Tag: debt levels

‘Mountain of Debt’

The White House Office of Management and Budget homepage currently features the following quote from the president:

President Obama says he wants to “invest in our people without leaving them a mountain of debt.”

That’s a curious statement because the Congressional Budget Office’s analysis of the president’s current budget proposal projects that publicly held debt as a share of the economy would reach levels last seen at the end of the Second World War.

When the CBO’s numbers are plugged into a bar chart, the projected Obama debt levels (red bars) look like…the upward slope of a mountain (!):

To be fair, Obama’s predecessors – particularly the previous Bush administration – share in the responsibility for the mountainous rise in federal debt. However, that’s all the more reason for the Obama administration to work toward a peak instead of a steeper incline.

Fiscal Imbalance and Global Power

Over at National Journal’s National Security Experts blog, this week’s question revolves around the health of the U.S. economy, and its relationship to U.S. power. 

The editors ask

How serious a threat is the mounting debt to the nation’s standing as the world’s only superpower? Can the U.S. continue to spend more than all other countries combined on its military forces given burdensome debt levels? In what other ways does the mounting debt undermine the country’s strategic position? […]

My response:

Our long-term fiscal imbalance, which increasingly amounts to a massive intergenerational wealth transfer, is clearly a sign of our decline. But it is a decline that has been a long time coming. (I first wrote about the insolvency of the Social Security system as a college sophomore, 23 years ago.) As such, it is tempting for people to assume that we’ll figure our way out of this mess before a complete collapse. Let’s call them, at the risk of a double negative, the declinist naysayers. And, even if they are willing to admit to the problem in the abstract, the naysayers can point to the more serious, and urgent, imbalances between pensioners and those who pay the pensions in Europe or Japan and say “At least we aren’t them.”

That is a pretty shoddy argument, but it seems to be ruling the day. We can talk about the obvious unsustainability of using taxes on current workers to pay benefits for retirees until we’re blue in the face. And my second grader can do the math on a system that was designed when workers outnumbered beneficiaries by 16.5 to 1, and in which, by 2030, that ratio will fall to 2 to 1. It simply doesn’t add up. (For more on this, much more, see my colleague Jagadeesh Gokhale’s latest.)

But this isn’t a math problem; this is a political problem. The incentive to kick the can down the road is overwhelming. The pain in attempting to deal with the problem in the here and now is, well, painful. It is hardly surprising, therefore, that members of Congress / Parliament / Bundestag / Diet, etc, have become very good at avoiding the issue altogether. And many of those who have chosen to tackle it are “spending more time with their families.”

What does all this mean for the United States’s standing as the world superpower? Less than you might think. Our difficulties in two medium-sized countries in SW/Central Asia have done more to puncture the illusion of American power than our political inability to deal with domestic problems. Our fiscal insolvency might convince other countries to play a larger role, if they genuinely feared for their safety. But other countries, especially our allies, are cutting military spending, while Uncle Sam continues to bear the weight of the world on his shoulders. In other words, our ability to maintain our global superpower status isn’t driven by our economic problems. But it is strategically stupid.

It is here that I take issue with Ron Marks’s contention that we spend less today than during the Cold War. While technically accurate, measuring military spending as a share of GDP is utterly misleading (as I’ve argued elsewhere.) If the point is to argue that we could spend more, I agree. But the measure doesn’t address whether we should do so.

We should think of military spending not as a share of the American economy, but rather relative to the threats we face. In real terms (constant current dollars), we spend today more than when we were facing down a nuclear-armed adversary with a massive army stationed in Eastern Europe and a navy that plied the seven seas from Cam Ranh Bay to Cuba. We spend more than during the height of the Vietnam or Korean Wars. Today, terrorist leaders are hunkered down in safe houses somewhere in, well, somewhere. In other words, what we spend is utterly disconnected from the threats we face, a point that is easily obscured when one focuses on military spending as a share of total output.

We spend so much today not because we are facing down one very scary adversary, but because we are facing down dozens or hundreds of small adversaries that should be confronted by others. After the Cold War ended, our strategy expanded to justify a massive military. Since 9/11, it has expanded further. Our fiscal crisis alone won’t force a reevaluation of our grand strategy. It will take sound strategic judgement, and a bit of political courage, to turn things around.

In the cover letter to his just-released National Security Strategy, President Obama acknowledged that it doesn’t make sense for any one country to attempt to police the entire planet, irrespective of the costs. Unfortunately, the document fails to outline a mechanism for transferring some of the burdens of global governance to others who benefit from a peaceful and prosperous world order. We should assume, therefore, that the U.S. military will continue to be the go-to force for cleaning up all manner of problems, and that the U.S. taxpayers will be stuck with the bill.

Prof. Krugman Is Wrong, Again

Prof. Paul Krugman asserts in his New York Times column of May 31st that “Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea – not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts.”

While Prof. Krugman and most other fiscalists believe this to be self-evident, it is not.  Indeed, this fiscalist dogma fails to withstand the indignity of empirical verification.  Prof. Paul Krugman’s formulation fails to mention the state of confidence.  This is an important oversight.  As Keynes himself put it: “The state of confidence, as they term it, is a matter to which practical men pay the closest and most anxious attention.”

By ignoring the confidence factor, economic theory can lead to wildly incorrect conclusions and misguided policies.  Just consider naive Keynesian fiscal theory – the type presented (as Prof. Krugman notes) in textbooks and embraced by most policymakers and the general public.  According to Keynesian theory, an expansionary fiscal policy (an increase in government spending and/or a decrease in taxes) stimulates the economy, at least for a year or two after the fiscal stimulus.  To put the brakes on the economy, Keynesians counsel a fiscal contraction.

A positive fiscal multiplier is the keystone for Keynesian fiscal theory because it is through the multiplier that changes in the budget balance are transmitted to the economy.  With a positive multiplier, there is a positive relationship between changes in the fiscal deficit and economic growth: larger deficits stimulate growth and smaller ones slow things down.

So much for theory.  What about the real world?  Suppose a country has a very large budget deficit.  As a result, market participants might be worried that a further loosening of fiscal conditions would result in more inflation, higher risk premiums and much higher interest rates.  In such a situation, the fiscal multipliers may be negative.  Fiscal expansion would then dampen economic activity and a fiscal contraction would increase economic activity.  These results would be just the opposite of those predicted by naive Keynesian fiscal theory.

The possibility of a negative fiscal multiplier rests on the central role played by confidence and expectations about the course of future policy.  If, for example, a country with a very large budget deficit and high level of debt (estimated U.S. deficit and debt levels as a percentage of GDP for 2010 are 10.3% and 63.2%, respectively) makes a credible commitment to significantly reduce the deficit, a confidence shock will ensue and the economy will boom, as inflation expectations, risk premiums and long-term interest rates decline.

There have been many cases in which negative fiscal multipliers have been observed.  The Danish fiscal squeeze of 1983-86 and the Irish stabilization of 1987-89 are notable.  The fiscal deficits that preceded the Danish and Irish fiscal squeezes were clearly unsustainable, and risk premiums and interest rates were extremely high.  Confidence shocks accompanied the fiscal squeezes, and with negative multipliers in play, the Danish and Irish economies took off.  (Evidence from the U.S. is presented in an article by Professors Jason E. Taylor and Richard K. Vedder which appears in the current May/June 2010 issue of the Cato Policy Report.)

Margaret Thatcher also made a dash for confidence and growth via a fiscal squeeze.  To restart the economy in 1981, Thatcher instituted a fierce attack on the British deficit, coupled with an expansionary monetary policy.  Her moves were immediately condemned by 364 distinguished economists.  In a letter to the Times of London, they wrote a knee-jerk Keynesian (Prof. Krugman-type) response: “Present policies will deepen the depression, erode the industrial base of our economy and threaten its social and political stability.”  Thatcher was quickly vindicated.  No sooner had the 364 affixed their signatures than the economy boomed.  People had confidence in Britain again, and Thatcher was able to introduce a long series of deep free-market reforms.

While Prof. Krugman’s authority is weighty, his arguments and evidence are slender.

Unions and State Government Management

State and local governments that have high levels of unionization have a harder time efficiently managing their finances and other aspects of their operations. At least, that’s my argument. The other day, I showed that states with higher levels of debt had higher levels of unionization. The statistical correlation was very strong.

Today, let’s look at the quality of state management, as measured by a major report by the Pew Center on the States. The Pew report gave letter grades to the 50 state governments for management of finances, employees, infrastructure, and information. Pew also provided an overall state score.

I’ve converted the Pew overall state government management scores to numbers from 1 to 10 and plotted them against state unionization rates (“10” is the best management score). The chart below shows that as the share of a state workforce that is unionized grows, the overall quality of state management falls, as measure by the Pew scores. The chart shows the raw data in blue dots and the statistically fitted line in pink. 

The bottom line: public-sector unionization is not a good idea, as it apparently leads to lower-quality government management and to higher debt levels. As such, I’ve argued that collective bargaining in state and local government workforces should be banned.

(Details: R-square at 0.12 indicates that unionization explains only a small share of management quality, but the F statistic at 6.3 and the t-stat on the management variable of -2.5 indicate that the regression is quite strongly statistically significant. Note that the unionization variable is the union share in state and local governments, but the Pew data regards only the states. Thus, I’m assuming that my unionization variable is a reasonable proxy for state-level unionization.  Thanks for data help from Amy Mandler )