The headline risk here, folks, is that if you wait for your central banker to give you insight into ...
Growth Won't Dig US Out of This Hole
02/09/2010 9:23 am EST
Wild optimism about economic growth is at the heart of the Obama administration's plans to shrink the federal budget deficit. And that's not the only problem.
Worried that the global financial crisis combined with the Great Recession in the United States has bankrupted not just ourselves, but our kids and their kids?
Good. You should be. Maybe then we'll do something about the problem before it's too late.
First, here's the good news for those of us who live in the United States. (If you live in some other den of fiscal iniquity, just remember that the names of the characters may be different, but the story is pretty much the same.)
The federal budget deficit for fiscal 2010, including a proposed $100 billion in new spending to create jobs, is expected to hit $1.6 trillion. This would beat the record (set in the distant past of fiscal 2009) by $150 billion and be equivalent to 11% of US gross domestic product (GDP). For reference, the budget deficit that has pushed Greece into crisis is equal to 12.7% of Greek GDP.
How can this possibly be good news? Because the new budget proposed by the Obama administration for fiscal 2011 (which starts in October 2010) says the annual deficit will shrink to 4% of GDP by fiscal 2014.
And now for the bad news: It ain't gonna happen. At least not if we follow the spending and taxing policies laid out in the administration's budget.
That budget assumes 2.7% GDP growth in fiscal 2010. That's reasonable. It's certainly close to the consensus among economists for this year.
But looking out toward fiscal 2014, the budget quickly arrives in fantasyland. The budget projections assume GDP growth of 3.2% to 4.3% for six consecutive years.
And this comes at a time when most economists—even the optimists at the Federal Reserve —are worried that this recovery will be weaker than most recoveries after recessions and that the long-term speed limit for growth in the US economy is headed lower. From 1975 to 1995, full trend economic growth in the United States was about 3%. The Fed now estimates the speed limit to growth at 2.5%.
Other economists, including those at the Congressional Budget Office, think it's even lower—2.3% annually or so.
In other words, the US can't grow itself out of this hole nearly as easily as the Obama administration wishes.
And the Bad News
Slower growth after the recession is one thing arguing against an easy solution, but it's by no means the only thing.
The interest rate the US pays on its debt is rising—just when the amount of debt has soared.
Cutting the budget looks impossible because our government, especially our wonderful Senate, is gridlocked. I find it hard to imagine how the Senate will pass any kind of budget this year.
Even in the best of political worlds, cutting the budget is hard. Only 40% or so of the federal budget is what's called discretionary, and that 40% includes the military budget. The rest consists of entitlements such as Social Security, Medicare, and Medicaid. These entitlements are the hardest parts of the budget to cut—and the fastest growing.
And we don't have a huge window in which to act.|pagebreak|
In this January 8 post, I wrote about research that argues that when a country's accumulated gross debt rises above 90% of GDP, it starts to reduce a country's economic growth rate by a median of one percentage point and an average of four percentage points. Under the current trend, the United States will show a debt-to-GDP ratio above 100% by 2012.
A slower economic growth rate caused by high debt levels makes it even harder to grow your way out of the hole.
And then, of course, there's the long-term demographic trend. The United States is an aging country. But we're not aging as quickly as most of the developed world, or even as fast as some parts of the developing world, such as China. (For more on how the world is aging, see this recent post.) But aging relatively slowly doesn't help in this situation. A country that is aging in absolute terms is getting older and can look forward to a slower rate of economic growth.
If all this makes the situation sound depressingly grave, I'm afraid I've got even worse news: The world's traditional fix for this kind of debt problem when it's the result of a few years of financial mismanagement doesn't work very well when we're looking at a deeper and chronic problem shared by many of the world's countries.
You can see the traditional solution—I'll call it the IMF solution because the formula is one the International Monetary Fund has applied to developing countries for decades—in the plan proposed by the Greek government to end its financial crisis. To get the annual deficit down from 12.7% of GDP to 3% by 2012, the government has proposed cutting wages for all public-sector jobs, cutting public-sector jobs, cutting wages in the private sector to restore the economy's global competitiveness, raising taxes, and cutting entitlement payments.
Aside for the high level of pain in such a "solution," it's not clear to me that the IMF formula can work when applied across the global economy. The plan really boils down to cutting wages so that the economy can export its way out of debt (while at the same time reducing the growth rate of that debt by cutting spending).
There Are Options, But Few Solutions
The entire globe growing its way out of debt by cutting wages and exporting more runs into a major problem: Where are the buyers if wages are down across the world? (For more on whether the Chinese consumer can save the global economy, see this recent post.)
According to some number crunching from Barclays Capital, the IMF formula wouldn't have to be all that painful in the United States. The US is comparatively lightly taxed (Shh! Don't tell anyone in Washington) compared with its peers. Taxes in the United States have come to just 27% of GDP, on average, over the past 20 years. In 2008, the figure for other developed countries in the Organisation for Economic Co-operation and Development was 41%.
All the US would have to do to start down the path toward reducing its deficits and the debt-to-GDP burden would be to raise taxes to 35% of GDP, freeze Social Security payments at current levels, and cut spending across the board.
That might be less painful in the short run, but 1) It's hard to see how that big a tax hike wouldn't reduce economic growth—you're talking about taking money out of the economy to pay down debt, remember—and 2) If cutting spending in the United States were that easy, we wouldn't be in the hole that we're in.
The traditional solution isn't the only way out. If we could find a way to increase productivity, then we'd get more economic growth and wouldn't have to raise taxes or cut spending as much.
It's not out of the question. Productivity in the United States has fluctuated widely in recent decades. From 1979 to 1990, US productivity grew by a slow 1.4% annually. From 2000 to 2008, productivity grew at a 2.5% annual rate. And from 1995 to 2000, productivity grew an annual 2.8% rate.
Unfortunately, even if we're measuring productivity accurately—and it's not clear we are—it's hard to come up with solutions that raise productivity in the short run. Better equipment, improved education and in-career retraining, and more access to lifelong education all work in the long run. But the research differs on exactly how much they contribute to raising productivity and over what period.
There's no reason not to try these long-term solutions. They might help in the short run, too, and the problem is certainly big enough and long-lasting enough that help that arrives in 2020 is still likely to be desperately needed.
A Matter of Trust (or Lack Thereof)
In the short run, though, probably the biggest help would be credible fiscal leadership. International investors and the bond markets need to be convinced that the US is serious about fixing this problem and that it has a credible plan to do so.
A big part of the crisis in Greece results from the bond markets not believing in either the government's plan or its ability to deliver it. The US could easily wind up in a crisis over the same lack of credibility.
I'm not hopeful that enough politicians in Washington will put aside their short-term goals for the 2010 elections long enough to come up with a budget plan. After all, the Senate couldn't even pass a proposal to set up a commission to recommend cuts that wouldn't go into effect until fiscal 2012.
So I've started scouting around for a T-shirt I can give to my kids. It would read, "My parents bankrupted the global economy, and all I got was this lousy T-shirt."
It's not as good as a secure financial future, but, hey, it may be the best my generation can deliver.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.
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