Credit Downgrade Should Serve As A Wake-Up Call

Just before Standard and Poor's downgraded U.S. debt, economist Tyler Cowen warned it would be a distraction to slam the ratings agency. Many analysts and economists doubt S&P, but Cowen argues in his blog "Marginal Revolution" that there are some real lessons to learn. He discusses them with Steve Inskeep.

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RENEE MONTAGNE, host:

This is MORNING EDITION from NPR News. I'm Renee Montagne.

STEVE INSKEEP, host:

And I'm Steve Inskeep.

Just before Standard & Poor's downgraded U.S. debt, the economist Tyler Cowen warned it would be a distraction to slam the ratings agency. Many analysts and economists are doubting S&P, as we've heard elsewhere in this program. But Cowen argues on his blog, Marginal Revolution, that there are some real lessons to learn. Now the downgrade is real.

Tyler Cowen is on the line.

Welcome to the program.

Mr. TYLER COWEN (Blogger, Marginal Revolution): Hello.

INSKEEP: S&P slammed political brinksmanship and gridlock. Were they right?

Mr. COWEN: Absolutely they're correct. It's a kind of wakeup call. We were on the verge of defaulting on our debt. We should have been downgraded.

INSKEEP: Meaning because of the debt ceiling fight, that this - obviously it was deserved, in your view?

Mr. COWEN: That's right. A lot of people are attacking S&P because they got so much wrong in the financial crisis. But just because they were wrong then it doesn't mean they're wrong this time. So those attacks on the rating agency I see as a distraction.

INSKEEP: Well, let's talk about the fiscal issues facing the United States in a constructive way. From your point of view, what do you think first on the Republican side - we'll get to Democrats - but on the Republican side what have Republicans done wrong?

Mr. COWEN: The Republicans need to accept that we need revenue increases. There is no other way to get the budget to add up. So the notion that we can do it all through spending cuts, it simply isn't going to work.

INSKEEP: When you say need revenue increases, you're saying, for example, that they might've done well to sign onto the grand bargain that was close, with President Obama, that included tax increases along with entitlement reform -spending cuts, that sort of thing.

Mr. COWEN: That probably would've been much better. We never really got to see what that grand bargain would've been. And probably, even the so-called grand bargain wasn't very grand. But as it turns out we did very little - there were very little spending cuts in what were agreed to. And the market reacted very negatively.

INSKEEP: And we should mention that some Republicans have said they're willing to sign onto revenue increases as long as they're phrased in the right way, not framed as tax increases, not tax increases on the marginal rates and so forth.

Now, on the Democratic side, what have Democrats done wrong in your view?

Mr. COWEN: Well, Democrats are torn between how much they're going to defend every entitlement program and how much they're going to agree to a grand bargain, which requires reforms - fundamental reforms to entitlements. I don't think the Democratic Party has decided which way it wants to go.

So there were reforms to Medicare embodied in the ACA, which was a good thing, but since that time Democrats have started thinking they can campaign against Republicans on the Medicare issue. And that's very dangerous thinking. That is hurting the chances for a grand bargain.

INSKEEP: ACA, that's the Affordable Care Act, the health care law that was passed in 2010.

And now, Mr. Cowen, having said what you've said and understanding what you do of the political system and the state it's in right now, do you see a realistic way to fix the long term debt issues that the United States does face?

Mr. COWEN: Well, keep in mind the debt issue becomes really serious in this country after 10 years from now when health care costs are spiraling. In the short run, we have a manageable problem. In the longer run, we do not. But the time is really now for us to get our act together. You cannot reform all of your entitlements overnight. What we need quite soon for the markets and for our own future is, I think, some kind of grand bargain where both sides give way quite a bit.

INSKEEP: Although, you raise an interesting point. We're not Italy here. Things are not desperate at this point. There's still time, you're saying.

Mr. COWEN: That's right. Europe at the moment is a much bigger problem than the United States.

INSKEEP: One other quick thing, Mr. Cowen. Do you think that S&P's downgrade on Friday night is actually going to make it harder for the United States to bring its budget into balance because it'll hurt economic confidence, could hurt economic growth over time?

Mr. COWEN: Well, I don't know. As was the case, we weren't really doing very much. So maybe this will be the needed wakeup call. And that may make it harder in the technical sense. But when you look at public relations, maybe now there's a greater understanding that we need to make more progress, quickly, rather than later.

INSKEEP: Could this hurt economic growth, which would hurt tax revenue?

Mr. COWEN: It will hurt economic growth. One big issue is a lot of municipal governments will now face higher borrowing rates.

INSKEEP: OK. Mr. Cowen, thanks very much.

Mr. COWEN: Thank you.

INSKEEP: Tyler Cowen. His blog is called Marginal Revolution.

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