Will reducing government debt improve our economy? History says no!
Budget reduction–it’s all the rage in Washington and, unfortunately, Obama himself has turned the page from a stimulus proponent to a budget reduction advocate as he marches to this new tune, though he is obviously not as comfortable in this role as the Republicans, for whom it registers as the single greatest act of their creativity. The new Washington formula for our fiscal crisis is that we have too much government debt, which will ruin the economy and choke America’s future. Not only is that the message from the Republicans, but they seem to have converted many Democrats who are now taking this issue more seriously (Senator Dick Durbin?). Debt reduction was a big part of Obama’s response to Paul Ryan’s Republican budget and he has already agreed to cutbacks in the current budget, amounting to about $40 billion, which can’t do anything but hurt the effort at creating jobs and surely make the unemployment picture worse.
According to the National Bureau of Economic Research, the Great Recession were are currently in began in December 2007 and officially ended in June 2009, making it almost double the length of the average post-World War II economic downturn. It has been a severe recession: during this period the GDP contracted by 4 percent and the unemployment rate doubled, with nearly nine million private jobs lost, wiping out an entire decade of job growth. This was coupled to $ 14 trillion in household wealth evaporation–an entire year’s worth of economic production. What’s worse is that our future economic engine, which must be based on education and innovation, the key elements needed to pull a country out of a serious recession, are less apparent in this Great Recession than they were during the Great Depression of the 1930s. So the government theme that was high on the economic stimulus plan of 2009 has now flip-flopped to view our current public debt as a menace that prevents economic growth and limits job creation. Everyone seems to have swallowed that line, led by Obama’s Deficit Reduction Commission. But history tells us otherwise. Indeed any attempt to further reduce government spending will delay and impede job formation: this is Economics 101. Yet, some economists (and of course the Heritage Foundation–the source of Ryan’s economic plan) have argued that we should be worried about the debt to GDP ratio and if that number gets too large, like 90% being the rabbit number pulled out of a hat, the nation is finished and will take forever to recover. Believe it or not, according to this fuzzy concept, reductions in government spending will create jobs. Proponents of this view, who have argued for a magic ceiling on public debt, have no long-term memory and should not be trusted to do anything. The wrong people who seem to be ever present at the loudspeakers of our economic planning are merely passing wind and making noise. They are not serious people, but impostors, posing as if knowledgeable about the national finance issues, while advocating policies that will make our weak economic recovery much worse. They hope that as the economy weakens further because of their policies, the Democrats will get the blame and, unfortunately, that is often how it works. The truth is, we need a new economy, with new protections for workers who lose jobs and we need good paying jobs, those that can support a family, purchase a home, own a car and contribute to the new needs of a country badly in need of a fresh start. Minimum wage jobs will not do and jobs without benefits are unacceptable and should be considered that way by all Americans. We don’t just need the unemployment rate to drop, we need it to drop by creating quality jobs with good pay, benefits and assurances of a future, something missing for the last thirty years of our Reaganomic policies.
Immediately after the election of 1936, still in the Great Depression, FDR tried a budget reduction strategy, which included raising interest rates and cutting government spending, as a concession to the banks. This caused unemployment, to shoot up (from 14.3 % to 19%) and it forced FDR to increase government spending to create more jobs and this effort led to a reduction in unemployment, though it remained unacceptably high until WW-II began. The Lessons derived from 1936 come along only once in a century, so it behooves all of us to pay attention and understand the meaning and significance of the experiments that come out of our only national laboratory for economic policy, which has historically served as the testing ground for widely different economic theories. And only the Keynesian experiment worked for everybody. In short, FDR tried debt reduction and got enhanced unemployment. The Republicans know this; they are not interested in unemployment numbers, they simply want taxes cut together with budget reduction. How unfortunate it would be to sweep such powerful historical examples away like a windshield wiper passing through our brains and wiping clean our engram. This is the other problem with the Republican philosophy–the lack of longitudinal thinking–no frontal lobe activation, a problem created by too little frontal lobe network firing. The Republicans have a Model T parked in their frontal lobe garage. How else could the Republicans straight jacket themselves in such a way that they cannot think on a slightly longer time scale. Maybe it’s because they want things to get a lot worse, so their constituents, the wealthy, will be able to rape and plunder the economy with less opposition. That must be it!
Looking for all the world like a group of unified Keynesians, the G20 met in June 2009, at a time when Obama had just taken office and had an imposing influence on the G20 dialog; collectively they declared “We pledge today to sustain our strong policy response until a durable recovery is secured. We will act to ensure that when growth returns, jobs do too. We will avoid any premature withdrawal of stimulus.” Yet, a year later, when meeting in July 2010 in Toronto, a very different posture was announced and everyone seemed to refocus their lens onto the issue of debt and the resumption of market economic forces to solve the global fiscal problem. What a difference a year makes. The new market force mentality of 2010 was somewhat easier to talk about, as the G20 thought the various stimulus packages executed the year before had worked, or were about to and therefore countries had to worry more about the debt that was created by the bailout and the fiscal stimulus, at least for those who had one. The conservatives were suddenly in charge and Obama went along, though you could tell he wasn’t going to lead in conducting that particular theme song. When conservatives worry about debt, you know job creation will suffer. Their allegiance is strictly to reduce taxes for the wealthy by reducing governments services for the poor and middle class–end of story. Entitlements too will be a big part of the budget discussion for 2012. Since Republicans typically handle debt by cutting government spending, the G20 switched to focus more on debt reduction than stimulating job creation and proposed government belt-tightening as the main course on the menu. And, in those countries where governments transitioned from liberal to conservative, such as Great Britain, the cuts in spending have been onerous and fall on the poor and middle class, and, in the case of Britain, the cuts were coupled with tax reductions for the wealthy, something our Tea Party Republicans want to do to America. The Brits have achieved something similar to what the Republicans want to do here, but in the U.S., the Republicans, always disingenuous, try to sell their plan as a jobs program. They have yet to explain how cutting government spending creates jobs, especially when you are firing people as a result of cutting budgets. It has to do with the magical debt to GDP ratio, the non-verbal certainty of the new Republican strategy. And it’s not just government jobs that get lost, because the multiplicative downstream impact of less unemployment helps feed other mouths.
But still, some economists have argued that too much public debt can have a sweeping negative impact on economic growth and a number like 90% is viewed by them as the absolute ceiling, beyond which disaster lies right around the corner. That is approximately where we are today. It should be noted that other countries, like Japan, have a far larger debt to GDP ratio: their debt number is at about 200% of GDP and will likely grow larger in response to the damage done by the recent earthquake and tsunami. The total cost for dealing with the Fukushima reactors could be astronomical and, like the United States, Japan’s policy is that the costs of meltdown containment will be met by the government, though the profits from the electricity generated by the reactors go to the power company, in this case Tepco, the Tokyo Electric Power Company. As something of an aside, it is very doubtful that without heavy public subsidies, the nuclear industry could not survive and these plants are only going to get more expensive in the future (more about that issue later). So further expansion of Japanese debt is probably unavoidable and the rationing of electricity in Japan is already impacting the global economy. I am not in favor of creating more public debt, unless such a step can lead to jobs during tough times, followed by debt reduction when boom years return. But our current, drastic economic meltdown has reached depression-like numbers, especially for young people, and it calls for depression-like solutions to get our country back on track without losing huge competitive advantages. We need a new economy, preferably one where workers have more control of their work environment. Greening America to face our grim planetary future is the best thing we could do for ourselves and for the future of our children and grandchildren. We cannot turn our back on the millions who are currently unemployed. But, can a government get healthy by cutting spending and reducing government debt as some have proposed or is it all smoke and mirrors with more job losses down the road? That’s the direction that England is moving towards and here in the states, the 2012 budget war faces Republican Tea Party stiffness in which compromising has to be all one-sided (Obama has to cave). If the Tea Party gets their way for the 2012 budget, we will look like a bad version of what England is going through and unemployment will shoot up again. We will see a double dip recession if severe budget cuts are imposed and by that time, the economy will have sputtered even further.
Recently Thomas Ferguson and Robert Johnson, both Senior Fellows at the Roosevelt Institute wrote an article on this topic “A World Upside Down? Deficit Fantasies in the Great Recession,” (available at www.rooseveltinstitute.org), which sheds sobering light on the debt issue debate. Their article is in response to those who want to argue that the magic debt to GDP ratio can’t go any higher. But the message delivered by Ferguson and Johnson is that we will only do harm to our economy if we focus on debt instead of jobs and those are the only two choices we have. According to the authors, in the modern era, only two countries are relevant to this discussion due to the dominance of their currency and influence when each was at the peak of their power: Great Britain and the United States. Understandably, a much longer economic history is available for Great Britain.
Great Britain Debt to GDP Ratio
The accompanying figure illustrates the historic debt to GDP ratio (red line; scale on the left) for Great Britain’s economic history from 1693 to 2008. The blue line, based on the scale on the right axis, illustrates the economic growth as a function of GDP. What’s important here is that the GDP/debt fluctuates enormously and at times exceeds 250%, while during other periods, it dipped into single digits. According to the conservative view, once the 90% level is reached, the country declines economically and Britain should have gone to pot on several different occasions. But note that throughout these periods of great fluctuation in the debt to GDP ratio, the growth of the economy was far more stable. Indeed, the first time that Britain showed a large debt load, coincided with the early 19th century as Britain developed and innovated the industrial revolution and engaged in the Napoleonic wars, eventually defeating France in 1815 at Waterloo. But for a long period after that, Britain had unusual prosperity and virtually cleaned the clock of all its economic competitors. Thus, through that investment and debt, Britain ruled the world for the rest of the 19th and early 20th century. They eventually discovered what we are about to discover–that the cost of empire exceeds the value of having one. Too bad empire is not traded as a commodity on the stock market. What do you suppose American Empire stocks would be worth today?
But here is another point that comes out of the Ferguson and Johnson article. Conservatives want to argue that the extreme excursions illustrated in the graph are the notable exceptions (the peaks of public debt for the wars in the early 19th and nearly half the 20th centuries) that must be given a free pass because they were periods of warfare. Conservative conjecture is that because the cost of war must occasionally be met, with substantial public sacrifice, mollified by loyalty to country, you can’t judge the impact on the economy by the excursions of debt seen during war. Therefore, the large debt peaks are irrelevant because they coincided with significant periods of conflict and expenditures were critical for survival. So the conservatives seem to argue that huge public debt is OK when the country invests in high levels of military hardware and personnel during wartime, the residue of which is often often left lying in the sand somewhere. Doesn’t it logically follow that if debts exceeding the 90% GDP/debt ratio, are allowed for times of war and are followed by periods of peace and prosperity, then what do you imagine would happen to such a huge level of investment if the country invested in its infrastructure and implemented a new economy on the way to achieving energy independence? Why not allow huge debts to develop when you are actually investing in the country and creating massive numbers of new jobs, rather than investing in a bunch of hardware that will lie fallow when the war is over? Furthermore, conservatives cannot account for the fact that the U.S. public debt, which reached a high of over 120% of GDP during and after WW II, was followed by gradual debt reduction created by strong economic growth. Indeed, the post WW II period in America was characterized by strong economic activity in which all boats were raised, the opposite of what we see today. 
The second figure (obtained here) is the debt/GDP ratio for the United States, with an obviously shorter history (also lacking the economic growth illustrated in the first figure). Conservatives who argue for a magic ceiling of Debt to GDP ratio and call for a limit of 90%, don’t have a leg to stand on and if their plan is implemented through significant budget cuts, it could force our economy into a much slower recovery and even a double dip recession. The Republicans who advocate this view are members of the group that we refer to a global climate change cranks and they need to become part of the historical fossil record. The time has come for them to disappear from history. The country badly needs a new set of politicians. The 2012 election will mean a lot more than the 2008 election, because this time around the country has sampled what each party has to offer. Which option would you choose? I would probably choose a third option, but then again, there are only two parties, so we’re stuck.
RFM
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