From his new book, Michael Mandelbaum lays out the challenge of the U.S.’s activist foreign policy, including an expensive war on terror, in an age of economic retraction and pending entitlements.

September 15, 2008, is an important date in the economic history of the United States, and indeed the entire world. On that day the New York-based international investment bank Lehman Brothers collapsed, creating a panic in the nation’s financial system and an immense loss of wealth, and deepening an already serious global economic downturn. That day is also significant, however, for the history of American foreign policy. What happened on September 15, 2008, accelerated a series of developments that will change the resources at the disposal of policy-makers in Washington, limiting the financial means available to conduct American foreign policy. The events of that day, in combination with trends in the American economy that were already under way and will expand in the years ahead, will reduce what the United States does in the world.

Because a credit crisis of the kind that the Lehman collapse produced, if severe and prolonged enough, can inflict catastrophic economic damage, the American government took radical steps to counteract it, expanding its role in the financial system to the point that it became, in effect, one of the country’s largest banks. The Federal Reserve Board offered loans to institutions that had never before been given them, and the government took control of the American International Group, a multinational insurance company, and two quasi-governmental purchasers of mortgages, known as Fannie Mae and Freddie Mac. The Congress appropriated $750 billion for the purpose of buying up bad housing loans, but the Treasury Department used the money instead to purchase shares in the nation’s largest commercial banks, in an effort to keep them solvent and unclog the flow of credit they provide. Despite these extraordinary efforts, with banks fearful of lending and consumers fearful of buying, the American economy, and economies all around the world, fell into a deep recession, the worst since the greatest and most destructive economic downturn of modern history, the Great Depression of the nineteen thirties.

In addition to the impact on the American and global economies, all this will eventually affect the foreign policy of the United States. For one thing, it shook Americans’ confidence in their government’s capacity for economic management, and confidence in government is crucial for foreign policy, which is, after all, conducted almost exclusively by the government. For another, in times of economic crisis, Americans, like people everywhere, tend to turn inward and devote more attention and resources to their own concerns than to problems beyond their borders. Still, the country experienced recessions after the Depression, including during the Cold War, which did not materially affect America’s major international commitments.

What makes September 15, 2008, important for the history of American foreign policy is not simply the financial crisis that the Lehman collapse crystallized, or the recession that it dramatically worsened, but rather the impact of these developments in combination with the principal economic challenges that the United States will have to confront in the twenty-first century, in particular the benefits promised to older Americans, the ranks of which will swell in the years ahead. Together they will vastly expand the economic obligations of the American federal government, which will in turn narrow the scope of foreign policy by diminishing the resources available for it. In the immediate aftermath of the economic crisis of 2008, as well as in the years thereafter, one economic challenge destined to weigh heavily on American foreign policy is the nation’s debt, a challenge severely aggravated by the deep recession set off by the September 15th collapse. During recessions the revenues flowing to the government in the form of taxes decrease; people lose their jobs and therefore their incomes and so don’t pay taxes. At the same time, federal expenditures increase as programs that recessions trigger, such as unemployment insurance, grow larger. The standard remedy for fighting recessions is deficit spending—expenditures funded not by tax revenues but by federal borrowing—and the American government applied that remedy liberally. In early 2009 the Congress approved a $780 billion package of programs designed to stimulate economic activity in the United States. All of the money to be spent was borrowed rather than raised through taxing the American people. The deficit for fiscal year 2009 reached $1.4 trillion, fully 10 percent of an economy with a total annual value of about fourteen trillion dollars, and much higher than the 3 percent widely considered the maximum “safe” annual deficit. Moreover, the country faced the prospect of comparably large gaps between expenditures and revenues in the years ahead. The fiscal year 2010 deficit was projected to be $1.6 trillion. By the estimate of the Congressional Budget Office, annual deficits might well average more than one trillion dollars every year for a full decade after 2009.

By the third decade of the twenty-first century the cost to American taxpayers of servicing the national debt is scheduled to exceed the entire defense budget.

These deficits will be added to a cumulative national debt—the total of annual deficits—of about nine trillion dollars, much of it compiled between 2001 (when it stood at $5.6 trillion) and 2007 through generous tax cuts, expanded federal programs, and a war in Iraq, the ultimate cost of which will certainly approach two trillion dollars and may be closer to three trillion dollars. A phrase often attributed to the Republican leader in the U.S. Senate in the nineteen sixties, Everett M. Dirksen, in describing what he considered his colleagues’ profligate spending habits is appropriate in this context: “A billion here, a billion there, and pretty soon you’re talking about real money.” Even allowing for inflation, the government’s tendency to spend has grown dramatically since Dirksen’s time: a trillion is a thousand times a billion. In Dirksen’s day, however, the government was in the habit of paying for its expenditures with tax revenues. Since then it has done so through borrowing: in the forty-seven years before 2008, the federal budget was balanced—that is, government income matched or exceeded outlays—in only five of them.

Although payment is deferred, borrowing comes at a price. The interest charge on the national debt must be paid every year: the greater the debt, the higher will be the cost of servicing it. That cost will reach 10 percent of the total federal budget by 2011 and 17 percent of total revenues by 2019, by relatively conservative estimates. If interest rates rise sharply it could be more. What the country spends on interest on the national debt it cannot spend on anything else, including foreign policy. Moreover, if lenders lose confidence in the federal government’s ability to pay back what it borrows, the cost of its loans—the interest rate on government securities—will rise, further increasing the national debt. By the third decade of the twenty-first century the cost to American taxpayers of servicing the national debt is scheduled to exceed the entire defense budget.

Debt in and of itself is not a bad thing. To the contrary, households, firms, and countries routinely borrow money. Debt is the fuel on which any modern economy runs. But the pattern of borrowing in which the United States has engaged for almost half a century has three particular features that distinguish what America owes from normal, desirable, economically healthy debt, and those three differences make the American national debt a prospective drain on American foreign policy.

First, prudent debtors use what they borrow for investment, which enhances their incomes, from which they can then both pay off their debts and improve their net worth. Much of what the United States has borrowed over the years, however, has gone to consumption of one kind or another, not to investment. Second, because the savings of citizens in the United States have been low, the government was forced to borrow a great deal from abroad. Indeed, American debt to other countries helped to sustain global consumption even as other countries, particularly China, saved a great deal. This arrangement underpinned an impressive rate of overall global economic growth for much of the first decade of the twenty-first century. China produced goods and sold them to the United States, which, in effect, paid for them by borrowing back from the Chinese what Americans had paid for those goods.

The arrangement suited all parties involved in the short term, but the dollars that flooded back into the United States from abroad helped to inflate the housing bubble whose bursting triggered the severe economic crisis of 2008. More damaging for American foreign policy is the fact that the arrangement cannot be sustained over the long term: China and other countries will not lend to the United States indefinitely and without limit. Americans will have to consume less and save more, and a dollar saved is a dollar not spent supporting the various foreign policies of the United States.

A third feature of the debt accumulated by the United States has the potential to affect American foreign policy. A highly indebted country is inevitably tempted to print the money it needs to pay its debts. In 2008 the Federal Reserve in fact created several trillion dollars to fund the measures it deemed necessary to prevent a financial collapse. The monetary authorities hope and expect to recoup these outlays by selling, at a propitious time, the assets, such as shares of large banks, that they created the money to acquire. That would withdraw money from the economy. Even in that case, however, the obligation to repay the money the government has borrowed will still remain. Using the printing presses to repay debt, an all too common pattern historically, leads to a devastating economic pathology: inflation. Severe inflation can produce a weak economy, a distracted and demoralized public, and a discredited government, all of which cripple the afflicted country’s capacity to act effectively in foreign affairs. The anticipation of inflation, moreover, causes purchasers of government bonds to demand higher interest rates, which further expands the national debt.

Inflation, debt, recession: these are the equivalents for a national economy of illnesses besetting an individual. And just as an individual afflicted with gout, or pneumonia, or heart disease will be less energetic than a fully healthy person, so a country suffering from economic ailments will be less vigorous in its collective pursuits, foreign policy among them. Still, none of these economic maladies is without precedent in American history. The United States encountered and overcame all of them in the past, as recently as during the Cold War, without seriously impairing its foreign policies. Indeed, by some measures the twenty-first-century afflictions are likely to be of historically modest severity. Indebted though the United States had become by 2008, as a percentage of its total output the country’s debt was only half what it had been in 1945, when the cost of waging World War II sent it soaring to 122 percent of the national gross domestic product (GDP). Even with another decade of large annual debts after 2008, the national debt-to-GDP ratio, by at least one calculation, would reach only 80 percent, which would still be lower than that of 1945.

In the two decades after 1945 the government reduced its debt while carrying out a foreign policy of global scope. At the heart of that policy was the political and military contest with the Soviet Union, in which the share of the American GDP devoted to defense routinely reached an annual level twice as high as what it was in the first decade of the twenty-first century. Occasionally it was even three times higher. The effective Cold War combination of a prudent fiscal policy and an expansive foreign policy is unlikely to be repeated in the second and third decades of the present century, however, because of an economic condition of towering, indeed era-defining importance that was largely absent in the post-World War II era. That condition, which, combined with the impact of the economic downturn of 2008 and enormous debt amassed by the American government, will have a decisive impact on the foreign policy of the United States, is the very large bill that will confront the country for expenditures known as entitlements.

The costs of the developments the events of September 15, 2008 triggered, along with the massive increase in the costs of America’s entitlement programs, will claim an ever increasing share of America’s national wealth, to the detriment of American foreign policy.

With entitlements in America, as in other countries, the government provides pensions and health care for its older citizens. Social Security and Medicare (and Medicaid, for indigent people) had become, by 2008, expensive programs. Added together, their benefits, to which every American age sixty-five or older is entitled (hence “entitlements”), commanded 40 percent of the federal budget. They far outstripped any other single federal expense, including the cost of what has historically been deemed to be every government’s first duty, national defense. What is spent on entitlements, like what is spent on debt service, cannot be spent on foreign policy.

Over the preceding half century the American government’s priorities, as revealed by the distribution of its expenditures, had undergone a basic shift—from guns to butter. For almost all of history, governments the world over had devoted their resources mainly to building and maintaining the military forces necessary to defend their countries and to pursue whatever military goals they set for themselves beyond their borders. By the first decade of the twenty-first century the federal government of the United States, judging by the pattern of its spending, was well on its way to becoming a giant domestic insurance company, albeit one with a sideline in foreign policy. As expensive as Social Security and Medicare had become by 2008, however, they will be even more expensive in the years ahead. In 2008, all forms of government-supplied pensions and health care (including Medicaid) constituted about 4 percent of total American output; at present rates they will rise steadily for decades until, by 2050, they account for a full 18 percent of everything the United States produces. This growth will fundamentally transform the public life of the United States and therefore the country’s foreign policy. The costs of the developments the events of September 15, 2008 triggered, along with the massive increase in the costs of America’s entitlement programs, will claim an ever increasing share of America’s national wealth, to the detriment of American foreign policy.

The massive increase will come about because of the eligibility for the benefits of these programs of the so-called baby-boom generation, the largest age cohort in American history. Between 1946 and 1964, seventy-seven million Americans were born. The leading edge of that vast population wave will turn sixty-five, and qualify for most retirement and health care benefits, in 2011; the rest will follow. The government does not have the money needed to pay these benefits. Social Security and Medicare are “unfunded obligations.” By the estimate of the Congressional Budget Office, the total cost of these unfunded obligations—the gap between what the government owes and what, at existing levels of taxation, it can expect to collect exceeds fifty-two trillion dollars—almost four times the output of the entire American economy in 2008. Some estimates are even higher.

The government does not have the money to pay for these programs because, since the inception of Social Security in 1937 and the beginning of Medicare in 1965, they have been funded on a “pay-as- you-go” basis: each generation of workers has paid for the benefits of those who have already retired. As long as the working population comfortably outnumbered retirees, paying for government-supplied pensions and health care was not unduly burdensome for the society as a whole. But the retirement of the baby boomers will turn the age structure of the American population upside down. The ratio of current workers to retirees will fall sharply. The burden on each worker of supporting the growing population of retirees will, accordingly, rise sharply. To meet these obligations, assuming that they do not change, taxes would have to increase by a politically impossible and economically ruinous 150 percent. To put the trend in America’s fiscal position in historical perspective, beginning in the second decade of the century the priorities and obligations of American society will, over time, change on a scale that, in the past hundred years, only the Great Depression and World War II produced. Those two monumental events led to dramatic changes in American foreign policy. So will this one.

The forecast of a transformation in American economic life and thus in American foreign policy depends in part on a prediction about the size and composition of the American population in the years ahead. Demographic predictions tend to be far more reliable than forecasts concerning other aspects of social life. Birth and death rates change slowly, not abruptly; and the predictions about the impact of demographics on the costs of entitlement programs are unusually reliable because the people who will lay claim to the tens of trillions of dollars in benefits have already been born. Moreover, their life expectancies, and thus the benefits they will collect, will only increase. All that is necessary for entitlement costs to soar, therefore, is the simple passage of time. Entitlement costs will rise for technological as well as demographic reasons. New and better methods of diagnosing and treating diseases are constantly being developed: the United States and other countries spend billions of dollars each year to do exactly that. These new therapies tend to be more expensive than those they replace, driving up the price of health care. Even as more people qualify for government-provided medical benefits, therefore, the price of treatment for each individual will rise. By 2030, by one estimate, public and private spending on health care will reach 41 percent of the income of the average American household. Under these circumstances Americans will seek to reduce spending on other things, including on their support for the nation’s foreign policies.

The United States is not the only country that will have to cope with the consequences of an aging society. What is known as the demographic transition—the combination of falling birthrates and longer life expectancies, leading to an older population—is already taking place all over the world. For most rich countries, in fact, the consequences of this transition will be more pronounced than for the United States.

The fact of inequality, combined with the insecurity about jobs and income that globalization has engendered in the United States as in other countries, creates political pressure on the American government to counteract these two trends.

Their birthrates are lower, so not only will their societies age more rapidly, but their total populations will actually shrink, even as America’s continues to grow because of higher rates of both fertility and immigration. The dependency burden—the ratio of retirees to active workers—will rise more rapidly in other countries than in the United States, imposing a heavier economic burden on their taxpayers. Many of these countries already have bigger debts, measured as proportions of total annual output. But the United States differs from its fellow wealthy countries in two major ways that aggravate the problems an aging population presents.

First, the impact on foreign policy will be far greater, because the United States conducts a much more expansive foreign policy and shoulders considerably greater global responsibilities than do the Europeans or the Japanese. Second, in the first decade of the twenty-first century income and wealth came to be more unevenly distributed in the United States than in other wealthy countries. By one estimate, in the three decades after 1970, the inflation-adjusted income of the top fifth of American earners rose by 60 percent, while it fell by 10 percent for all others. The reasons for this inequality, which had increased over the course of four decades, are complicated and controversial. The most often cited causes are technological change and globalization—the broadening of international trade and capital flows and the shift of jobs from rich countries, such as the United States, to poorer ones where wages are lower. The fact of inequality, combined with the insecurity about jobs and income that globalization has engendered in the United States as in other countries, creates political pressure on the American government to counteract these two trends.

The obvious way to counteract them is to make entitlement programs more rather than less generous. The health care reform measure passed by the Congress and signed by the president in March 2010 testifies to the widely felt impulse for greater public generosity. But the passage of that bill will probably not eliminate public pressure for more extensive (and therefore more expensive) social programs and will certainly not reduce the ever-rising costs of medical care in the United States. The bill will not avoid, and may even increase, further pressure on the nation’s non-entitlement expenditures, including foreign policy.

The ways that the aging of the population, in combination with the economic crisis of 2008 and the increase in the country’s indebtedness, will affect the public policy of the United States are not foreordained, but two consequences are virtually certain. One is that, in response to the surge in claims on the American government, commitments to retirees will eventually be modified. Americans will have to pay more to fulfill the obligations that the country has assumed. Taxation will ultimately increase, but since fulfilling the nation’s obligations, as they stood in 2008, to the letter would raise taxes to a level that would crush the American economy, entitlement programs will also be modified. Twenty-first-century Americans who are sixty-five or older will receive fewer benefits from the government than they have been promised.

Of the two major entitlement programs, Social Security will be the easier to modify—by some combination of raising the retirement age, changing the formula for cost-of-living increases in the stipend, and perhaps taxing the benefits provided to recipients with high incomes. If a group of people knowledgeable about the issue were to convene in a single room, it has been said, it would take them only ten minutes to agree on a formula for restructuring the Social Security program, and it would take that long only because the first seven minutes would be devoted to exchanging pleasantries.

Medicare presents greater economic, political, and indeed moral difficulties: to restrict the growth of its costs will require rationing health care, which will mean denying payment for some therapies to some people, which will cause some of them to die sooner than they would have if the government had paid for all possible treatments. To say that such measures will be controversial is an understatement, and the controversy will unfold where issues of public policy are decided: in the political arena. This leads to the second predictable consequence of the tidal wave of economic obligations that will engulf the United States: it will transform American politics.

The collapse of 2008, the surge in American indebtedness, and the retirement of the baby boomers with the resulting explosion of claims on the federal government will create a different economic imperative: higher taxes, more saving, and less consumption.

Ever since the late-nineteenth century, economic policy has played a central and often a defining role in American political life. The Democratic candidate for president in 1896, William Jennings Bryan, who denounced American adherence to the gold standard because it injured western farmers, could easily have adopted the motto of Bill Clinton’s campaign slogan almost a hundred years later: “It’s the economy, stupid.” From 1961 to 1981 the politics of economic policy was dominated by an allegiance to a version of the teachings of John Maynard Keynes, the great English economist of the first half of the twentieth century. According to the then-dominant interpretation of Keynes, downturns in economic output can be prevented, or at least cushioned, by deficit spending by the government. (This strategy was revived by the Obama administration to deal with the economic crisis that began in 2008.) From 1981 to 2008 a different orthodoxy governed economic policy, one that holds that tax cuts are always good for the economy because they always lead to increased production.

Although they differ in significant respects, these two approaches have an important common feature: both lend themselves to ever-higher consumption without ever-higher taxation. Each approach made Americans an offer they could not, and did not, refuse: more spending, both public and private. These circumstances were favorable to those seeking resources to support a wide range of public policies, including foreign policy.

The collapse of 2008, the surge in American indebtedness, and the retirement of the baby boomers with the resulting explosion of claims on the federal government will create a different economic imperative: higher taxes, more saving, and less consumption. This change will reduce the resources available for all public purposes: there will be less to go around. Along with other publicly funded activities, the change will impose new limits on the conduct of foreign policy. It will do so by altering the framework within which American foreign policy is made and carried out.

Foreign Policy Limits

For the American public, matters of foreign policy are more distant and less familiar than domestic issues. Where taxes and government-provided benefits are concerned, Americans tend to have clear views, which they transmit forcefully to their elected representatives. On issues close to home, they feel at home. When it comes to policies toward other countries, the direct stakes for individual citizens seem (and usually are) low. Accordingly, most Americans know little about them and pay only occasional attention to them. Americans organize themselves into sizable, powerful lobbies, to which they contribute time and money on a large scale, to press for direct economic benefits from the government; the lobbies that focus on international affairs are smaller and less powerful. In foreign policy-making, in fact, the American public is divided into two groups of vastly different sizes: a small one, located mainly on the two coasts and especially concentrated in Washington, D.C., follows international issues closely, writes about and discusses them in the media, and, when its members serve as government officials, sets and carries out the foreign policy of the United States. The much larger majority of the population has far less information, interest, and influence. Foreign policy is the province of the expert. The foreign policy community is the equivalent of a physician, to which the public cedes responsibility for diagnoses and prescriptions governing America’s relations with other countries. This does not mean, however, that on matters of foreign policy the American government can do whatever it wants, or that it is restrained only by the opinions and activities of the members of the foreign policy community who do not hold office. In foreign affairs, as on domestic issues, policies are subject to democratic control. To be sure, the government has wider latitude in initiating foreign policies. But the public ultimately renders a verdict on them, through public opinion polls approving or disapproving of them and, most powerfully, through elections, in which those responsible for the policies are either returned to office or defeated. On matters of foreign policy the public in effect says to the government: You do what you think serves the interests of the United States. After seeing the result, we’ll pass judgment on what you’ve done. If we don’t approve, we’ll fire you.

The public’s verdict is not always favorable. Public officials do get fired. The presidents responsible for initiating the American wars in Korea, Vietnam, and Iraq all suffered public rejection. (In none of these cases did the public oppose the goals on behalf of which the war was being waged—a non-communist South Korea and South Vietnam and a united, stable, democratic, pro-Western Iraq. Instead, Americans concluded that the government was spending too much, in both lives and dollars, in pursuit of those goals.)

Nor is electoral punishment the only constraint on the freedom to manage American foreign policy. The government operates within limits that arise from a broad consensus about what is desirable and what is feasible for the United States. During the Cold War, for example, it scrupulously avoided measures likely to bring the country into direct military conflict with the Soviet Union, for that would have sharply increased the chance of a catastrophic nuclear war. At the same time, the United States maintained a large and expensive military presence in Europe, because this was widely agreed to be necessary to protect American interests by deterring a Soviet attack. The limits that govern American foreign policy are not formally encoded in a foreign policy charter and are seldom even set out explicitly. They are more like customs in small-scale societies or good manners in larger ones: they are tacitly, but widely, understood. Prudent people who wish to be considered members in good standing of the foreign policy establishment take care not to violate these limits.

In the United States, issues of foreign policy, like their domestic counterparts, are energetically debated. Sharply different preferences are regularly advocated for advancing American interests in the Middle East, for example, or on the subject of nuclear proliferation. Those debates, however, take place within these limits. Just as the rules of baseball determine what players can and cannot do on the baseball diamond in pursuit of victory for their teams, so the tacit boundaries of American foreign policy determine what may be legitimately proposed and carried out to further the national interests of the United States. The economic crisis of 2008 and especially the gargantuan economic obligations that will confront the country in its wake will redraw those boundaries in two closely related ways. First, the limits of the possible for foreign policy will be narrower than they have been for many decades. The government will still have an allowance to spend on foreign affairs, but because competing costs will rise it will be smaller than in the past. Evidence of the narrowing of the publicly permitted scope for foreign policy appeared in a poll conducted by the Pew Research Center and the Council on Foreign Relations in the latter half of 2009. It found that a higher proportion of Americans agreed that the United States should “mind its own business internationally”—49 percent—than at any time since the Gallup survey had first asked this particular question, in 1964. Only 44 percent of the respondents disagreed with this sentiment. Not coincidentally, the proportion of Americans who considered the national debt the country’s most serious problem rose sharply, according to other polls. Second, the limits that constrain the government in its external initiatives will be drawn less on the basis of what the world requires and more by considering what the United States can—and cannot—afford. In an era in which fewer resources will be available for everything, it is certain that fewer will be available for foreign policy. When working Americans are paying more than in the past to support their fellow citizens who have retired, and retirees are receiving fewer benefits from the government than they were promised, neither group will be eager to offer generous support to overseas ventures.

To be sure, a tug-of-war between domestic and foreign obligations is nothing new. Since the end of the nineteenth century, after all, the trade-off between international and domestic expenditures—between guns and butter—has been part of American political debate. Critics of foreign policy of all types, but especially of wars, have decried the diversion of resources to foreign adventures that they believed could better have been spent at home. Moreover, American foreign policy has always operated within limits of some kind. The country has never been free to do anything it wished, nor has the government ever been free to carry out any foreign policy it chose, regardless of cost.

Yet for the foreign policy of the United States for almost seven decades beginning with World War II, and in contrast to the experience of almost every country throughout history, freedom of maneuver rather than constraints on action was the norm. In foreign affairs as in economic policy, the watchword was “more.” That era has ended. The defining fact of foreign policy in the second decade of the twenty-first century and beyond will be “less.”

Michael Mandelbaum is the Christian A. Herter Professor of American Foreign Policy and Director of the American Foreign Policy Program at Johns Hopkins, SAIS. He is a former faculty member at Harvard University, Columbia University, and the U.S. Naval Academy. His Ph.D. in political science came from Harvard University.