Tuesday, June 21, 2011

Wrong Track Economic Policy

Press reports indicate that Vice President Joe Biden and House Majority Leader Eric Cantor are enjoying the meetings they are attending on deficit reduction.  They even have nice things to say about each other. 

Superficially, this may sound good.  Negotiations over a package of deficit reduction measures and a debt limit increase are not marked by rancor, and there may even be an agreement.  If that is true, the likely consensus, at least initially, would be that policymakers are being responsible in addressing the fiscal problems of the U.S. government.

Of course, we do not know what the final package will be, but there is plenty of reason to worry.
For example, press reports indicate that Medicaid cuts may be part of the deal.  It is not clear what form that will take, nor, if there are cuts, when they would take effect.  But cutting Medicaid spending now would be the wrong thing to do.  People who lose their jobs often lose their health insurance; in fact, one of the primary reasons that some people now work is for health insurance.  When people lose their health insurance, they may need Medicaid for their health care needs.  As it should take no leap of imagination to understand, becoming unemployed can be extremely stressful and can increase vulnerability to disease and other health problems.  Do we really want to make things harder for people who are struggling to find jobs in a difficult economy?

Unfortunately, some states are planning to reduce what they provide under this program.  State budgets are under stress as revenues have gone down and Medicaid expenses have gone up because of the poor economy.  Medicaid is a large spending item for the states and is therefore a place where state governments look for possible cuts as they try to bring their budgets into balance.  Federal cuts to Medicaid would make this situation worse for those who need this assistance, even in states that are not cutting their portion of the program.

Also, in general, cutting federal government spending currently is exactly the wrong thing to do when the unemployment rate is over nine percent.  Spending cuts that fall disproportionately on the lower income segment of society, such as cuts in Medicaid and food stamps, while maintaining tax cuts for people much better off is both bad economic and social policy.  Moreover, if there is going to be any hope of getting budget deficits down over the medium-term, the unemployment rate has to come down and the economy has to grow faster.  Increasing fiscal restraint at the current time could have the opposite effect by prolonging the slump.  Do we really want a “lost decade” (or longer)?

In today’s Wall Street Journal, Alan Blinder has an excellent article – “The GOP Myth of ‘Job-Killing’ Spending.”  He makes a persuasive argument that, in the current economic situation, government spending creates jobs rather than destroys them.  Those who think otherwise should read his article.  He concludes:  “…as long as one political party clings to the idea that government spending kills jobs, it’s hard to see how we extricate ourselves from this mess.  As Keynes understood, ideas, whether right or wrong, have consequences.”

While, as Blinder argues, the government should not spend money on stupid projects in order to create jobs, there are plenty of things the government does that are worthwhile.  For example, as many have noted, our infrastructure (such things as bridges, public transportation, and water and sewer systems) is aging and needs to be improved. 

Also, some spending restraint measures that some Republicans are advocating do not have a great deal of fiscal significance, such as cutting subsidies to the Corporation for Public Broadcasting or not increasing the budgets of the SEC and the CFTC.  While arguments can be made for and against the current level of spending for public broadcasting or financial regulation – and I would not dismiss the importance of the issues involved – it is not this type of spending that is significant in either stimulating the economy or increasing the budget deficit.   

In addition, over the longer term, such measures as automatic triggers for spending cuts are unwise.  Spending as a percentage of GDP increases when the economy is in a slump or a recession, because the nominator is increasing as the denominator is stagnant or falling.  Why would one want to interfere with this automatic stabilizing process and make government policy procyclical in an economic slump?  Moreover, if political realities dictate that automatic triggers be circumvented, Congress and the Administration will find a way to do it.  If outright repeal of the triggers is not possible, then there will be a resort to budget gimmickry which can end up costing more money.  (An example of this was the way the George H.W. Bush Administration funded part of the costs of resolving the savings and loan crisis.  To get around the Gramm-Rudman-Hollings restrictions of the time, a funding mechanism for $30 billion of the costs was devised that resulted in higher interest costs than if the Treasury had borrowed the $30 billion by issuing Treasury securities.)

There is reason to worry that the Obama Administration will give the Republicans too much, to the detriment of the economy.  As I have argued in previous posts on the debt limit, the Republicans’ negotiating hand is weaker than it might seem when it comes to using the necessity to increase the debt limit as negotiating leverage to force through their preferred fiscal policies.  While I would not underestimate President Obama’s abilities as a negotiator and political strategist, so far it is not clear what the strategy is.  We’ll see how he and his Administration play the endgame.

Both the Republicans and the Democrats need to be careful.  A prolonged economic slump would not only have huge human costs and make eventually reducing the budget deficit much harder, but it also has potential political consequences that neither political party would find comfortable.  As history demonstrates, economic distress often provides an opening for political extremes of the right and the left to appeal to more people.    

Dangers to the economy not only reside in potentially badly conceived fiscal policy.  Europe is giving plenty of reason to worry, as the Europeans struggle to figure out what to do about Greece and, a much larger country, Spain, has an unemployment rate of around 20 percent.  Troubles in Europe can spread to the U.S. no matter what we do.

But the U.S. should not compound the problem by cutting current government spending because of worry about the budget deficits in the medium- and long-term.  As mentioned, we do not know what will be in the final deal from the Biden-led talks or even if there will be a final deal from that forum.  We also do not know if the Congressional leaders can get a package agreed to by the Administration and the Congressional leadership on deficit reduction and a debt limit increase through the House and Senate.  We can hope that something more or less reasonable will emerge that serves to create jobs currently and makes at least somewhat sensible policy changes over the longer run.  However, the mutual admiration expressed by Biden and Cantor leads one to think that the Administration may be following a triangulation policy, which may or may not be smart politics in the very short run.  It could well be bad politics over the next year or so, if the economy worsens as a result.  

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