Austerity Nuts

by The Editors | June 24, 2010

“American families have done their level best to stay afloat—spending less and working more while trying to map out a financially sound future. They deserve that same degree of discipline and vigilance from their government.” That’s what House Minority Leader John Boehner had to say this past weekend, after President Obama proposed a new economic stimulus package. And precisely because the statement came from a Republican leader, it was difficult to take seriously. After all, Republicans have no compunction about running up deficits when they’re in charge by pushing tax cuts for the wealthy. It’s only when Democrats take over that the GOP suddenly discovers the virtues of fiscal responsibility.

But Republicans aren’t the only ones making the argument for focusing on deficits. More serious people are making a similar case, including Democrats in Congress who recently forced the administration to lower the proposed stimulus from $200 billion to $50 billion. The country should cut spending, say some observers, while the Fed should consider raising interest rates. The only real path to prosperity, in short, is austerity.

“Austerity” is a fairly abstract term, so it’s worth reminding ourselves just what austerity would entail right now. Obama’s modest proposal would give money to states, so that they could continue to cover the cost of unemployment benefits, Medicaid, housing assistance, and the like. With unemployment still hovering around 10 percent, the demand for these services is outstripping the ability of states to pay for them. That leaves the states with painful choices—like yanking state-funded health insurance away from 14,000 poor children, as Alabama is contemplating, or eliminating the financial assistance that allows 35,000 children in Colorado to attend all-day kindergarten. 

 

Of course, state cutbacks inevitably involve layoffs, which have their own chilling effect on the economy. The austerity lobby insists this doesn’t matter, since balanced budgets will supposedly boost the private economy even as the public workforce contracts. As the argument goes, the real impediment to growth right now is the deficit, which spooks financial markets and crowds out private borrowing and investment. Defenders of this view cite the 1990s to validate their theory: As U.S. budget deficits came down and eventually turned into surpluses, the economy boomed.

But, as economists like Paul Krugman have argued, the analogy to the 1990s is hopelessly flawed. A major impediment to growth back then was high interest rates; deficit reduction persuaded the Fed and the markets to lower interest rates, which encouraged growth. By contrast, interest rates today are at historic lows, which means borrowing money has never been cheaper. The main problem right now is a lack of consumer demand. Businesses aren’t investing and expanding because they don’t see rising sales on the horizon. That would seem to call for the more traditional Keynesian remedy of deficit spending.

 

Deficit spending may seem illogical given the prospect of rising debt for years to come, but, as Obama economic adviser Larry Summers, a key architect of the 1990s recovery, recently noted in a speech at Johns Hopkins University, boosting the economy can reduce deficits—and help restore fiscal balance over the long haul. Reducing spending, meanwhile, can eliminate jobs, slow growth, and reduce tax revenues. After Franklin Roosevelt, worried about deficits, cut spending in 1937, unemployment rose 4.7 percent and GNP fell 4.5 percent. “It is not possible to imagine sound budgets in the absence of economic growth and solid economic performance,” Summers said. “Spurring growth, if we can achieve it, is by far the best way to improve our fiscal position.”

It’s advice that some of Summers’s counterparts abroad would do well to heed. German Chancellor Angela Merkel, for instance, has proposed $144 billion in tax hikes and spending cuts. There certainly are countries like Greece that are teetering on the edge of default and will have to reduce their deficits; but, if the world’s economic powerhouses follow this advice, they will reduce consumer demand, which will mean reducing the demand for imports. Fiscal austerity, then, would have the same effect as passing a tariff on foreign goods. Think Smoot-Hawley, in its twenty-first century incarnation. This is a recipe for a double-dip world recession.

Merkel defends her position by warning Germans that “we can’t have everything we want.” That’s true enough-especially in the United States, where enthusiasm for public services chronically outstrips willingness to pay for them. Deficit spending makes sense for the moment, not forever. Achieving a fiscally responsible future will require controlling health care expenses and, once the economy is on solid footing, raising some taxes. (Compared to other nations, the United States remains a relatively low-tax country.) The Obama administration has taken steps in these directions by passing health care reform and starting a fiscal commission that can consider both spending cuts and tax increases. Those seriously concerned about our economic future ought to focus on bolstering these long-term efforts, rather than fighting to balance budgets now—a course that will mean pain not only today but tomorrow as well.

For more TNR, become a fan on Facebook and follow us on Twitter.

Source URL: http://www.newrepublic.com//article/politics/75604/austerity-nuts