 5 4

The United States is so large, and there are so many channels of communication and so many different and often conflicting views on public policy, that effective communication is not always easy. It is the president, at the national level, and to a lesser extent governors and mayors at the state and local levels, who have the strongest and most widely heeded voices. Since the early 20th century, the president has been the focus of media attention in the nation’s capital, and is usually taken by foreign audiences (and often by Americans as well) to speak for the country as a whole. The president occupies what has come to be known as the “bully pulpit,” from which his words and ideas can reach all Americans and others beyond the country’s borders. He has by tradition at least one opportunity annually, in his State of the Union address to Congress, to command the country’s undivided attention and occasionally makes other special national addresses, especially during emergencies. (Governors and mayors have similar, although less potent, opportunities.)

It gives him the chance to set the national agenda, although it by no means guarantees the enactment of that agenda. As in other countries, it should be noted, officials in the United States conduct their bureaucratic battles by means of leaks to the press, so the executive branch, even under the tightest presidentially imposed discipline, does not always speak with a single voice.

3

The government fails to coordinate its communication efforts. Statements often contradict each other. The government is not able to coherently communicate and justify the goals of its policies to the public.

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2 1

6. Implementation and Efficiency To what extent can the government achieve its own policy objectives?

The government can largely implement its own policy objectives.

10 9 8

5

It became customary in the 20th century for the president to put together a legislative program and announce it in his annual State of the Union message to Congress at the beginning of each calendar year. On a few occasions, most of that program has been enacted into law during the president’s term of office. But in the political conditions that prevail in 2013, such an achievement is most unlikely.

4

7 6

The government partly fails to implement its objectives or fails to implement several policy objectives.

US FLI CODEBOOK

The government is partly successful in implementing its policy objectives or can implement some of its policy objectives.

Because power is divided in the American system, different branches and levels of the government can and do have different objectives. Indeed, this system was originally designed to make it difficult to put into practice a comprehensive program of any kind, or at least to prevent such a thing from being done quickly. Moreover, the current unusually sharp divisions between the two major political parties further inhibit effective implementation of any particular policy agenda. Each party opposes, blocks and where relevant seeks to cancel or reverse what the other is attempting to do.

3 2 The government largely fails to implement its policy objectives.

1

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To what extent does the government make efficient use of available human, financial, and organizational resources?

The government makes efficient use of all available human, financial, and organizational resources.

10 9 8

The government makes efficient use of most available human, financial, and organizational resources.

7 6 5

The government makes efficient use of only some of the available human, financial, and organizational resources.

4 3 2

The government wastes all available human, financial, and organizational resources.

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1

The quality of the government’s workforce, although difficult to measure, has probably declined somewhat in recent decades. Beginning in the 1930s, government service came to be seen as important and constructive, and in comparison with the private sector it was reasonably well-compensated work. In recent decades, each of these qualities has declined: One reason for the financial crisis of 2008, for example, was the relatively weak government oversight of the financial industry, the result not only of the limits of existing regulations but also of the fact that someone with an interest in finance could make so much more money in the private than in the public sector. Another difficulty, peculiar to the U.S. federal government, inhibits maximally effective employment of human resources. Departments and agencies often lack leadership at the outset of a presidential term, when the executive branch’s power to make and enact policy tends to be greatest, because their leaders must be confirmed in office by the Senate. This confirmation process has become ever more complicated, protracted, intrusive and, for the purpose of recruiting talented people to fill the positions in question, discouraging. To confirm all the senior appointed officials of the Kennedy administration in 1961 took 10 weeks; of the Reagan Administration in 1981, 20 weeks; and of the Obama administration in 2009, 18 months.

7. Adaptability Policy Learning: How innovative and flexible is the government?

The government demonstrates a pronounced ability for complex learning.

It acts flexibly and replaces failed policies with innovative ones.

10 9

The government demonstrates little willingness or ability for policy learning.

Policies are rigidly enforced, and the routines of policy-making do not enable innovative approaches.

8 7 6 5 4 3 2

The government demonstrates no willingness or ability for policy learning.

1

The United States has experienced policy learning—or at least significant change in policy—in recent decades. The wars in Vietnam in the 1960s and 1970s and in Afghanistan and Iraq in the first decade of the 21st century triggered political backlashes that led to more cautious foreign policies. (In Iraq the armed forces themselves engaged in learning, leading to the change in tactics in 2007 known as the “surge.”) The inflation of the late 1970s led to a tighter monetary policy, and contributed to the deregulation and increased reliance on market forces of the 1980s. A major reform of the Social Security system was enacted in 1983, and tax code reform in 1986.

US FLI CODEBOOK

The government demonstrates a general ability for policy learning, but its flexibility is limited. Learning processes inconsistently affect the routines and the knowledge foundation on which policies are based.

this goal. (American reliance on oil imports has waxed and waned, but for reasons largely independent of public policy.)

The same is true of the failure to reform Social Security and Medicare, as discussed earlier. These situations are not due to a lack of expertise or the failure to consult outside the government. Nor can they be explained by the absence of institutional mechanisms to foster adaptation. Indeed, all three were on display in the 2010 report of the National Commission on Fiscal Responsibility and Reform, popularly known as the Simpson-Bowles Commission after its two co-chairmen, Alan Simpson, a former Republican senator and Erskine Bowles, a Democratic former White House chief of staff. President Obama created the commission to study and make recommendations on the nation’s fiscal challenges; it had 18 members, including six Democratic and six Republican members of Congress. Its mandate included a provision for a vote on its recommendations in both houses of Congress should a large enough majority of the commission endorse them. The commission’s report was widely praised as both an effective path to addressing the nation’s fiscal problems and a program with the potential to attract support from both political parties. It won the support of a majority of commissioners, but not a big enough majority to force a congressional vote. The president did not endorse it, and it became a dead letter.

Here again, the chief obstacle to a needed adaptation in public policy was the sharp polarization of the American political system in the second decade of the 21st century, to the extent that the two parties struggle to agree on any significant measure.

Public opinion presents another obstacle to the reform of energy policy and entitlements. Effective adaptation would in both cases entail short-term economic sacrifice on the part of the American public. While Democrats and Republicans disagree on most important matters of public policy, they have both been reluctant to propose measures that require sacrifice of any kind, especially sacrifice on the part of segments of society that they represent and that support them. They calculate that this would have negative electoral consequences for them because the American public will not agree to short-term sacrifice, no matter how compelling the case for it. The gap between what is needed and what the public is willing to authorize obstructs policy adaptation in the United States.

In recent years, however, the government has become more rigid. Changes of policy widely considered to be necessary to secure the country’s future have nonetheless not occurred. Every president since Richard Nixon, for example, has preached the need, for reasons of national security as well as economic well-being, to decrease American reliance on imported oil. Yet the government has never managed to pass the necessary measures—a tax on carbon, or oil, or imported oil—that would achieve

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Institutional Learning: To what extent does the government improve its strategic capacity by changing the institutional arrangements of governing?

The government improves considerably its strategic capacity by changing its institutional arrangements.

10 9 8

The government improves its strategic capacity by changing its institutional arrangements.

7 6 5

The government does not improve its strategic capacity by changing its institutional arrangements.

4 3 2

The government loses strategic capacity by changing its institutional arrangements.

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1

Since the 1930s, reform of the functions of the U.S. government has usually come in two varieties. One kind of reform is an effort to coordinate better the disparate agencies and departments of the federal government: examples include the establishment of the National Security Council in 1947 and the National Economic Council in 1993, both with their headquarters in the White House, and the appointment of various “policy czars� with mandates spanning more than one agency or department.

President George H.W. Bush appointed two such czars, President Clinton eight, President George W. Bush 33 and President Obama 37. Because the government is so large, all presidential administrations develop some mechanisms of coordination, even if they do not acquire formal status or outlive the administration that established them. The other kind of reform is the addition of departments of agencies to reflect new challenges and the political importance of new constituencies. As the government has grown since the 1930s, departments and agencies have multiplied. This assures official attention to a wide array of social and economic issues. It speaks to the ever-wider scope of governance in the United States, in common with other advanced industrial countries.

Occasionally various agencies are consolidated, as with the Department of Homeland Security, which was formed in 2002. Whether that growth or those consolidations have improved the strategic capacity of the government and, if so, to what extent it has fostered such an improvement, are matters of debate.

III. TRACK RECORD OF PAST CRISIS MANAGEMENT

In the 1930s the Great Depression administered a political as well as an economic shock to the United States, as to other Western countries, but the political system itself was not in serious danger. The Keynesian economic policies implemented by the administration of Franklin D. Roosevelt, beginning in 1933, mitigated the economic damage during the balance of that decade. World War II, which began for the United States in late 1941, injected stimulus on a large scale into the U.S. economy in the form of military spending.

The United States also coped reasonably well with the great financial crisis of 2008, which had global consequences but centered on the American financial system. The failure of the investment bank Lehman Brothers on Sept. 15, 2008, triggered the crisis, freezing the flow of credit and jeopardizing the existence of large financial institutions, not all of them banks. The federal government stepped in with emergency measures that stabilized the financial system. It played, in effect, the classic governmental role of lender of last resort. Close cooperation on an ad hoc basis among three major economic officials—Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, and the president of the Fed’s most important regional branch in New York, Timothy Geithner—was responsible for the generally successful efforts to cope with the crisis. The process was not an entirely smooth one. Congress rejected the first proposal for a Troubled Asset Relief Program (TARP), passing it only after the initial rejection had triggered a sharp drop in the stock market. Nor did the U.S. economy escape serious damage: the financial crisis contributed substantially to the longest and deepest recession the country had experienced since the 1930s. Without the

effective work of the trio of economic officials, however, the damage would surely have been worse.

Score: 9 Does the political system facilitate crisis remediation in a timely manner?

While the American political system permitted crisis remediation in the fall of 2008 and thereafter, it did not facilitate what turned out to be an escape from the worst possible outcome of the near-meltdown of the financial system. Indeed, the crisis management process had a troubling feature: The institutions with the greatest power and therefore most extensive responsibilities under the Constitution—the presidency and Congress—contributed very little to the policies that mitigated the economic shocks. While the presidency had been at the center of the Cold War political-military crises, making the ultimate decisions and rallying public support for them, in the 2008 financial crisis President George W. Bush appeared to have delegated the authority of the executive branch to the secretary of the Treasury. Congress came into the picture when it was asked to provide an emergency injection of funding to support the financial system in the form of TARP. But the House of Representatives initially rejected the program on Sept. 28, 2008, sending a shudder through financial markets in the United States and elsewhere, before it finally passed the necessary legislation on Oct. 3. In general, the bulk of the crisis remediation came from the Federal Reserve, which is the least democratic, in the sense of being the least publicly accountable, part of the federal government. Its insulation from public pressure enabled the Fed to operate swiftly, effectively and on a large scale during the crisis, but also made the measures it took less comprehensible to and less popular with the public than would have been the case had the president and Congress been identified with them. Moreover, postcrisis legislation has curtailed some of the Fed’s powers, and to be successful over the long term in a democracy such as the United States, a program of any kind, including a financial program, must have public support. Moreover, the polarization of the political system makes any major legislation, no matter how urgent, difficult to pass.

Polarization may even create crises, for example if Congress follows through on the threat some of its members have made to refuse to raise the nation’s debt ceiling when necessary unless substantial reductions in federal spending take place. Without an increase in the debt limit, it is conceivable that the United States could, for the first time in its history, actually default on its debt payments.

This is highly unlikely but unfortunately not impossible.

Score: 7

INCRA USA Ratings Report

US FLI CODEBOOK

Is there evidence from historical events that the country and society have already mastered economic and political shocks in the past?

The United States has had the good fortune not to have experienced a genuinely regime-threatening crisis since the middle of the 19th century, when divisions in the country led to a bloody civil war. During the Cold War, the government had to navigate several political-military crises, which derived their urgency from the possibility that nuclear weapons would be used, conceivably on a large scale, by the United States and its chief rival the Soviet Union. The most serious of these arose over the status of Berlin in 1961 (a previous Berlin crisis, without the acute peril of nuclear war, had taken place in 1948) and over the Soviet emplacement of nuclear-capable missiles in Cuba in 1962. In both cases American policy, led by the president, produced a resolution of the crisis on terms favorable to the United States and without war.

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Is the signaling process between decision makers (the government, central bank, employers and employee representatives) so well established that confusion about (and resistance to) the expected outcome of decisions by one decision-maker on the others can be avoided or at least minimized?

There is adequate communication among the relevant parties in the political and economic systems in the United States. What is lacking is sustained cooperation, due less to the constitutionally mandated separation of powers than to the sharp ideological polarization of the second decade of the 21st century.

Score: 8 Are there constitutionally anchored and politically accepted procedures for sequencing and timing countermeasures in a crisis?

There are no such procedures. Usually the country looks to the president to chart a response to a crisis and orchestrate the policies necessary to follow it. In 2008, although the country did cope more or less adequately with the financial crisis once it erupted (as opposed to preventing it in the first place), this pattern did not occur in precisely the way that it had in the past.

Score: 6 What is the special international economic role of the United States?

One particular feature of the U.S. role in the global economy is germane to assessing its credit rating. The United States supplies the currency most widely used globally as a reserve. Other countries hold more than 60 percent of their reserves in dollar-denominated assets.

Because this produces wider tolerance among other countries for economic policies that incur the rebuke of markets when carried out by a country other than the United States, it gives the U.S. government greater scope for such policies. In other words, America’s credit receives a boost in practice from the special status of the dollar, which is bolstered by the fact that the other two plausible candidates to serve as reserves—the euro and the Chinese renminbi—are for different reasons unsuitable for the task at present. Uncertainty surrounds the euro because of the difficulties some of its members have had in financing their deficits; as for the renminbi, the Chinese economy is too tightly controlled by the ruling Communist Party to make it attractive for others to hold its currency on a large scale.

The dollar’s dominance carries with it a danger, however, especially in view of America’s clouded fiscal prospects: It means that if other countries and global markets should lose confidence in the dollar, the consequences for both the American and world economies would be particularly severe. A run on the dollar could do more damage than the instability of the euro that began in 2011 or the crash of Asian currencies in 1997 and 1998.

Score: 8

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CONCLUSION The Overall Objective of This Report This sample rating report is the logical next step for INCRA to demonstrate that the current system of sovereign ratings can be changed. All six of our INCRA sample ratings, including the US rating, prove that:

• A broader understandability of sovereign ratings can be achieved by introducing new forms of presentation, such as our “rating radar.”

• Both quantitative and qualitative indicators should be included in every sovereign risk analysis.

In essence, we believe it is time to change the public narrative about sovereign ratings. Instead of viewing them as a “national insult” in the case of a downgrade or as an unpredictable and not serious assessment of a country, they should be seen as a starting point for an in-depth debate about the reforms a country might need.

Overall, we still believe CRAs need major improvements.

Since sovereign ratings are public goods, it should be the responsibility of all the major societal players to support their improvement. As such,we still advocate that the G20, representing the most important economic and financial players in today’s world, is the best forum within which to evaluate the political will for founding a new institution that will be embedded not only in financial markets but also in society in general. Additionally, corporate players, NGOs and foundations should make commitments to help improve the sovereign risk sector.

The first INCRA report and this report demonstrate that there is an alternate way to address the highly important and sensitive issue of how sovereign ratings are conducted.

The second INCRA report, with its sample ratings of Brazil, France, Germany, Italy and Japan, along with this US rating report, show that INCRA’s methodology works for assessing sovereign risk and can provide investors and the public with a clear, transparent assessment of a country’s outlook. INCRA is an innovative solution that merges the changing demands and interests of investors assessing sovereign risk and the desire of governments and the broader public for more transparency, legitimacy and accountability.

CONCLUSION

• Transparency—providing all the data, background information and average scores from committee voting— can be a basic principle of sovereign risk assessment.

As the sample ratings prove, in order to evaluate a country’s willingness to repay its debts, a more comprehensive set of indicators is needed. That is why INCRA, as shown in this report, would conduct its sovereign risk assessments using a set of macroeconomic and FLI that will provide the basis for high-quality analysis. The FLI capture a more meaningful picture of a country’s long-term socioeconomic and political prospects and the potential political and social constraints on its ability and willingness to pay back its debt. In this regard, INCRA would be an incubator for best practices in sovereign risk analysis.

The financial realities of the 21st century have already outpaced the traditional trans-Atlantic partnership. INCRA reflects the new realities of an increasingly globalized financial world. The quality of sovereign ratings is crucial not only for Europe and the US, but also for emerging economies such as China, India, Brazil and Mexico, etc.

Therefore, INCRA would help guarantee the participation of all the relevant international players—it would be the first truly international CRA. But in order to create a more coherent international system for CRAs, whether they are for-profit or non-profit, we need a broader dialogue on how to overcome the irresponsible fragmentation of regulatory requirements around the world. A broadly accepted and implemented international regulatory framework must be developed to oversee and govern this sector in the future.

Beyond that, there are further challenges ahead in order to bring INCRA fully to life: 1. Investors may need to change their organizational behavior. Though they are frustrated to some extent with the current system, most investors continue to rely on information from the big three CRAs, whose ratings are often embedded in internal investment guidelines.

INCRA will be seen as the “new kid on the block” of the CRA world. Its model needs to be robust enough to convince investors that it will provide added value for their investment decisions.

2. Governments must take a stand. They must turn from simply criticizing how sovereign ratings are conducted to reforming the system in a way that is convincing and sustainable.

3. Representatives of the non-profit sector, whether they are NGOs or foundations, need to be encouraged to play a meaningful role in the financial world.

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The members of the G20 have already made it clear that CRAs need to be reformed. As we have explained, the G20 would be the best forum to evaluate the political will of key players to give the new institution a chance.

Changing the current system requires bold and big thinking. INCRA is a big idea based on a reasonable operational concept. It would require an endowment of $400 million. At first glance this is a lot of money, but it is a small, manageable investment if divided among multiple funders. In comparison to the hundreds of billions of dollars already paid for public bailouts—partially the result of flawed corporate and sovereign risk analysis— such an investment is a modest and safe call.

INCRA has the potential to become a cornerstone of a financial system capable of dealing with 21st century problems. As the sample rating in this report will demonstrate, not only do we need different institutions to assess sovereign risk, but we also need a more coherent and transparent methodology to analyze that risk. What is required now is the political will and support of visionary leaders around the world.

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INCRA RATINGS SCALE AAA

7.70 - 7.99

AA+

7.30 - 7.69

AA

7.00 - 7.29

AA-

6.70 - 6.99

A+

6.30 - 6.69

A

6.00 - 6.29

A-

5.00 - 5.99

BBB+

4.00 - 4.99

BBB

3.00 - 3.99

BBB-

2.00 - 2.99

Below investment grade

I N C R A R AT I N G S S C A L E

8.00 - 10.00

1.00 - 1.99

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MACROECONOMIC INDICATORS CODEBOOK I. Economic Fundamentals Real GDP Growth (%) Is real GDP growth adequate to raise real income over time and sufficient to satisfy domestic political needs?

1

2

3

4

5

6

7

8

9

10

Totally inadequate

Substantially exceeds needs

GDP per capita (current exchange rates in US$) and GDP per capita (PPP basis: US$) What is the level of wealth and development of a country? GDP per capita (PPP basis) is within which percentile, and what is expected to happen over time?

1

2

3

Lowest

4

5

6

Lower Middle Income Countries

Upper Middle Income Countries

7

8

9

High Income Countries

10 Highest

Real Exports (% Change) What is the importance of exports in this country’s performance?

1

2

3

4

5

6

7

8

9

10 Export sector performing well or exports not important to country’s performance

Export sector performing poorly

Real Imports (% Change) To what extent is the country’s performance affected by its import needs?

1 Import needs are high/import needs are affecting the country’s performance

50

2

3

4

5

6

7

8

9

10 Import needs are low/import needs are not affecting the country’s performance

Gross Domestic Investment/GDP (%) Is a country’s investment ratio sufficient to address its development needs and support infrastructure at a level that will not hinder growth?

1

2

3

4

5

6

7

8

9

10

Investment ratio insufficient

Investment ratio sufficient

M A C R O E C O N O M I C I N D I C AT O R S C O D E B O O K

How does a country’s investment ratio compare now and is expected to compare in the future to the median of its income peers?

1

2

3

4

5

6

7

8

9

10

Investment ratio is significantly below peer median (current or expected)

Investment ratio is at peer median (current or expected)

Gross Domestic Savings/GDP (%) To what extent is a country’s savings ratio sufficient to support necessary investment without causing balance of payments problems?

1

2

3

4

5

6

7

8

9

10

Savings ratio insufficient

Savings ratio sufficient

How does a country’s savings ratio compare now and in the future to the median of its income peers?

1 Savings ratio is significantly below peer median (current or expected)

2

3

4

5

6

7

8

9

10 Savings ratio is at peer median (current or expected)

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Inflation/CPI (%) Are price changes distorting economic decision making, either through excessive inflation or deflation, and how will price changes affect future economic performance?

1

2

3

4

5

6

7

8

9

Price changes already or are likely to cause major problems for the economy (e.g. hyperinflation or pernicious deflation)

10

Price changes are not creating, nor likely to create a distortion

Population Growth (% Change) Is a country’s demographic trajectory beneficial or burdensome to long-term economic performance and sustainability of the social security system?

1

2

3

4

5

6

7

8

9

Highly burdensome

10 Highly beneficial

II. Public Sector Policy General Government Debt/GDP (%) To what extent does a country’s debt/GDP ratio constrain its economic progress?

1

2

3

4

5

6

7

8

9

Debt/GDP ratio significantly constrains economic progress

10 Debt/GDP ratio does not constrain economic progress

How does a country’s debt/GDP ratio compare to its income peers today and in the future?

1 Debt/GDP ratio is significantly higher than peer median (current or expected)

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2

3

4

5

6

7

8

9

10 Debt/GDP ratio is at or below peer median (current or expected)

Nominal GDP Growth (Local Currency %) Is expected nominal GDP growth adequate to meet government financing over time?

1

2

3

4

5

6

7

8

9

Totally inadequate

10 Substantially exceeds needs

General Government Debt/General Government Revenue (%)

1

2

3

4

5

6

7

8

9

Debt/revenue ratio significant constraint

M A C R O E C O N O M I C I N D I C AT O R S C O D E B O O K

To what extent does a country’s debt/ revenue ratio put pressure on revenue generation and constrain the government’s spending flexibility?

10 Debt/revenue ratio not a constraint

How does a country’s debt/GDP ratio compare to its income peers today and in the future?

1

2

3

4

5

6

7

8

9

Debt/revenue ratio is significantly higher than peer median (current or expected)

10 Debt/revenue ratio is at or below peer median (current or expected)

General Government Interest/General Government Revenue (%) To what extent does a country’s debt service costs put pressure on revenue and spending flexibility?

1

2

3

4

5

6

7

8

9

GG interest/ revenue ratio is a significant constraint

10 GG interest/ revenue ratio is not a significant constraint

How does a country’s GG interest/revenue ratio compare to its income peers today and in the future?

1 GG interest/ revenue ratio is significantly higher than peer median (current or expected)

2

3

4

5

6

7

8

9

10

GG interest/ revenue ratio is at or below peer median (current or expected)

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General Government Primary Balance/GDP (%) How large is the primary deficit or surplus, and what is expected in the future?

1

2

3

4

5

6

7

8

9

Country has significant primary deficit (current or expected)

10 Country has significant primary surplus (current or expected)

General Government Revenue/GDP (%) How broad-based is the tax system and what is the rates’ level? Can the latter be adjusted easily? How flexible is the revenue structure?

1

2

3

4

5

6

7

8

9

Narrow, inflexible tax system and inflexible revenue structure

10 Broad-based, flexible tax system and revenue structure

General Government Expenditure/GDP (%) How effective are expenditure programs and infrastructure? To what extent does the pension system affect expenditure flexibility?

1 Ineffective expenditure programs; pension system reduces expenditure flexibility

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54

2

3

4

5

6

7

8

9

10 Effective expenditure programs in place; pension system allows expenditure flexibility

III. Monetary Policy Is monetary policy accommodative?

1

2

3

4

5

6

7

8

9

Not accommodative

10 Very accommodative

M A C R O E C O N O M I C I N D I C AT O R S C O D E B O O K

IV. Capital Markets and Financial Risk Domestic Credit/GDP (%) Is the domestic credit/GDP ratio consistent with the country’s economic progress, and is it likely to be so in the future?

(If possible, countries should be compared to peers: High-income countries automatically receive a 10. Middle or lowincome countries need to be compared to their peers.)

1

2

3

4

5

6

7

8

9

Domestic credit/ GDP ratio far higher or lower than peers (current or expected)

10 Domestic credit/ GDP ratio similar to peers (current)

Domestic Credit (% Change) Is domestic credit growth a potential source of credit risk now or in the future? (If future trends are expected to be different, then adjustments need to be made in the final score.)

1

2

3

4

5

6

7

8

9

Credit growth is far in excess of nominal GDP growth

10 Credit growth is near or below nominal GDP growth

What is the overall strength of the banking sector?

1 Banking sector is weak; nonperforming loans account for more than 10% of total loans for the system

2

3

4

5

6

7

8

9

10 Banking sector is strong; Nonperforming loans comprise no more than 2% of total loans for the system

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V. External Sector How does an emerging market (EM) country’s current account position affect its development today and in the future?

1

2

3

4

5

6

7

8

9

10 Any country, which has maintained, and appears likely to continue to maintain a current account surplus in excess of 5% of GDP

Any deficit in excess of 10% of GDP today or expected in the future

How does an EM country’s current account position compare to its peers today and in the future?

1

2

3

4

5

6

7

8

9

10 Any country, which has maintained, and appears likely to continue to maintain a current account surplus in excess of 5% of GDP

Any deficit in excess of 10% of GDP today or expected in the future

External Debt (US$)*, External Debt/GDP (%)* and External Debt/Exports ratio (%)* How does an EM country’s external indebtedness constrain its developmental progress?

1

2

3

4

5

6

7

8

9

Debt service costs greatly constrain developmental progress

10 Debt service costs do not greatly constrain developmental progress

How does an EM country’s debt service ratio compare to its income peers today and in the future?

1 Debt service ratio is significantly higher than peer median (current or expected)

56

56

2

3

4

5

6

7

8

9

10 Debt service ratio ratio is at or below peer median (current or expected)

Coverage by Reserves External Debt/International Reserves (%)* [Foreign Exchange Reserves (US$)* is the same thing as International Reserves] How significant is an EM country’s debt/reserves cover to avoid financial risk? (What does this imply about the possibility of a debt crisis?)

1

2

3

4

5

6

7

8

9

Country’s debt/ reserves ratio is in excess of 100% and is far in excess of its peer median (current or expected)

10

M A C R O E C O N O M I C I N D I C AT O R S C O D E B O O K

Country’s debt/ reserves ratio is equal to 100% (current or expected)

M2/Foreign Exchange Reserves* Does the ratio of M2/FX reserves pose a risk today or in the future of capital flight in an EM country?

1

2

3

4

5

6

7

8

9

Expected M2/FX reserves ratio in excess of 6

10 Expected M2/FX reserves ratio is 1

Reserves to Imports (months)* How many months of imports of goods and services does an EM country’s international reserve cover today and in the future?

1 Less than 1 month today or in the future

2

3

4

5

6

7

8

9

10 One year’s cover today or in the future

INCRA USA Ratings Report

57

Composition of Debt Servicing Debt Service Ratio (%)* Is an EM country’s debt service ratio manageable today and in the future?

1

2

3

4

5

6

7

8

9

Debt service ratio at or above 100% (current or expected)

10 Debt service ratio less than 15% (current or expected)

Short-Term External Debt/Total External Debt (%)* How pressing is an EM country’s short-term external debt on the ability of an EM country to have market access today and in the future?

1

2

3

4

5

6

7

8

9

10 Short-term/ external debt ratio is less than 20% (current or expected)

Short-term/ external debt ratio is near 100%

External Short-Term Debt + Current Maturities Due on Medium-to-Long External Debt/FX Reserves (%)* How well positioned is an EM country to sustain a loss of market access?

1

2

3

4

5

6

7

8

9

Ratio significantly in excess of EM peers

10 Ratio of less than 100% (current or expected)

Liquidity Ratio Total Liabilities Owed to Bank for International Settlements Banks/Total Assets Held in BIS Bank (%)* 1 Ratio far in excess of 1.00

58

58

2

3

4

5

6

7

8

9

10 Ratio of close to zero

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