According to President Obama, “every economist who’s looked at it says that the Recovery Act has done its job.” The four economists gathered at the National Press Club on Tuesday were apparently not asked for their opinions on the matter.
Tuesday’s program, “Debt and Deficits: Implications for U.S. and Global Economic Recovery,” featured a panel of academics who addressed not only the unsustainable rate of spending but also legislative solutions to rein in the $13 trillion debt. Naturally, to remedy any situation, it is essential to understand the source of the problem.
That problem is ignoring the second half of the Keynesian model: Spending must be financed, and long-term financing results in rising debt. Veronique DeRugy, a Senior Research Fellow at George Mason University’s Mercatus Center, explains that “in Keynesian thought, a fall in economic demand causes a fall in spending.” A decrease in spending makes a nation poorer; thus when the government makes budget cuts, the result is job loss. That seems pretty uncontroversial, but Keynesians argue that government spending can take the place of private spending to revitalize demand and economic growth. So, does it work?
DeRugy cites a study by Harvard’s Robert Barro and Charles Redlick in which they analyze the effects of government spending on the overall economy, using defense spending as a proxy. Barro and Redlick concluded that one dollar of government spending results in a growth in GDP of 40–70 cents—a strong negative relationship between government size and economic growth. In other words, not a very savvy investment.
The ultimate test case for the Keynesian model, of course, is the American Recovery and Reinvestment Act, which promised that 3.5 million private sector jobs would be created at a price of $787 billion. The President warned that if the stimulus were not signed into law, the country could face 8.8 percent unemployment.
One only needs the post-enactment facts in order to ascertain the success of the stimulus bill:
• 862,000 jobs created at an average cost of $282,000 per public sector job and $647,000 per private sector job
• Four of five jobs created are in the public sector
• Government spending is not correlated to areas of high unemployment, and
• The rate of unemployment has reached 9.3 percent after peaking at 10 percent.
The facts confirm the Barro and Redlick—and countless others’—research. The Keynesian model didn’t work in the case of the current recession, and even if one accepts the stimulus as an a priori good, it is unsustainable at its current rate. According to David Primo, associate professor at the University or Rochester, “Bailing out states rewards their bad behavior.” When states receive federal funds to sustain their spending habits, they are not forced to “face the music” and engage in budget reform. Essentially, it is that budgetary reform that targets the source of the financial crisis and will ultimately fix it.
What form should state and federal budget overhaul take? Primo suggests a Constitutional Budgetary Rule that is broad in scope, has few escape clauses, and affords minimal accounting discretion. Such a rule would create the congressional commitment and external enforcement that render current efforts to cut spending ineffective. Without strong external enforcement and minimal loopholes, reform proposals are “gimmicks at worst, band-aids at best,” says Primo.
When states are faced with the task of cutting spending, they will have to make unpleasant and politically unpopular choices, but those choices are easier to make before Congress faces a fiscal emergency that will force its hand. A gradual cut in spending and the necessary corollary decrease in entitlements will also be easier for the public to swallow.
That is why Miron, Primo, and DeRugy propose that serious budget reform begin now, gradually cutting spending over the course of time. Cutting entitlements will be unavoidable because “even if we slashed [all spending] except for unemployment, it would only buy us a few years until we reach credit default,” says Miron. In fact, he suggests a Social Security freeze while phasing out other programs.
After, or in conjunction with, the initial spending reductions, Bruce Yandle, former Executive Director of the Federal Trade Commission, suggests a strict budgetary statute or the kind constitutional of amendment Primo proposes. A constitutional amendment on the federal level may be unlikely, but states could more feasibly enact such a measure, spurring economic growth.
The stimulus bill failed to do just that: spur economic growth. Yandle explains what is at stake if the deficit continues to grow:
The average family’s private world will contract while the public sector expands. Their expectations for future wealth and prosperity will gradually be revised. And they will not likely know that deficits and public debt led to these results.
In the wake of a failed stimulus package, one might think that “if at first you don’t succeed” doesn’t apply to the logic of economics. Think again, because the Administration is pushing a second, larger stimulus bill. That’s Obamanomics.