A Broader Perspective on the Resilience of the US Economy – Institutional Erosion and its Economic Consequences

International financial markets have traditionally regarded the US economy as exceptional – as a safe haven for investors worldwide. However, recent political and economic developments under the current administration raise fundamental concerns about the deterioration of political institutions and its implications for the country’s economic stability and public finances. The last materialisation of these concerns was on 17 May 2025, when Moody’s downgraded the US sovereign credit rating, leading to weakness of the dollar against other major currencies (Reuters, 2025). This post examines warning signs, market responses and what academic research suggests about the economic consequences of continued institutional weakening.

Institutional Erosion

The current administration has systematically weakened constraints on executive power, with expert assessments of democratic performance reaching historical lows amid concerns about executive overreach and intensifying partisan polarisation (Bright Line Watch, 2025). Some legal experts now characterise this transformation as a shift from constitutional governance to executive rule (Luttig, 2025) which creates conditions that mirror autocratic systems in which institutional weakness enables elite capture and power consolidation. These developments align with what political economists classify as ‘extractive institutions’ – social systems that concentrate power and economic benefits among narrow elite members rather than fostering broad-based prosperity.

Implications and Risks

Academic research demonstrates a positive relationship between institutional quality and economic outcomes. A cross-country analysis shows that nations with stronger constraints on their elite members experience significantly lower volatility, less severe crises and higher long-term growth (Acemoglu et al., 2003). Importantly, these effects persist even when controlling for macroeconomic policy. This suggests that if US institutional deterioration continues, policy interventions alone may prove insufficient, as weak institutions create instability through multiple channels – from political crisis risk to contract enforcement problems and sustainable policy challenges (see Girardi & Bowles, 2018 for a case study on Chile in the early 1970s). This is bad news not only domestically but also, given the vast size and connectedness of US firms, around the globe.

Early Warning Signs

Financial markets have begun incorporating these institutional risks in asset pricing. The recent simultaneous decline in the US currency, equity markets and government bonds mirrors patterns typically observed in emerging markets experiencing adverse macroeconomic shocks (Foroohar, 2025). This unusual combination of asset price movements has only rarely occurred in recent decades, suggesting that investor behaviour may reflect institutional concerns rather than traditional economic fundamentals (Cecchetti & Schoenholtz, 2025). While the US remains one of the key advanced economies and cannot yet be classified as a submerging one, these market signs indicate shifting perceptions about its long-term economic stability.

Conclusion

While the US is showing signs characteristic of a submerging market economy, this trajectory is not inevitable. The fundamental challenge is not simply to correct specific policies, e.g. trade policy, but to address the institutional erosion that enables them. Academic research demonstrates that institutions are the foundation of economic stability and growth. The key question now is whether US political and civic institutions retain sufficient resilience to halt and reverse the current deterioration before more serious economic consequences materialise – for them and the rest of the world.

References

Acemoglu, D., Johnson, S., Robinson, J., & Thaicharoen, Y. (2003). Institutional causes, macroeconomic symptoms: volatility, crises and growth. Journal of Monetary Economics, 50(1), 49–-123.

Bright Line Watch. (2025). Accelerated transgressions in the second Trump presidency: Bright Line Watch February 2025 survey.

Cecchetti, S. G., & Schoenholtz, K. L. (2025). Are U.S. assets losing their lustre? Money, Banking and Financial Markets.

Foroohar, R. (2025). America the Unstable. Financial Times.

Girardi, D., & Bowles, S. (2018). Institution shocks and economic outcomes: Allende’s election, Pinochet’s coup and the Santiago stock market. Journal of Development Economics, 134, 16–-27.

Luttig, J. M. (2025). The end of rule of law in America. The Atlantic.

Reuters. (2025, May 19). Dollar softens on US ratings downgrade; trade tensions back on radar.