Thursday, February 03, 2011

Time to Rethink My Stance on Deficits?

-- Posted by Neil H. Buchanan

I recently attended a faculty lunch at GW Law School -- my first since returning from my sabbatical. One of my colleagues asked: "So, Neil, are you still not worried about deficits?" I confirmed that my view was unchanged. My colleague (referring to a work-in-progress that I presented a little more than three years ago) replied: "You know, you almost had me convinced about that. But I've seen the recent Congressional Budget Office forecasts of the deficit through 2020, and I'm now very worried."

It is true that the CBO's forecasts of overall federal debt are much higher now than they were a few years ago. Even so, the baseline projections have deficits falling from this year's recession-induced 9+% down to the 3-4% range through the rest of this decade. Even so, the actual deficits could turn out to be larger, because the baseline includes some unrealistic assumptions, such as no continuation of the "doc fix" for Medicare, and the expiration of the Bush tax cuts (which Obama now owns) in 2013. Even under the baseline, moreover, the CBO emphasizes scary-sounding factoids, such as the interest on the debt more than doubling as a percentage of GDP over the next decade.

My colleague took the view that the US could soon experience a bond market crisis, based on these numbers. I replied that it is difficult for me to take seriously the US-as-Greece story that is so avidly being peddled these days. The big problem -- if there will be a big problem -- remains health care spending over the very long term. That is, if health care spending were not (under official forecasts) projected to rise faster than GDP for the next 75 years, and instead stayed flat, there would be no long-run budget problem at all. Moreover, if medical costs actually do end up rising that fast, there is nothing that we can do to the rest of the budget that will forestall total ruin. For that matter, I emphasized again that total ruin to the economy would inexorably follow from health care costs rising that fast, even if the federal government had no role whatsoever in financing health care.

Undeterred, my colleague argued that, because we now know that the US political system is too scared to do anything to rein in medical care costs, we need to cut everywhere else. Perhaps by cutting everywhere else, we can at least delay the destruction of the economy by a few years, even if health care costs are going to ruin it. I am sympathetic to the imperative to delay inevitable demises (especially my own); but I continue to believe that so little can be accomplished to dent the long-term deficit through non-health care cuts -- and that the costs of doing so are themselves so high -- that denuding the federal government's non-Medicare spending amounts to self-destructive enabling behavior.

Coming out of that conversation, I have been thinking that my colleague and I had allowed ourselves to become distracted from the more central point. The question my colleague was really asking, after all, was whether the changes in the US deficit/debt picture that have occurred during the Great Recession should change our fiscal strategy. I believe that the answer is no, in both the long run and the short run. That answer is, to a large degree, independent of what one thinks about "enabling" behavior in the area of health care.

It remains true that cuts in spending right now are a terrible idea. Not only the large, unspecified cuts being proposed by the new majority in the House, but any overall cuts at all. Until the unemployment rate really starts to fall, and the economy really shakes off the effects of the housing bust and the financial crisis, and the states stop slashing and burning their own budgets, the economy needs federal spending -- more of it, not less.

It also remains true that public investments are always a good idea, even if they must be financed by borrowing, so long as we engage in public investment spending that is likely to have rates of return that are higher than borrowing rates. In that regard, President Obama's State of the Union address was heartening, in that he focused on some important areas of public investment (education, infrastructure, transportation) that really do cry out for expanded public investment. That he is proposing too little of this, and doing so on an ad hoc basis, is par for the course. His opponents' immediate smearing of investment as "spending" (which it obviously is), and thus evil (which it obviously is not) was entirely predictable.

Are either of these strategies -- short-term stimulus spending, or long-term investment spending -- affected by recent CBO forecasts? They could be. If a country is at the point where lenders simply will not lend it any more money, then the only short-term strategy is gruesome austerity measures. Fortunately, we remain nowhere near that situation, even under the new forecasts. Notwithstanding ideologically-motivated warnings from Wall Street types, the markets continue to treat the US rather differently than they treat Greece, Portugal, Ireland, Spain, and so on. This is because the short-term borrowing needs of the US Treasury do not threaten long-term fiscal disaster. Only long-term borrowing needs could do that; and the markets obviously do not take seriously the possibility that health care will ultimately become 50% of the US economy (which is the implication of the long-term forecasts noted above).

There is even less reason to abandon the long-term investment strategy under the new forecasts. When interest rates rise, then the list of viable long-term investment projects will necessarily shrink; but we are so far away from the optimal strategy right now that we could engage in trillions of dollars in public investment spending without exhausting the best possibilities. It has always been a bad idea to pass up long-term growth strategies that would reduce the ratio of federal debt to GDP, in the name of reducing debt. It still is.

Not every piece of news requires a change in strategy. While there are plenty of ways that I could think of to lower the long-term trajectory of debt for the federal government, it would be a bad idea to implement them for several more years. Most importantly, whether or not we later implement those ideas (or any else's), properly vetted long-term investments are always a good idea.

1 comment:

egarber said...

I think the pundits understate the economic downturn as a prime driver of all this.

Most of the focus is on spending, and it's certainly true that's a major component -- but the real problem (healthcare) is side-stepped, because the rhetoric centers on the non-defense discretionary side, where cuts won't really make a dent.

What's missing is a debate about growth. I saw somewhere that half of the short-term deficit is the result of the recession itself. Tax revenues have dried up because of the contraction. That's why as an economic matter, austerity right now would be an utter disaster; aggregate demand would be sapped (given that individuals are saving), triggering a deflationary spiral. That means growth would be even slower and deficits much worse.

I'm a little baffled that Republicans fail to play this up; after all, the whole idea behind trickle-down economics is that growth pays for the policies. Why on earth is it not possible for growth to pay for direct spending on projects, and then some? Where in basic economics does it say that only spending on tax cuts fits this model? [Of course, as we know, the irony is that tax cuts usually don't pay for themselves, unlike direct investment.]