U.S. House Republicans plan to try to slash $100 billion from the federal budget as early as January if they wrest power from Democrats in this year’s midterm elections, setting up possible early showdowns with President Barack Obama on taxes and spending.
Yesterday I described the US economy as a "second gear" economy. The economy is growing, but very slowly. However, there are several points that indicate a spark could lead to growth if given the right impetus. This also means the economy is far more susceptible to shocks such as a cut in government spending.
And no, this is not some theoretical model on which I'm basing this call. Austerity has been tried in the current environment several times and it has uniformly failed.
For example:
Neil Shearing, economist at Capital Economics in London, said the real lesson from the region was that, “aggressive fiscal consolidation at a time when the private sector is also retrenching is likely to lead to much weaker levels of activity and a surge in unemployment”.Much like Spain, Ireland and the UK, the Baltic states were badly hit by the bursting of a credit bubble in 2008 that sent their economies into freefall and their budget deficits soaring.
While others cushioned the impact with stimulus spending, the Baltic trio plunged straight into austerity. As a result, they suffered the deepest recessions in the European Union last year, with Latvia’s economy shrinking by 18 per cent.
The region has since stabilised but, for many ordinary people it still feels like a depression. Wages have plummeted while unemployment has rocketed, with more than a fifth of the Latvian labour force out of work.
And then there is Ireland's High Cost of Austerity:
Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes, the type of austerity measures that financial markets are now pressing on most advanced industrial nations.
“When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”
Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.
Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.
And countries that are proposing austerity measures uniformly agree it will lead to lower growth:
Britain will take an axe to its welfare state on Wednesday as part of an 80 billion-pound ($125 billion) cut in public spending that will dictate the future of both the economy and the coalition government.After months of bitter negotiations, Conservative finance minister George Osborne will announce his spending review at 1130 GMT (7:30 a.m. EDT). Cuts of 25 percent on average are in store for most government departments outside priority areas.
Economists are split between those who say the drastic action is needed and those who argue it will tip Britain back into recession. Almost all agree, however, that growth will slow and the Bank of England (BoE) will have to keep monetary policy super-loose for the foreseeable future.
Austerity measures aimed at bringing down Portugal's towering budget deficit are crucial to regain creditor confidence, Finance Minister Fernando Teixeira dos Santos said Saturday, while also acknowledging that they will slow down economic growth next year.Measures contained in the government's 2011 budget proposal are intended to "not only reduce the deficit, but will also regain the confidence of those who lend to Portugal," Mr. Teixeira dos Santos said at a news conference explaining the proposal, which the minority government late Friday had presented to parliament amid continued uncertainty on its approval.
The government expects gross domestic product in Portugal to recover by 1.3% this year, but the harsh austerity measures included in the proposal will contribute to a slowdown in GDP growth to 0.2% in 2011, Mr. Teixeira dos Santos said, because the measures will have an effect on domestic demand.
Folks, this is not difficult. First we have data -- as in facts and figures -- that can tell us is this is a good idea right now. The facts indicate it is not a good idea. And no, this is not some complicated mathematical formula. In fact, it's simple math -- hell, it's even addition which you can do on your fingers for God's sake.
Here is the GDP equation:
consumer spending + investment + exports net of imports + government spending =GDP
So, if we lower government spending (which BTW has historically accounted for about 20% GDP for the last 30 years) we are lowering GDP by definition.
There is a time to put the fiscal house back in order. When GDP growth is slow, unemployment is high, consumer spending is slow, the housing market is trying to recover and demand is soft, cutting spending is a really bad idea -- as in probably the worst idea you can imagine.
7 comments:
I respect your knowledge and veracity. I suspect you are correct, if the right gets its way. I do have one silly question. I have read several stories that companies are sitting on something like $1 Trillion dollars in cash. Is there some chance that, after the election - presuming the republicans take control of at least the house - a critical mass of these corps will start to inject a meaningful amount of that money into the economy so that the claim can be made "because now the good guys are in power" we now have the right climate for "investment"? I know, I know, my tin-foil hat is firmly in place but with all the Chamber of Commerce shenanigans and Citizens United money effect, well you get my drift. Thank you so much for this blog, I learn so much.
gene
The good news, is that I dont think the cuts will happen. The GOP repeatedly talks about cutting spending, but they also repeatedly avoid specifying what they would cut. Even in that article, if I read it correctly, 100 billion is just a number they put out, but havent specified where it will come from. Assuming they get specific, and cuts to popular programs pass a GOP House, I think they will run into problems, in what looks like it will be a narrowly divided Senate, and if it gets past that, it needs to get past the veto pen.
Re: Corporate cash overseas. The cash is taxed if it remitted to the US, not so if it stays overseas. It is concentrated - about half is in 10 tech companies, and they really have nothing to invest in here in the US. If they were able to remit it they would probably just 1) pay in dividend, or 2)use it to invest in Asia.
Both business and politicians use the existence of this cash as a justification for their proposed policies, when in fact one has nothing to do with the other.
The problem with govt being in the equation of GDP is that the govt cannot create wealth. Wealth is created by a business offering a good or service, someone paying for that good or service, the business earning a profit, then the business expanding capacity. This is how capitalism works. The govt is not able to do this as it cannot run profitable enterprises. It is only able to merely shift wealth around. It takes from one person via taxation and gives to another. That shift is wealth may have some societal value, and it sometimes does but often doesn't, but it does not result in wealth creation. The govt also often tries to gather funds to redistribute via borrowing or printing money. Borrowing may boost the economy in the short term, but it has very negative longer term effects. Printing money just dilutes the currency and creates inflation by definition. This act can be useful to plug deflationary holes, but beyond that it creates bubbles or types of inflation which makes larger numbers of Americans poorer, usually the lower class.
Anon -
The government creates plenty of wealth. For example, the interstate highway system -- which was creased in the 1950s -- is still paying dividends as it allows goods to move between cities far mo,re efficiently. Try calculating the IRR on that investment and you'll see a mammoth payoff.
And how about all of the inventions that came from the space program? Or the internet? Or medical research?
Then of course there is education -- creating the workforce that helps to create wealth. How many people went to state sponsored schools? The vast majority.
I could go on, but you get the point. The whole "shuffling wealth around" argument is incredibly superficial and shallow.
Said differently, the government redistributes and it also enables. Redistribution is medicaid, social security, assistance to the poor. Enabling, as Bonddad points out, is infrastructure, schools, research.
The average US citizen lives a myth of the "self made man", not acknowledging the contribution made by previous generations' investments in social (schools, hospitals, police) and physical infractructure (rail, roads and utilities). One thing that had enormously enabling consequences was Eisenhower's highway project - because it freed business from having to locate production close to population centers. It was the greatest competitive advantage in the 20th century (non-war).
Ironically, conservatives are dead set against the one policy - a massive, $1T infrastructure program - that would do more to enable wealth generation than any other public or private sector action. The consequence is they assure their own lost opportunity.
This comment by the resident deficit hawk on my site makes it seem that the massive austerity measures that Europe is undergoing are absolutely necessary and that there are no alternatives. Is that true?
The PIIGS (Portugal, Italy, Ireland, Greece, and Spain..) as part of Eurozone (since they don't have control of the money supply..) effectively have only three things they can do in response to the crisis.
Austerity, default, or raise taxes.
Following the links above Ireland has done two, austerity and raised taxes. A default for Ireland or any of the other PIIGS would likely result in a ejection from the Euro. (would possibly lead to an unraveling of the Euro which would be very chaotic...) Given those scenarios which would you choose..?
Latvia is in a similar spot.. they don't use the Euro but have petitioned to become part of the Eurozone and have much of their debt denominated in Euros. They could default on their debt but unlike Argentina (the largest sovereign debt defaulter so far..) they are not rich in resources but depend heavily on trade. Also default would substantially delay their entry to the Eurozone.
The bond market has made it clear that they will not loan more money for stimulus. Given that these countries can not borrow more money (except at usurious rates which would make things worse fairly quickly) their options are defaulting or raising taxes. Apparently Ireland has already done the latter. Greece is notorious for tax avoidance (at all income levels... Supposedly sort of a holdover from when they were occupied by the Turks and tax avoidance from the Ottomans (at that time...) was considered patriotic.) but has taken no action to even pursue tax scofflaws.
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