The social cost of deficit spending

In a recent article, Robert Barro, professor of economics at Harvard, takes up the problem of the US debt deal and its long term consequences. He chides the Obama administration for using an “unrealistically high” spending multiplier when predicting the effects of its expenditures on the national economy. The concept of the multiplier, developed by economists Kahn and Keynes, claims that government spending will add something more to the economy than just debt. The sum, if you like, is more than the value of its parts: individual “pump priming” government projects will together push the private sector to start investing again, with the multiplier a measure of how much more production can result from a given amount of government stimulus. In practice, 800 billion US dollars have been channeled into the economy via the Fed’s quantitative easing policy, with more in the pipeline, and yet the US economy remains in the doldrums. As Barro points out, this spending is now having a contractionary effect on the economy as it takes the form of an unwieldy debt burden.

A standard critique of Keynesian pump priming is that its long-term impact is nil and all it does is burden individuals with higher taxes as governments seek to pay off their debt. Another is that spending by the state has the effect of “crowding out” private sector investment. This presumes that there is a dynamic private sector out there, being stifled by government intervention – one of the main arguments made for rolling back the British state in the early years of Thatcherism in the 1980s.

Whether or not there is a dynamic private sector in the US being held back by the Fed’s quantitative easing will be a matter for future posts. For the moment, it is worth considering Barro’s proposal for dealing with the US debt burden. His arguments illustrate well the way in which the effects of pump priming can be regressive in the long run, hitting those very people neo-Keynesians think they are helping. Barro recommends that reducing the US debt burden should start with setting US corporate tax and estate rates at zero. He also argues for the phasing out of tax expenditure ideas, like tax preferences for home-mortgage interest and employee fringe benefits. He also recommends the lowering of the structure of marginal income tax rates, stressing that rates on higher incomes are already high enough. His final recommendation is perhaps the most important: a flat-rate value added tax. A rate of 10%, he writes, would raise about 5% of GDP.

Barro’s proposals are highly regressive. It would represent an added tax burden for lower earners relative to higher earners. The rightwing critique of government spending is that it only leads to higher taxes. But the bit they don’t mention is that those taxes, when they come around, will hit lower earners hardest. It may seem crazy to be talking about cutting spending during a recession but increasing spending is no solution either. As well as failing to stimulate an anemic private sector, it risks leaving lower earners with the burden of paying off the debt. Austerity budgets may be no solution, but neither is pump-priming.

The Debt-deal, or, the Chickens of Third-Way New Democracy Come Home to Roost

Readers know the details: $1 trillion cuts, $1.5 more through a supercommittee with a trigger if they can’t agree, and the further possibility, by the end of 2012, that the Bush tax cuts for the wealthy sunset. Major spending cuts just as GDP growth was revised down for the past three years, and a double dip recession becomes an increasing possibility. In fact, stimulus money is just about dried up and, as we noted in a previous post, was considerably counterbalanced by contraction at the state-level. This plan looks less like a resolution to economic problems and more like a continuation of the trend of redistributing resources upwards: cuts in social spending (yes yes, some are protected, but not all, and it’s always revisable…) and preservation of tax cuts. There is a lot to say here, and we will try to do it succinctly, but to put the conclusion up front: this is not just a problem of a weak, neoliberal President and wacky-tacky right-wing, it’s also the product of decades of Democratic Party tactics and ideology. And more broadly, signals a deep, and not just American, problem facing left-wing thinking – this is an international, not just national story.

Before getting to those points, a few minor observations. First, these cuts are, of course, revisable by future Congresses – a thought occasionally offered to placate critics, but there’s no reason why revisability softens the blow. Under certain political conditions, that could just mean programs like Social Security and Medicaid would get put back on the table. Second, there is a contradiction in the ‘success’ of the austerity project: contraction of federal spending is ‘procyclical’ in that it exacerbates recessionary tendencies. If it accelerates a recession this could hurt many members of the class that stand to benefit the most from the current arrangement – profits decline, bankruptcies loom, higher lending costs. Short-term gains, but long-term pain. Third, one of the promises Obamacrats have held out in support of this deal is that it puts the budget deal to rest and allows them to move to better territory – jobs. That is what Biden told unhappy Democrats. But this is not very credible. How exactly would a jobs program, or other major stimulus, work when transportation is on the chopping block and the administration has just, very aggressively, affirmed the need to control spending? One can’t shake the feeling that Obama is concerned about jobs up to and only insofar as he can use it to get re-elected. He hopes it is the symbolic issue that he can use to abuse Republicans in 2012, even if nothing very significant policy-wise actually comes out of the coming debate.

Here we get to the nub of the issue. An excellent recent piece by Glenn Greenwald reminds us that Obama has always wanted significant cuts in social spending, and more generally been a champion of ‘entitlement reform.’ (Greenwald supplies the bulk of the evidence here). The key point is that Obama was not just pushed by nutty right-wingers, he has been a supporter of significant revisions to social programs for a long while. Of course, the plan may not exactly have been to Obama’s liking. And we can debate just how much Obama conceded versus got what he wanted (the best version of this debate is here), but most of this debate is besides the point. This budgetary compromise did not come to be in a vacuum. It is not just Obama but the entire Democratic Party that has been unable to provide convincing responses, and for good reason.

For the past twenty years, the Democratic Party has been the part of austerity. The Clinton years have been celebrated as years of fiscal responsibility, whose crowning achievement was a balanced budget. The 1996 welfare reform entrenched the view that Democrats, too, thought there was a problem with the ‘culture of entitlement,’ and that individual households need to be more ‘responsible.’ The New Democrats also attacked the ‘old left’, echoes of Obama’s recent attack on the ‘professional left,’ and especially their tax and spend attitudes. Additionally, although it was Clinton who said ‘it’s the economy, stupid,’ it was the New Democrats who argued for a restructured role for the state in the economy. Their post-Cold War savvy told them the government should not try to do too much, correct market failures, alter incentives, but never compete with private industry (think recent health care reform and the rejection of the public option) and certainly forget about something as ambitious as a jobs program. No wonder the Democrats were unable to mount a very convincing case against the Bush era tax cuts, against cutting social spending, and against the stupidity of austerity on the brink of a double-dip recession. The neoliberal chickens of New Democracy have come home to roost.

The political economy of New Democracy was, in fact, oddly contradictory. It was, on the one hand, the dream of a frictionless economy, spurred by the heady, speculative, but deeply inegalitarian dynamics of the ‘New Economy’ (whose myths have been decisively dispelled in After the New Economy). The post-industrial economy could grow on symbols, credit and knowledge alone. On the other hand, it promoted an ethos of limits: don’t expect the government to do what it once did, collective solutions to political problems are possible only on the margins, the individual must manage more with less. The government’s job is to keep things reasonable, like a balanced budget. The New Economy crashed (twice), and the Democratic Party was left holding the sputtering torch of its post-political economic theory. All that remains is its political (and funding) alliance with the new financial class, and decline of its former political basis in organized labor. No wonder, then, the Democrats have found themselves outmaneuvered. They have spent the last twenty years arguing against the ideas they suddenly hoped to trot out now – indeed against the very possibility of dramatic collective solutions to serious economic problems.

Finally, as much as this drama has taken turns unique to the American political system, it is a particular example of a general trend. Last year’s British austerity budget included an average 19% four-year cut in departmental budgets, including cuts in pensions, education and transportation (the UK experiencing the familiar sluggish growth). Spain, Portugal, Italy, Ireland and especially Greece are all facing or passed austerity budgets, regardless of the kind of government in power – though in many cases with considerably more social protest than in the United States, and often with at least a slightly more equitable distribution of pain. Amidst 20% unemployment, Spain’s Socialist Party, for instance, cut spending 8% but included tax raises at the upper end. The general point is that the Tea Party added a touch of crazy, and Obama added a touch of ruling class cool, to a much more general problem for the Left. The mainstream parties of the Left, from New Democrats to Spain’s Socialists to British Labour, have been preaching austerity and a new era of limits for decades. In such an environment, austerity in a time of recession, extended joblessness, and growing inequality seems like the reasonable thing to do.