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World faces a day of financial reckoning

  • A national strike shut down Greece's economy in protest against budget austerity
  • Fareed Zakaria says Greece's problems are long-standing, more severe than most
  • He says Western governments assumed massive debt in economic crisis
  • Zakaria: Spending will have to be cut or taxes will have to rise -- or both

Editor's note: Fareed Zakaria is an author and foreign affairs analyst who hosts "Fareed Zakaria GPS" on CNN U.S. on Sundays at 10 a.m. and 1 p.m. ET and CNN International at 2 and 10 p.m. Central European Time/ 5 p.m. Abu Dhabi/ 9 p.m. Hong Kong

New York (CNN) -- As a nationwide strike highlights Greece's painful effort to fix its finances, much of the rest of the world is confronting an equally sobering reality, says analyst Fareed Zakaria.

"You can't spend money you don't have forever and hope people will lend you money, which is what has been going on," Zakaria said in an interview with CNN.

He says governments, particularly in developed countries, rushed to bail out financial institutions in the economic crisis, leading to a massive increase in public debts. Now the bill is beginning to come due.

Zakaria says Greece has had chronic budget problems, and its plight is far more severe than that of other nations. In Athens, workers struck for 24 hours and thousands marched. Transit systems, schools, banks, television news and newspapers were closed down. Greece's government is cutting services and raising taxes to bring down its budget deficit.

Zakaria, author and host of CNN's "Fareed Zakaria GPS," spoke to CNN on Thursday. Here is an edited transcript:

CNN: Is Greece's financial crisis a sign of things to come for many more countries?

Zakaria: I tend to think that some of the panic about the lessons of Greece is overdone. Greece has been a very badly managed economy for a very long time. I read somewhere that Greece has been in some kind of state of default for about half of its existence as a nation since 1832.

To put it simply, Greece has been a basket case for a while. This recession has just dramatically exacerbated that problem and forced a crisis in Europe. We should be careful about drawing very broad analogies between Greece and other countries that are in very different situations.

That said, clearly the financial crisis has been transformed into a governmental crisis in this sense -- basically the financial crisis was caused by the massive indebtedness of the financial system in many Western countries. Those debts have in effect been taken on by the government. The government had to bail out the financial industry.

All of that debt has been moved from the private sector to the public sector, and so you see in the United States that debt as a percentage of GDP [Gross Domestic Product] has gone up 20 percentage points in two years. That's probably the fastest rise ever since World War II. It's gone from roughly 50 percent of GDP to 70 percent in two years.

CNN: So at what level does it become unsustainable?

Zakaria: No one knows the answer to that question. At one level, it's sustainable as long as the rest of the world has confidence in you. And clearly what happened to Greece was that the world lost confidence in Greece.

Japan has a massive debt to GDP ratio -- 200 percent -- but generally speaking, it's still the second-largest economy in the world, there's very large domestic savings so there's a tendency to believe they're good for their debt.

CNN: What's the risk if countries do lose faith in the U.S.?

Zakaria: If people lose faith in a country, it means that you have to raise your interest rates to sell your debt. The only way people will lend you money is at very high interest rates.

If you can only borrow money at very high interest rates, the only thing you can do to get money is to kill your economy. If you raise interest rates, it kills economic activity in your own country.

CNN: The government made a choice during the financial crisis to take on debt to stimulate the economy, but at a certain point, do governments have to turn away from stimulating the economy and turn their focus to fighting inflation?

Zakaria: They certainly have to turn their attention away from stimulating the economy and toward having stable finances. I'm not sure inflation is the great danger, but you can't run huge deficits forever, you can't have your debt-to-GDP ratio keep going up.

This crisis has exacerbated a problem that existed within the Western world, which is very large structural deficits, which exist because we're basically been unwilling to cut spending or raise taxes. So the result is you have these big gaps between what we want from our government in terms of services and what we're willing to pay ... the United States has a particularly bad case of this. The deficit is now 10 percent of GDP.

The basic problem is that we want more government than we are willing to pay for. Either we have to accept the reality of higher taxes or we have to accept the reality of significant cuts in spending.

CNN: Are there any countries in the world that are taking the right approach?

Zakaria: We are at a unique moment. If you were to look at the countries that have significant problems with their public finances ... where their debt to GDP ratio is, 60, 70, 80, 90 percent of GDP, they're by and large all the richest countries in the world: The United States, Japan, France, Britain.

If you look at the countries that have much lower debt to GDP ratios, much more stable public finances, managing their macro-economic politics much more sensibly, they're all the developing countries: China, countries like Brazil, Indonesia, South Africa. In Europe, it is by and large the Western European countries that are in much worse shape than the Eastern European countries.

It's kind of a world turned topsy-turvy. It used to be assumed that the badly managed countries with the high debt loads are the developing countries, and the well-managed countries with low debt loads would be the Western countries, most importantly the United States.

CNN: So what should be done?

Zakaria: The solution is actually not very complicated. I said we either have to raise taxes or cut spending. In fact because the gap is so large ... it has to be a combination of the two. If you were to look at it in terms of the purely economic level, it wouldn't be that difficult. The United States has a $14 trillion economy. There's a lot of space in there to do both. If we were to adopt a value added tax, sort of a national sales tax, you could bring in $300, $400 billion dollars a year in revenues, ...You could use the revenues from that to cut income tax rates a little bit.

You could do entitlement reforms, which are quite unnoticeable because you could protect the people who are currently getting them ... you could make technical fixes such as having the benefits tied to inflation rather than wage increases.

You also need to raise the retirement age, because life expectancy has gone much higher.

The biggest and more complicated one is health care. Without any question, you've got to get a handle on health care costs. If you were to do a bunch of these kind of sensible reforms, you would dramatically bring down the problem in America. What I've described as economically simple is, of course, politically close to impossible. That's the tragedy of where we are.

We're not in some kind of economic nightmare situation, we're not Greece, we don't have a basket-case economy. We just have a basket-case political system that can't make the choices that at this point would not be very painful. But if we keep kicking the can down the road, the problem just keeps getting worse, and then at some point it will be very difficult to deal with because the consequences will be so painful.

CNN: What's your view of the health care legislation Democrats may pass in the next week?

Zakaria: My own feeling is it's a missed opportunity -- while it would be great to expand coverage, it doesn't fundamentally reform a broken health care system. We have a system that has out-of-control costs, where there's a huge incentive for the overconsumption of costs by the consumer and oversupply by the producers. Patients are willing to consume more health care services than they need, and doctors and hospitals are willing to supply more health care services than are required ...

We consume many more tests, we do many more interventions, all of which are much more costly and at the end of the day, we don't live longer, we don't have better outcomes on virtually any disease.