Why the United States is not Italy

@CNNMoney November 14, 2011: 1:11 PM ET
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Italian workers hold a banner reading 'Give a future' during one of the protests in recent months against the Italian government's economic austerity measures.

NEW YORK (CNNMoney) -- Italy's debt crisis raises an uncomfortable question in the United States: Is America like Italy?

Both countries' government debt levels are too high. Italy's gross debt is 120% of its economy, and U.S. gross debt is already at 100%, according to data from the International Monetary Fund.

And the United States can't continue to ignore its long-term fiscal problems indefinitely.

But the U.S. debt situation is not as immediately critical as Italy's for several reasons.

Economic growth: Italy's economy has ranged between slow and stagnant for the past decade and is expected to remain stagnant for the next several years.

Indeed, Nariman Behravesh, chief economist at IHS Global Insight, expects Italy's economy to contract this year, sending the country into recession.

By contrast, while the U.S. economy has been recovering slowly and its growth prospects in the next few years aren't knocking anyone's socks off, they are still far stronger than Italy's.

Italy: Definitely too big to fail, maybe too big to bail

A key reason: the U.S. economy is generally more flexible and has become much more productive since the financial crisis, said Barry Anderson, a budget expert and former official at the Organization for Economic Cooperation and Development.

By contrast, Italy's regulations governing workers and businesses have stifled competition and innovation, Behravesh said. For example, parts of the service sector are highly protected from competition and many workers are protected from lay-offs because of permanent contracts, according to the IMF.

An austerity plan approved over the weekend attempts to address some of these problems.

Taxes: Taxes aren't popular anywhere in the world. But the United States has more room to increase tax revenue to help reduce debt than Italy does.

Why? Because the United States takes in considerably less tax revenue as a percentage of GDP than Italy does, Behravesh noted. Indeed, Italy's tax burden is one of the highest among major economies.

Demographics: The population is aging in both the United States and Italy, and the labor force that supports retirees is shrinking.

And that demographic shift puts pressure on each country's pension and health care systems.

The difference is that Italy's population is aging at a faster rate than the United States, Behravesh said.

To be sure, congressional proposals to make Medicare and Social Security affordable for the long run are unpopular.

But U.S. lawmakers are fighting over how to slow the growth in benefits, not to cut those benefits below current levels. Indeed, the changes that most experts believe must be made won't affect current retirees or those on the cusp of retirement.

Italian public pensions, by contrast, are too generous to be sustained.

Europe's debt crisis - full coverage

"It's a nice life. But they can't afford it," said Behravesh, who grew up in Italy. He noted that a relative of his was able to retire at 55 on a pension very close to 100% of his pre-retirement income.

As a result of Italian pension reforms already passed, the incomes of middle-income seniors will fall by roughly 15% relative to middle-income working adults, according to the IMF. But even that isn't enough to stem the fiscal pressures caused by the aging population.

Capacity to borrow: Italy's debt situation has become more urgent of late because its borrowing rates have breached a level considered unsustainable for any period of time.

Last week, the rate on Italy's 10-year bond went above 7% for a few days. As recently as Sept. 8, its 10-year bond was trading below 5%.

The 10-year Treasury, by contrast, has been trading around 2%, thanks to the perception that the United States remains a safe-haven relative to other countries, especially euro area countries.

"Relative to Europe, it's doing so much better," Anderson said.

It's also significant that the U.S. dollar is the world's reserve currency managed by a single government. By contrast, the euro is used by 17 countries with their own monetary needs.

The long term

So does the United States have nothing to worry about? No.

"We don't have short-term liquidity problems. But we have long-term sustainability problems. And they're serious," Anderson said.

Barring deliberate action, it's possible U.S. debt levels will approach those of Italy within the next decade, Anderson and Behravesh said.

So investors will be watching to see whether the United States is willing to take its fiscal problems in hand before they get out of hand, Anderson added. That could start to happen once interest rates start to normalize as economies recover.

If investors conclude Congress won't do what's necessary in the next few years, they may opt to move their money elsewhere. (Video: Protect your next egg from Europe's troubles)

Since the Treasury market is still the largest and most liquid in the world, it's hard to imagine where. But Anderson believes big lenders like China and oil-exporting countries may start to look inward.

Instead of reinvesting the dollars they get from selling exports to the United States, Anderson said, "they'll take our money and convert it into goods and services for their own people. They don't have to lend to us if they don't want to." To top of page

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