March 27, 2017
It would be a much better world if the people involved in economic policy debates understood basic economics. Unfortunately, such knowledge is sorely lacking in Washington.
Robert Samuelson gave us a great example of accounting ignorance in his column where he pushed the idea that the budget should be near balance when the economy is close to full employment. There is of course an important economic point; if we believe what economists thought about prime age (ages 25 to 54) labor force participation rates back before the recession, we are still around 2 million jobs below full employment.
But leaving such trivia aside, there is the accounting issue of having a balanced budget at full employment. Samuelson cites economist Herbert Stein as his authority on this point. It is important to note that Stein made this comment when our trade was much closer to balanced.
This matters because if we have a large trade deficit, it was $540 billion (around 2.9 percent of GDP) in the last quarter, then this is a reduction in domestic demand compared to a situation in which trade was balanced. This $540 billion is creating demand in Europe, Canada, China, and elsewhere , not in the United States.
With this sort of drain on demand, we have to make this up from some other source. We can pray to the god of incentivizing entrepreneurs and hope that we will get a huge investment boom, but adults don’t believe in this nonsense. Investment has moved within a fairly small range as a share of GDP over the last half century. At best, we can hope that good policy will lead to very modest gains in investment as a share of GDP – not enough to make up for a trade deficit of 2.9 percent of GDP.
We can hope that consumers will go on a huge spending binge, boosting the economy with a consumption boom. The problem is that this is both unlikely to happen and it’s not clear that it’s good if it does. If people spend more, it means they save less. Sorry folks, that’s definitional. If we think it’s good that people have money to support themselves in retirement, we shouldn’t want them to spend too much. As it stands, savings is at a relatively low level by historical standards (around 5 percent of disposable income), but it is higher than it was at the peaks of the stock bubble in the late 1990s and the housing bubble in the last decade.
This brings us to the last possible source of demand to offset the drain from the trade deficit. We can have an asset bubble. In the late 1990s, in addition to boosting consumption, the stock bubble did also boost investment as 20 year-olds were able to get billions from initial public offerings for hare-brained ideas that didn’t have a prayer of success. In the last decade, we had a surge in residential construction, as house prices rose out of line with historical precedent and the fundamentals of the market.
Perhaps Robert Samuelson hopes for another bubble, but most folks probably would not share his enthusiasm in this area. This leaves us with budget deficits; there is nothing else in the bank to make up for the shortfall in demand. (We can look to reduce supply by reducing work hours – work sharing, more vacations, etc. — but this is too complicated for Washington policy types.) In other words, if we have a large trade deficit, we need large budget deficits to have full employment.
There is one other point worth noting about budget deficit fetishism. Direct government spending is only one way in which the government pays for things. Right now we have Donald pledging to pay for $1 trillion in infrastructure spending with tax credits to the private sector. Ignoring the future tax loss from these credits, the private companies undertaking the investment expect to get paid by tolls and other revenue sources.
If we paid for the infrastructure directly and then had the government collect tolls this spending would count as part of the deficit and contribute to the national debt, however because we have the private sector collect the tolls it doesn’t count. This difference may make Robert Samuelson and the deficit hawks happy, but it has no meaning in the real world. We will be paying just as much in tolls in both cases (probably more in the private route, since they want a profit).
The other big route through which the government pays for things is by granting patent and copyright monopolies. This is clearest in the case of prescription drugs. We can pay for research directly, which we do to a substantial extent as we give $32 billion a year to the National Institutes of Health. However we can also give drug companies an incentive to do research by granting them patent monopolies.
As it is, because of patent monopolies and related protections, we will spend around $440 billion this year on drugs that would likely cost us less than $80 billion in a free market. This gap of $360 billion (1.9 percent of GDP) is effectively a tax that we allow the drug companies to impose on the public (and the government since much of it is paid out by public programs like Medicare and Medicaid) to pay for their research. We allow the software industry to collect similar taxes in addition to the entertainment industry and other sectors with substantial intellectual property claims.
Anyone concerned about the burdens we are imposing on future generations would be focused on these other ways in which we will effectively be taxing them. However the folks like Samuelson, who want to cut Social Security and Medicare, will yell about the deficit.
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