Three ways an early resolution of the budget problem would ease uncertainty and boost the economy
This blog post was originally published on “Back in the Black,” the blog for the Committee for Economic Development’s Fiscal Health Initiative.
The standard argument for repairing the nation’s hemorrhaging budget is that it would be good for the economy. Many economists are in the lead of the campaign to do so. However, many would-be economists are among the cheerleaders, and some of the chants that you hear make no sense. Still, fixing the budget is an economic imperative. We just need to understand the relevant laws of physics to do it right, and not wind up causing more harm than we avoid.
First of all, before the fix, to understand the fix we’re in: Economic policy is truly painted into a corner. An exit will require the fanciest footwork ever put on film. The public debt is excessive, the deficit adds to it daily at an alarming rate, the baby-boom generation is beginning to retire and claim its benefits, but the private sector (like the state and local government sector) is so weak that the federal government dare not abruptly cut spending or increase revenues. This is what we get for indulging ourselves instead of paying down debt to build a reserve (that is, borrowing capacity) for future emergencies and to prepare for the demographic challenge (in which cause we could have strengthened the affected programs themselves as well). Truly, the lesson of where we are is never to get to where we are.
Some supposed experts will tell you that the three ways to reduce the deficit are cutting spending, raising taxes, and increasing economic growth. Doggone. Economic growth! Why didn’t I think of that?
The problem is that there is no neglected silver-bullet program to increase economic growth, nothing that we could pull out of the bag now to add to the GDP and the tax base and reduce the demand for government benefits and services. All of the devices that have any supposed promise of increasing growth are in use, all of the time, by the public sector and the private sector as well. Some argue that tax cuts or infrastructure investment would accelerate growth. As questionable as those claims may be, it is more to the current point that both would increase the deficit permanently, or at least over the relevant time horizon. (The Arthur Laffer argument has flunked the test of time, and much of the benefit of infrastructure investment is non-monetary – and even when monetary in nature accrues to the private sector and yields the federal treasury only a small share.)
Some might argue that the budget problem will force the nation to make difficult decisions that have been put off in good times. Tax reform – closing tax preferences to finance reduced marginal tax rates – is items one through eight on that list. But the truth is that every policy that anyone has suggested to accelerate economic growth is made much harder by the budget problem, and tax reform is no exception.
Tax reform inevitably creates winners and losers – the winners being those who have no tax preferences to lose, and therefore come out net winners from the rate reduction; while the losers are those who give up more in preferences than they get from lower rates. The most basic political science would tell you that the “interested minority” of tax-reform losers is both more motivated and more influential than the “disinterested majority,” making such tax reform a tough slog. If the federal government had a few spare bucks, it could cut tax rates for everyone a little more, and thereby buy off at least some of the losers. In 1986, a tax increase on corporations paid for a tax cut for individuals in an overall revenue-neutral reform, greasing the political skids substantially. In sharp contrast, a deficit-reducing tax reform today will have far more losers, and will be far more difficult to sell.
Infrastructure investment, likewise, is made harder by the budget problem. It is difficult to pour billions into roads and bridges (if you believe that those are the major roadblock – sorry – to long-term economic growth, which is debatable) if you must count millions to prevent your debt from exploding in the here-and-now.
Some would-be experts turn the causation around and say that deficit reduction will increase economic growth. Well, yes (and more on that later); but said that way, and as a means to “pay for” deficit reduction, it is a double-count. If the nation continues on its current course, with the debt growing faster than the economy, the eventual consequence – no one knows precisely when – will be financial and economic collapse. A deficit reduction that just keeps us on a normal growth trajectory will merely preserve the standard baseline projections for revenues and outlays, nothing more. That is “increasing economic growth,” but relative only to disaster, and it does not “pay for” anything. In the longer term, still more deficit reduction will increase national saving, investment, and output. But the relevant time horizon for that computation begins well beyond our current slow-moving “crisis.” And furthermore, the math of this argument is more subtle than it may appear. All of that additional investment would produce more goods and services for consumption, and someone – here or abroad – has to buy them. (Investing more in perpetuity solely to produce more investment goods is a chain letter.) Overcapacity in some industries, notably but not exclusively automobile manufacturing, is a non-trivial problem today.
So deficit reduction is not the eternal answer to every question, nor will it be easy or painless. It should not be pursued for its own sake in blind confidence that it will solve every ill. However, given our nation’s overgrown debt, we must find our way there soon; and for all of the difficulties enumerated above, there will be benefits as well.
Here are some of the ways in which an early resolution of the budget problem would help the U.S. economy. These points interact with one another and so overlap considerably, but discussing them separately helps to illustrate the entire picture. This is not the “silver bullet” that some propose in lieu of spending cuts and tax increases; but it is the reason why, if our policymakers really do act responsibly, outcomes might be better than mechanical projections would suggest.
The place to invest. Much of the rest of the world is in economic or financial turmoil. Europe will continue to be troubled for years to come, as near-zero-sum bargains are negotiated and re-negotiated among debtor and guarantor nations. Japan struggles with debt twice as large (relative to its economy) as the United States, and with population demographics no less daunting. China has almost boundless potential human resources, but remains less than fully accessible to outside business firms, and suffers from less-than-fully-mature financial and governance institutions. India is similar to China, though perhaps less extreme in its advantages and disadvantages. Many of the developing countries elsewhere around the world survived the financial downturn well, but they lack the larger nations’ advantage of scale.
Relative to every other nation, the United States enjoys important commercial advantages – some essentially timeless, while others are changes to our situation of the last two decades or so.
In principle, manufacturers always want to be close to their markets. This provides better knowledge of what the customer wants, helping the manufacturer to capture market share and then keep it as tastes and needs change. And although it sacrifices the possibility of large temporary profits from fortuitous swings in currency values, it also obviates the risk of large temporary losses when currencies move the wrong way. (And any large firm that wants to place bets on currency fluctuations can find less clumsy ways to do so than building factories.) This regularity of building close to your customers is a large part of the reason why U.S. manufacturers have tended to locate more of their operations overseas: Because they have expanded their overseas sales, they have expanded their manufacturing capacity in those same locations.
The United States, as the world’s largest consumer market, should be a prime location for manufacturing to service our market. And in fact it is – with, for example, many Japanese, Korean and European auto manufacturers building cars here. Such investments should become more attractive for several reasons. First, as manufacturing advances technologically, meaning that the number of person-hours for any given product declines, the relatively high U.S. cost of labor becomes less of a deterrent. Second, and associated with the first point, the high level of skills in the United States provides an advantage in technologically sophisticated manufacturing processes. And third, although the technology of moving goods has improved (notably through containerization), increases in fuel costs have offset the labor-cost advantage of manufacturing elsewhere and shipping to the United States. So superimpose on that improving calculus for U.S. manufacturing the benefit if the United States, the largest consumer market in the world, puts its fiscal problems behind it, while the rest of the world suffers from the aftermath of the financial crisis and from other handicaps. This nation could have a window of time during which there will be important reasons to locate in the United States.
To be sure, productivity growth means that manufacturing entails fewer jobs per dollar of activity than it did in the good old days; and financial health could mean that the value of the dollar rises, making U.S. inputs more expensive relative to those of other nations. But in an uncertain world, certainty and sound national management could be even greater advantages.
Years of low-cost financial capital. Closely related but not identical to the above is the potential effect of a budget settlement on the ability of the United States to raise financial capital in international markets. Surprising to many has been the continued financial “safe haven” status of the United States despite our obvious budget woes. The possible reasons include our standing as the “best-looking horse in the glue factory” (a phrase first attributable, I am told, to Nariman Behravesh of IHS Global Insight); our recognized Churchillian behavior pattern of doing the right thing after we have exhausted every other alternative; and our reputation. It is risky to live off of one’s reputation; and yet we continue to attract the world’s savings. Imagine what our status would be if we made good on that reputation. Given the problems in the other major nations around the world, we realistically could expect as a nation to be able to borrow at low rates for years. If managed with discipline and forethought, that opportunity could allow our nation to improve its public capital stock at the lowest possible cost. It would give us time to get ahead of the curve of the costs of servicing our swollen debt load. And it would give the Federal Reserve the best possible environment to unwind the financial securities on its balance sheet without triggering inflation.
To be sure, cheap foreign capital and low market interest rates are not unalloyed blessings. It would take discipline to avoid an ultimately expensive national consumption binge. Foreign capital inflows would raise the value of the dollar, which would offset partially the competitive advantages of productivity-enhancing physical investment. And low interest rates do reduce the retirement incomes of seniors (which is one reason why we should be grateful that we retain a defined-benefit Social Security program). But on net, the U.S. position in the global financial markets, with the budget problem solved and behind us, would be a major asset.
Lifting the cloud of uncertainty. The United States may have the reputation of always doing the right thing in the end. However, there still could be palpable relief when we do it – this time especially, when the downside risk of failure is so incredibly large. The particular circumstances of this moment are uniquely adverse – the “fiscal cliff” with its potentially expiring tax cuts and mechanistic automatic spending cuts – and so the situation might improve to some extent even if the Congress and the President were merely to kick the can down the road to a slightly safer location. However, there are reports already of U.S. businesses postponing investment and hiring because of the uncertainty surrounding the budget mess. Predictability could conceivably lift uncertainty beyond that caused by the fiscal cliff narrowly defined, and lead to more commitments of resources that would add momentum to the current slow-building recovery.
Per the qualifications at the outset, this benefit should not be overstated. Even some elected policymakers these days seem to think that firing a public employee will cause a private-sector job to spring up immediately in his or her place – failing to recognize that private-sector jobs will be lost when that public employee and his or her family go missing at the supermarket and the department store. Deficit reduction will have direct adverse effects on the economy. However, if well timed – though it will not be easy – a gradual deficit reduction, phased after an extension and tapering off of the recent stimulus programs and tax cuts, might allow the recovery to build momentum, and to absorb the direct restraint of the deficit reduction less painfully.
So if we address the deficit problem (and we must), but we do it carefully (and we must do that, too), there will be significant benefit to the economy (beyond the mere avoidance of disaster). How precisely to do it – in the chaotic calendar of decision-making in this election year? A discussion of that minor issue will come next week.
- Stumbling Toward The Cliff
August 9, 2012
- Stimulus II: How (And How Not) To Do It
July 31, 2012
- The Supreme Court Ruling And The Budget
June 29, 2012
- What is the “Medicare Guarantee”?
June 25, 2012
- Capital Gains, Tax Reform and the Budget
May 1, 2012
- Where The Budget Is Going In 2012
April 5, 2012