Friday, March 18, 2016

Politics and the Economic Milieu

Winston Churchill is often quoted for his observation, “The best argument against Democracy is a five-minute conversation with the average voter.”  Or as some might say in these times, a fifteen-second sound bite from Presidential candidates as reported in the mainstream media.

The campaigns so far have not generated much serious conversation about the serious budgetary challenges facing our country.  According to a recent CBO analysis, the federal budget deficit this year will rise to $544 billion, about 2.9 percent of GDP, up from 2.5 percent of GDP in 2015.  While federal revenues will grow at a respectable 3.9 percent, federal spending will grow by even more – 6.3 percent.  This is not a path to fiscal soundness.  

The CBO predicts that this trend – spending growing faster than revenues – will continue over the next decade, though at a slower rate.  By my calculations, the CBO figures reflect an annual growth rate for revenues at about 4 percent while spending grows at just over 5 percent.  This translates into an annual budget deficit of $1.366 trillion in 2026 – with debt held by the public totaling $23.8 trillion, up more than $10 trillion from 2015 levels. 

In 2015, the federal government financed its whopping $13.1 trillion in debt held by the public with a net annual outlay of interest totaling $223 billion.  This translates to an average interest cost of about 1.7 percent.  As the CBO notes, this interest outlay is less than what it cost to finance the national debt some years ago, when debt was smaller but interest rates were much higher.  Not surprisingly, the CBO predicts higher interest rates in the future.  By 2026, the net interest cost is $830 billion, which averages out to 3.5 percent of the total predicted debt of $27.7 trillion.   These are still very low average borrowing costs, looking back to recent history.  But all of this depends on many variables -- CBO points out that a mere one percent variation in interest rates could affect the deficit figures by over $1.6 trillion, plus or minus. 

Can we afford to continue these trends?  Probably not.  If interest rates rise modestly above current levels, interest costs will constrain the government’s ability to engage in discretionary spending.  Governments require trust in order to sell securities to finance their deficits, and fiscal unsoundness does not engender trust.  (Of course, monetizing debt remains an option – look at a “federal reserve note” in your wallet – it pays no interest and has no maturity date.  But this is not a good option if government wants to maintain the dollar as the world’s reserve currency.)  Gridlock in Washington seems to be keeping us on the same path, but it is a road to perdition. The CBO results are likely on the optimistic side, assuming no economic downturns in the coming decade. 

Conventional solutions to these problems are not easy to implement. Constraining federal spending is a tough political bargain, as mandatory spending through entitlement programs, including social security, healthcare, and higher education subsidies, are popular.  Some candidates even promise to grow these benefits.  (Santa Claus, are you listening?) Raising taxes is also a tough bargain, which entails risk of slowing economic growth.  But growth is a key.  The CBO figures assume that GDP will grow at a higher rate than average in the early part of the next decade, but then at an average rate of 2 percent, adjusted for inflation.  Herein lies the problem – and a potential way out.
We should be focusing more carefully on growth.  Cooter and Schaeffer in their book, Solomon’s Knot, focus on the power of growth in bringing positive changes to society.  The math is simple:  over the course of a century, a 2 percent growth rate increases wealth by about seven times.  In contrast, a 10 percent growth rate increases wealth by about 14,000 times (13,780.61 times, to be precise).  If you care about redistributing wealth, isn’t it better to have more to redistribute?  And if you want the government to engage in spending to help people, isn’t it better to have more national income?  So argue Cooter and Schaeffer.   Query how the debate would change if we begin evaluating policy prescriptions through a lens that focuses on the impact on growth.  (And in case you wonder, protectionism is not a pro-growth policy.  See my colleague Ernie Goss’ previous post.) 
[Note:  This blog was previously published at the blog site of the Institute for Economic Inquiry, where I also write.  Feel free to check in there for other blog posts:]
Ed Morse

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