Monday, February 25, 2013

Is U.S. Fiscal Policy Near the Tipping Point?

Of the various critiques of the empirical work presented by David Greenlaw, James Hamilton, Peter Hooper, and Frederic Mishkin, Ryan Avent nails it:
I was immediately concerned by the data sample: 20 advanced economies over 12 years. What's particularly distressing is that just over half of the sample countries are members of the euro zone. In choosing to study advanced economies, the authors specifically note the problem of "original sin" in studies of emerging markets—that countries which borrow in foreign currencies are subject to different debt dynamics—only to then use a sample in which most of the chosen economies are unable to print their own money.
For more on why this matters – see Paul Krugman. But to be fair, I am intrigued by the author’s dynamic debt modeling and this:
we calculate the level of the primary government surplus that would be necessary to keep debt from continually growing as a percentage of GDP. We argue that if this required surplus is sufficiently far from a country’s historical experience and politically plausible levels, the government will begin to pay a premium to international lenders as compensation for default or inflation risk.
The authors rightfully worry about the U.S. polarized political system and our political will to increases taxes enough to cover spending and pay down the debt slowly over time. I have to seriously question, however, why an 80% percent debt/GDP ratio is the tipping point. Let me explain with a simple and perhaps pessimistic version of their model, which really harkens back to Domar’s modeling and Sargent and Wallace’s unpleasant arithmetic. Let’s assume that the real interest rate (r) = 3% and the long-run growth rate (g) = 2% so the present value of primary surpluses expressed as a percent of GDP (s) is given by s/(r – g) which is 100 times the primary surplus ratio given our unpleasant assumptions. How hard would it be for U.S. fiscal policy to have taxes as a share of GDP to exceed government spending as a share of GDP by say 1 percent so we could readily handle the current level of debt in the long-run? I’ve been looking over government spending and revenue figures as shares of GDP over the past 60 years. I prefer to do this as overall government spending and revenues (Federal, state, and local) as we know the Federal government could push certain responsibilities such as Medicaid off to the states if Ryan Republicans have their way or could assist cash strapped states with more Federal revenue sharing if I had my way. Recall that we did manage to pay down the massive Federal debt after World War II despite the fact that we had a larger defense budget as a share of GDP than we even saw under President Reagan or Bush43. OK, we have higher state and local government purchases now than we did in the 1950’s and transfer payments as a share of GDP have risen over time. But notice that in the late 1990’s, we did see total taxes as a share of GDP reach 31%. So can we get back to that level and keep spending at 30% of GDP? Well we did have government purchases drop below 18% of GDP in the 1990’s even as state and local purchases being 11.5% of GDP and nondefense Federal spending being 2.5% of GDP by telling the Pentagon that they get less than 4% of GDP. Oh, I know Republicans hated the decline of the military industrial complex but I would argue this is just smart policy. So the trick on the spending side will be to limit government spending on health care to 6% of GDP if we maintain Social Security benefits at 6% of GDP. While that will be a real challenge, the other challenge will be to find some political agreement on how to raise taxes as a share of GDP. We Democrats should admit that we are loathed to increase the tax burden on the working class even as that is really the Republican’s secret desire. And we know the Republican agenda is to insure that their rich political masters see an even less tax bite than they face today. But if we can get past this class warfare, avoiding fiscal default is something we know how to do.


JW Mason said...

we did manage to pay down the massive Federal debt after World War II

Nope. Wrong. Debt ratios fell after World War II because g > r. Primary surpluses had nothing to do with it.

ProGrowthLiberal said...

While it is true that real interest rates were modest and real growth averaged 3.5% per year up to 1980 but we did run primary surpluses. Plus the inflation of the lates 60's and the 70's played a role. Then again - the Reagan fiscal irresponsibility changed all that - lowering growth to 3% per year and driving up real interest rates as we run primary deficits. And guess what happened to the debt/GDP ratio?

juan said...

“Real global GDP growth averaged 4.9%a year in the Golden Age years from 1950 through 1973, but dropped to 3.4% annually in the unstable period between 1974 and1979. Dissatisfied with the instability, inflation, low profits and falling financial asset prices of the 1970s, advanced country elites pushed hard for a switch to a more business friendly political-economic system; global Neoliberalism was the result. World GDP growth averaged 3.3% a year in the early Neoliberal period of the 1980s, then slowed dramatically to 2.3% from 1990-99 as Neoliberalism strengthened, making the 1990s by far the slowest growth decade of the post war era.” (James Crotty)

With the exception of parts of Asia, economic development throughout the world failed to gain traction, chronic excess capacity on one hand and credit fueled financial exuberance on the other.

Given the system’s inability to create employment so rapidly as required, a glut of labor and an expanding informal sectors as well. All the ‘better’ to intensify the international (and domestic) competition among workers, drive and hold wages down so also make consumer credit increasingly important to retention of living standards, no matter that this has been only another transfer to loan capital.

Average weekly earnings, constant 1982 dollars, for all private nonfarm workers in the U.S. peaked in 1972 at $331.59, falling to $257.95 in 1992 until ‘recovering’ to $277.57 in 2004 and likely having faltered again since then.

It is at least interesting that conditions of surplus labor, lower wages, deficit funding, tech innovations, etc, have not been able to generate another long wave expansionary phase.

Joe said...

"notice that in the late 1990’s, we did see total taxes as a share of GDP reach 31%. So can we get back to that level and keep spending at 30% of GDP?"

Revenue was only that high because the $10 trillion stock market bubble was boosting capital gains. Absent another bubble, it would take MUCH HIGHER tax rates to get to that level of revenue.