A recent WSJ features this piece by Alan Blinder claiming that the GOP is wrong to assert that excessive government spending is killing jobs. The lead paragraphs:
It was the British economist John Maynard Keynes who famously wrote that ideas, "both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else." Right now, I'm worried about the damage that might be done by one particularly wrong-headed idea: the notion that, in stark contrast to Keynes's teaching, government spending destroys jobs.
No, that's not a typo. House Speaker John Boehner and other Republicans regularly rail against "job-killing government spending." Think about that for a minute. The claim is that employment actually declines when federal spending rises. Using the same illogic, employment should soar if we made massive cuts in public spending—as some are advocating right now.
He begins with a straw-man characterization that any increase in federal spending causes a corresponding decrease in employment. We all know this is false, yet it is deployed here as a rhetorical device. Let's put aside the gratuitous "no, that's not a typo" designed to imply that it's OBVIOUS that the Republicans have lost their sense.
What Boehner and the Republicans are claiming is not that gov't spending necessarily causes private sector employment decline. What they are claiming is that our CURRENT levels of spending, characterized by deficits no other nation could even come close to running, is hampering the creation of new jobs. After all, if the administration can talk about jobs "saved or created" then clearly a valid criticism is jobs "prevented or destroyed". The "prevent" part is the main GOP criticism of spending.
Blinder asks: "How, exactly does more Government spending kill jobs?" That's a valid question that should be explored, even though it is a mischaracterization of the Republican claim. Blinder's first attempt to answer it is revealing:
One possible answer is that the taxes necessary to pay for the government spending destroy more jobs than the spending creates. That's a logical possibility, although it would require extremely inept choices of how to spend the money and how to raise the revenue. But tax-financed spending is not what's at issue today. The current debate is about deficit spending: raising spending without raising taxes.
Blinder's statement here is significant for two reasons. First, he essentially stipulates that higher taxes have a negative impact upon jobs, since what he considers to be qualifications of his statement ("although it would require inept choices of how to spend the money and raise the revenue"), are accurate characterizations of standard practice in Washington. Rather than rare circumstances that make something a "logical possibility", inept choices about how to spend the money and raise the revenue are the standard, indeed inevitable, condition of Washington fiscal practice-- the rule, not the exception. This is not due to any particular malfeasance in Washington; it's simply the phenomenon Hayek documented in his famous essay "The Use of Knowledge in a Society"; namely, the required information needed to make truly excellent decisions about where to spend money and raise revenue is never aggregated (and certainly not in Congress). Rather, it exists only as little fragments of rapidly-changing information individually kept by a multitude of different people. While Hayek demonstrated this as a sound argument against centrally managing an economy, the same critique applies equally to gov't spending and revenue decisions, which are the key means by which the political class attempts to centrally manage the economy.
Since Blinder constrains his comments to only deficit spending ("raising spending without raising taxes"), his entire argument essentially boils down to this: deficit spending does not have a negative effect on jobs. As long as tax increases aren't considered, we should theoretically be able to run a deficit forever without negatively affecting jobs.
Your common sense is probably telling you that you can't go farther into debt every year and become prosperous, but Blinder is correct-- provided you make some rather unrealistic assumptions.
Theoretically, you COULD run a deficit every year with no negative effect on job creation. Consider the business that launches with a loan of borrowed money and grows rapidly. If that growth radically outpaces the interest rate on the borrowing, then this is clearly a net gain for the business. Simply put, the enterprise is a far more productive use of capital than paying it back. It "makes sense" that money should be put into a business growing at 15% per year, rather than paying off debt at 5% interest.
So what if the US is that business? Is our economy growing faster than our indebtedness? If it is, then our indebtness should comprise an ever-decreasing fraction of our economic value (GDP). Here is the chart of US indebtness as a percentage of GDP. You read this chart simply-- when the green line is going up, we are going farther in debt relative to our GDP, when the line is going down, our GDP is growing faster than our debt (i.e., the ratio is shrinking). The slope of the line tells you how fast things are getting worse or better.
Revenue to the government can either be spent or it can pay off debt (ok, theoretically it might be saved, but let's not make a farce of this). If the trend is upward, then the debt is growing faster than the economy, and paying off debt (or NOT spending) is a better investment. If the trend is downward, the the debt is shrinking relative to GDP, and paying it down might not be as good an allocation as other "investments."
The key takeaway is that there is a certain level of indebtedness that is sustainable, if the economy is growing. What might this level of indebtedness be? How much growth must there be? Historically, revenue to the government regresses to a mean of about 20% of GDP- no matter what the tax rates, credits, and such happen to be. So a level of spending that is 20% of GDP is sustainable in the long run. If the economy is growing 5% per year, then we begin to see the first factor that may help sustain defict spending. For example, let's estimate GDP in a baseline year-- year One. Based on that GDP info, I budget to spend 22% of that amount. Assuming actual revenue will come in around 20% of Year One's GDP, I have planned a deficit. But if I grow 5% from Year One to Year Two, my increase in revenue will more than offset the "deficit" I ran in Year One. So if I start with no national debt at all, I can theoretically sustain deficit spending forever because the economy is growing faster than my debt.
If I already have a debt though, the amount of sustainable spending goes down because I have to pay the interest on the existing debt.
Another factor in sustainable spending is the rate of inflation. If inflation is 2% per year, then the US could theoretically deficit spend by 2% per year without incurring any REAL debt because the debt would be repaid with weaker dollars.
We can formulate the sustainable spending point as such:
Sustainable Spending Rate (SSR)= 20% of GDP + Inflation Rate - Cost of Debt (%GDP) + rate of economic growth
Putting numbers to that for 2010, we get:
SSR= 20% of $14.66T + 1.6% inflation + 2% economic growth - 1.3% of GDP (interest)
SSR= 20% + 1.6% +2% - 1.3%
SSR= 22.3% of GDP ($14.66T)
SSR= 3,268, 180 Million Dollars or ~ 3.27 Trillion.
What was actual 2010 Spending? 3.818 Trillion, or 23.58% of GDP. Not too bad, right? Less than 2% of GDP over a sustainable target. What about 2011? Uh-oh, that was 25.32%. CBO projects spending to never fall below 22% of GDP.
It gets worse. The analysis above ignores uncertainty. The real world treats uncertainty as an expense. This is why those with spotty credit ratings pay higher interest rates than those with excellent credit; the higher uncertainty of repayment commands a price premium. Similarly, the uncertainty of economic growth requires that we cannot assume a 2% growth rate-- it must be de-rated. The amount is a matter of speculation, but the point here is that SSR never goes higher than we proposed. All spending above that point is NOT sustainable indefinitely.
As the government can only spend money by either 1) taking it from the economy or 2) borrowing against future takings, all borrowing represents future tax liability, which Blinder has already stipulated has a negative effect on the economy. Blinder seems to miss this point.
Blinder's additional unrealistic assumptions ignore the unfunded liabilities in Medicare and Social Security as well. When these entitlement expenses explode and push spending to 30% of GDP or more, then what? Then, we wave at Greece as we pass it on the road to ruin.
Blinder goes on:
A second job-destroying mechanism operates through higher interest rates. When the government borrows to finance spending, that pushes interest rates up, which dissuades some businesses from investing. Thus falling private investment destroys jobs just as rising government spending is creating them.
There are times when this "crowding-out" argument is relevant. But not today. The Federal Reserve has been holding interest rates at ultra-low levels for several years, and will continue to do so. If interest rates don't rise, you don't get crowding out.
So because TODAY interest rates are low, we don't have a spending problem? At some point, record deficits MUST lead to higher interest rates, and the "crowding out" that Blinder pooh-poohs will occur. Higher interest rates will occur because that higher debt will greatly increase either 1) inflation via monetization of debt or 2) uncertainty of US repaying its debts. The only reason we don't currently have high inflation is that demand for cash (hoarding of money) is soaking up a lot of extra dollars, keeping them from circulating and keeping the velocity of money very low relative to the quantity.
High deficits must eventually lead to elevated interest rates, and those rates to a much lower Sustainable Spending Rate. Since the SSR will be lower, the existing amount of excessive spending becomes even less sustainable.
Blinder goes for the Coup de Grace:
Let's try one final argument that is making the rounds today. Large deficits, it is claimed, are creating huge uncertainties (e.g., over what will eventually be done to reduce them) and those uncertainties are depressing business investment. The corollary is a variant of what my Princeton colleague Paul Krugman calls the Confidence Fairy: If you cut spending sharply, confidence will soar, spurring employment and investment.
As a matter of pure logic, that could be true. But is there evidence? Yes, clear evidence—that points in the opposite direction. Business investment in equipment and software has been booming, not sagging. Specifically, while real gross domestic product grew a paltry 2.3% over the last four quarters, business spending on equipment and software skyrocketed 14.7%. No doubt, there is lots of uncertainty. But investment is soaring anyway.
Despite all this evidence and logic, some people still claim that fiscal stimulus won't create jobs. Spending cuts, they insist, are the route to higher employment. And ideas have consequences. One possibly frightening consequence is that our limping economy might have one of its two crutches—fiscal policy—kicked out from under it in an orgy of premature expenditure cutting. Given the current jobs emergency, that would be tragic.
Yes, Professor Blinder-- ideas DO have consequences. Large deficits are creating huge uncertainties. But more than just the deficits are depressing business investment. The Administration's health care activism has created huge uncertainty around what is becoming one of the largest costs of hiring an employee. The Administration's war on domestic energy production has created huge uncertainties on what energy prices will be. Mr. Blinder seem oblivious to the possibility that deficit cuts may be a necessary but insufficient condition for spurring economic confidence.
As for the business investment in the face of such uncertainty, Mr. Blinder is being disingenuous. Is it not rather suspicious that Mr. Blinder singles out investment in equipment and software? Why not people? It is far more likely that this spike in investment in equipment and software is displaced demand-- companies are investing where they think it's "safe" because hiring actual workers is far too risky. Also, current tax policy often forces businesses to spend when they otherwise wouldn't to to avoid extra taxation. Add to this inflationary fears fueled by huge deficits and more printing of money as additional incentive to spend. The fact that the investment is confined to software and equipment should be seen as evidence of the uncertainty created by Administration policies, not as some kind of black swan.
As if the "evidence" and "logic" Mr., Blinder cites is so conclusive, he expresses befuddlement at how someone can dare to insist that someone might want to spend less money. Like a good Keynesian, Blinder believes so strongly in the ability of "stimulus" to get the economy going. Where's the evidence now? How has the stimuli enacted by Bush and by Obama helped our economy?
The reality is that the stimulus was a complete bust because it wasn't intended to stimulate the economy. It was designed to prop up marginal businesses that had good political clout. Hence the bailout of the auto industry and its lawless transfer of ownership to the UAW. A chart of GDP growth, unemployment, or any other common metric defies an observer to find the impact of the stimulus. It has had no lasting effect, despite the Keynesian reassurances to the contrary.
Blinder's portrayal of fiscal policy as being one of the two crutches holding up our limping economy (presumably monetary policy is the other) shows that in spite of all of his education, he really doesn't grasp the idea that an economy is just free people interacting to their own benefit. Many economists gets so lost in the numbers that they have a "Blinder" to the reality the economics is just psychology with math. It is about people, first and foremost: their needs, wants, expectations, and approach to managing the fundamental disconnect between what we have and what we want.
In the end, cutting spending is directionally beneficial to the economy because it reduces the scope of an intrusive government whose economic interventions are generally disadvantageous to the public at large.