The President’s Budget and the Case for Shelving Austerity

The President released his FY 2014 budget today, and right off, it makes more economic sense than most of what passes for serious fiscal discussion in DC.  In particular, it offers up new public investments, uses revenues and entitlement changes to restore long-term fiscal sanity, and phases in those changes down the road when the economy (hopefully) is stronger.  Apart from Fed policy, the budget is government’s most powerful tool for affecting economic growth.  So, the critical economic question is what budget approach would most effectively boost U.S. growth, for both the near-term and longer.  The best answer for now is a plan built around an ambitious public investment agenda, serious measures to broaden the tax base and pare entitlement benefits for well-to-do retirees, and reform that finally resolve the festering issues left over from the 2008-2009 financial meltdown.

To appreciate why continued austerity would be economically reckless, just review the economic data from 2012.  Yes, the United States grew faster than almost any other advanced economy.  But that’s only because the Eurozone has been back in recession, France and Britain treaded water at 0.1 percent and 0.2 percent growth, and Germany grew less than 1 percent.  Even in Northern Europe, Denmark contracted and Sweden expanded just 1.2 percent.  So, the United States looked good with 2.2 percent growth – although only 0.4 percent in the final quarter of 2012 – in-between Canada’s 1.9 percent rate and Australia with 3.3 percent growth.

With such dismal growth, here and across the developed world, the budget’s first mission should be to strengthen it.  There is no economic basis for any short-term spending cuts or tax increases, especially on top of the continuing, mindless sequester.  To be sure, under very special conditions, austerity can stimulate economic activity in a weak economy – namely, when high inflationary expectations drive up interest rates, constraining investment and consumption.  But those conditions have nothing to do with our current economy since interest rates here and across the advanced world are at or near record lows.  The case for austerity, then, is simply politics, and the continuing calls from conservatives to slash federal programs merely mask their fervid preference for a small, weak government. 

Economics matters more in this debate, and progressives should use our slow growth to promote an expanded agenda for public investment.  They could call on Congress to dedicate an additional one percent of GDP to investments that will strengthen the factors that drive growth.  That could mean, for example, more support for reforms to improve secondary education, reduce financial barriers to higher education, and provide retraining for any adult worker who wants it.  It also could mean renewed public support to develop light rail systems across metropolitan areas and improve roads, ports and airports.  This is also the right time economically for Washington to more actively promote the frontiers of technological innovation by expanding support for basic research.  Finally, let’s review federal regulation with the aim of lowering barriers to new business formation.  New and young businesses are reliable sources of new jobs and greater competition.  Those elements, in turn, stimulate higher business investment, particularly in new technologies.

Progressives also would be well advised to accept long-term entitlement reforms that could accompany the new public investments.  Since Social Security provides at least 90 percent of the income of more than one-third of retirees, pension reforms should focus on some form of means-testing.  The best template to contain healthcare spending is more elusive. The Affordable Care Act includes a half-dozen measures calculated to slow rates of health spending.  So, a bipartisan effort to strengthen those measures, perhaps with malpractice reforms to entice conservatives, would be a good place to start. 

These initiatives, by themselves, still won’t be enough.  Economic history teaches us – if only we’d listen – that the recovery that follows a financial crisis is always slow and bumpy, unless policymakers directly resolve the distortions that brought about the crisis.  Many of those distortions in finance and housing linger on.  In finance, the challenge is to get financial institutions to divest themselves of their remaining toxic assets and, equally important, further limit the impulse of these institutions to speculate in exotic financial instruments that remain only lightly unregulated, like a hedge fund.  The political resistance will be daunting, of course.  But the economics is clear: Until such changes occur, Wall Street will not focus sufficient resources towards supporting home-grown business investment.    

The challenge in housing is as difficult politically, though technically less complicated.  Across the nation’s five largest mortgage holders, almost 12 percent of all mortgages were in serious trouble at the close of last year.  Some 6.5 percent of all mortgages were delinquent, another 1.6 percent of them were in bankruptcy proceedings, and 3.6 percent were in foreclosure.  So long as these rates are abnormally high, especially foreclosures, housing values will be weak – and the primary asset of most U.S. households will languish.  Even worse, a weak housing market consigns most homeowners to stagnate economically or even grow steadily poorer; and that means they will consume less and the recovery will continue to be stunted.  One sensible approach would be a new federal program to help people avoid home foreclosures through government bridge loans – like student loans -- made available until the job market recovers. 

This year’s budget debate will probably follow a now-familiar and sterile course, in which the President offers his plan, which is promptly met with partisan invective, followed by personal attacks from all sides.  For average Americans to see their economic prospects really improve, progressives will have to forgo the partisan fights and instead use the Obama proposal to start a new public conversation, one focused on the challenges and changes necessary to get this economy back on track.  

This post was originally published on Dr. Shapiro's blog