Professor Paul Palley's
          Economics Seminars

Here is a link to a very good article about the U.S. government’s total debt position and the government budget deficit: http://www.nytimes.com/2009/06/10/business/economy/10leonhardt.html?hp

As we know, the President and Congress enacted expansionary fiscal policies to stimulate the economy out of the recession that started December 2007. These policies are the classic response when an economy is confronted with a deep recession, and the vast majority of economists agreed with this sort of policy response. The result was larger budget deficits, and these deficits became an issue much debated in the news. What is the source of this debate? Some are logically focused on the problems related to dealing with the debt in the future. Higher taxes and restraint on government spending will be required. This will slow economic growth at the same time in which households need to restrain their own spending and reduce their debt, and this will further hamper economic growth. Productive investments in infrastructure, research and development, education, and other investments will be needed to support economic growth. On the other hand, there are those who are politically motivated who are opposed to the economic stimulus efforts that were enacted because they wanted to fight against programs they are opposed to or want to promote their own political agenda.

As the article I identified above points out, the programs promoted by President Obama are responsible for only a small portion of the deficits. The sources of the deficits that started in the early 2000s after budget surpluses existed prior to President Bush taking off include; the business cycle, the large tax cuts enacted after President Bush took off, large increases in government spending, and finally President Obama’s policies.

Congressional Budget Office (CBO) data indicated that 37% of the deficit is the result of revenue reductions due to the recession in 2001, and the very deep recession that started December 2007. Also, recessions trigger increases in spending on government safety net programs like unemployment insurance and welfare programs (this spending does tend to both help those in need and decrease the depth of an economic downturn). The CBO reports that about 33% of the deficit is due to legislation signed by President Bush and the war in Iraq. This includes tax cuts, changes to Medicare, and other programs. An additional 20% has resulted from President Obama supporting continuation of these programs, including the war in Iraq. The remaining 10% is due to the stimulus bill signed buy President Obama in February 2009 (7%) and President Obama’s agenda on education, energy, and health care (3%). The reasons for the relatively smaller impact of President Obama’s programs are that some do not cost the government money or are funded by tax increases or reductions in other spending.

The problem is that plans are not firmly in place to unwind this debt or reduce the deficit in a prudent way. Economists do agree that health care reform is a necessary condition for dealing with long-term fiscal deficits as this is required for dealing with rising Medicare costs. The question is, will the plans accomplish its positive goals while also reducing costs in both the near term and long-term. Most economists do agree that it will restrain costs in the long-run, but not necessarily the short-run. Another issue not mentioned in the article is spending by the Pentagon. It is believed that the U.S. spends more on defense than the entire rest of the world combined. Do Americans want to continue this? This is a debate that has not really begun in a significant way.

What is needed is restraints on spending and increases in taxes. Given this, let’s look at the data to identify trends. The CBO offers the following useful historical database: http://www.cbo.gov/ftpdocs/100xx/doc10014/HistoricalMar09.xls.

The data tells us the following. First, when we look at table F-2 we see that U.S. government revenues as a percentage of GDP during the period of 1969 to 2008 have fluctuated between about 16% and 21%. The adjustments have tended to fluctuate due to changes in economic growth. We see declines in the early and mid 1970s, early 1990s, and 2002 and 2008 due to recessions. The increases in the late 1990s correspond to strong economic growth. That being said, the declines in the mid-1980s, and the low numbers in the period of 2003-05 correspond to periods of large tax reductions that occurred prior to these years. The figure of 17.7% in 2008 is clearly a relatively low number on a historical basis. Outlays or expenditures we see have exceeded revenues as a percentage of GDP consistently since the 1970s, except during the period of 1998-2001 when budget surpluses were run. It should be noted that the period of 2002-2008 in this table is a period in which the U.S. was at war and still tax cuts were enacted. One can interpret the data as indicating that the people of the U.S. are unwilling to pay for its government.

It is interesting to review sources of U.S. government revenues as a percentage of GDP when evaluating this data. Table F-4 indicates that individual income taxes as a percentage of GDP has fluctuated between 7.0% and 10.3%. The high years came as expected during a period of very strong economic growth in the late 1990s to 2001. We see that individual income taxes as a percentage of GDP is relatively low today. Estate taxes are much in the news. It is clear from this that at only 0.2% of GDP this is clearly not an issue for the vast majority of people in the U.S. See table F-8 for defense, international, and domestic discretionary outlays as a percentage of GDP. We see that defense spending as a percentage of GDP has steadily increased since 2001. International spending is often attacked, but this is relatively very low. It is table F-10 where we see slow but steady increases in Medicare and Medicare and this indicates why this is in focus so much now.

What do you think?

The deepest recession since the Great Depression started at the end of 2007, and the depth of this downturn, exacerbated by the financial crisis, indicates a slow and relatively weak recovery. Heading off a complete collapse of the financial system in the U.S. and globally meant the avoidance of another depression, but real financial issues continue to plague the economy. The biggest issues remain the significant amount of mortgage and other debt being serviced by households that limit household consumption. Second, the right balance between regulation of the financial services industry and reliance on market solutions is required. The series of efforts to deregulate the financial markets since 1980 have been coupled with a series of financial crises the likes of which had not occurred between the regulatory efforts in the 1930s and 1980. The fact that the financial markets need to reestablish a proper footing and that it is hard to see how household consumption can lead the economy indicates the need to identify what is needed to foster sustainable economic growth. The best place to start this analysis is to look at the factors that sustain and increase productivity over time. These factors include labor and human capital, capital (plant, equipment, and infrastructure), natural resources, and technology. As a result, the best efforts to sustain and grow the economy will depend on the success businesses, government, and individuals have in investing in these productive factors.

Efforts to improve the productivity of labor will depend on the degree to which society successfully invests in its current and future workforce. This requires investments in education at the K-12, college, and post-graduate levels. It is also important to invest in job training and for employers to invest in their employees. The fact that educational attainment in the U.S. at the high school level in critical areas like math, science, and language skills is at or near the bottom of industrialized countries indicates a need for both reform and investment. What this means at this time is that workers in the U.S. who do not go to college are very likely to be at a competitive disadvantage relative to those in other counties in terms of productivity and work skills. Fortunately, colleges and Universities in the U.S. perform very well compared to those in other industrialized countries. Investment in research at the university level is very productive in that it leads to advances in critical fields of study, new businesses and industries, and our understanding of the world around us.

Capital and infrastructure investments are essential to increase productivity, compete in a business environment that changes very rapidly in the U.S. and globally, and to facilitate communications and move goods and services. Modernization of plant an equipment increases productivity tremendously. We have, for example, all experienced this in our workplaces as we see the way computers facilitate our work efforts. We have also experienced this as communication infrastructure has facilitated information sharing, communications, banking and finance, and facilitating efforts by businesses to grow domestically and internationally. It is true that we are also behind in some very important areas. Here is an example, if any of you have flown into New York then you have probably experienced delays, and noticed the old and dilapidated airport infrastructure, and both of these factors lead to lost productivity. This is odd given the importance of the city. It is also odd when one compares the airports in New York with other much more modern airports in large and important cities internationally. The U.S. is also significantly behind in high-speed rail, and cell phone and communications technology. Investment in infrastructure and the modernization of capital creates jobs and sustains productivity. The fact is that data demonstrates that public investment in the infrastructure of this country, and education too, over the course of the last 25-30 years has been significantly lower than it had been during the prior 30 years.

Natural resources are critical inputs in the production of every product. This includes everything from food to automobiles and computers. The U.S. is a resource rich country. The one area in which this reality is challenged most often though is in energy production as the U.S. relies greatly on importing oil. The fact is that we consume far more oil than what we can produce or would be able to produce if all lands were open for oil production. As a result, this appears to be a real constraint, but it should not be. The reality is that once the global economy starts to grow then the demand for oil will increase more rapidly than supply can under any reasonable scenario, and the price of oil will increase. Given this, alternative energy sources will need to be developed. The U.S. should lead in this process because of its financial resources, research facilities, and universities. What is needed to facilitate this are the appropriate private and public investments in the development of transit, technological, and capital solutions. The benefits associated with this will include the development of new industries, companies, employment, and productivity opportunities.

Technology has figured in each of the above sections in different ways. Technology is at the most basic level knowledge. Research and development investments are what we most often think about when we think about technological development, but more is behind this. The foundation for the development of knowledge is education. The foundation for much of our science is pure mathematics, theoretical chemistry and physics, and experimental biology and medicine, and other theoretical or experimental efforts. It was mathematicians and physicists who led much of the development of computers and the Internet for example. In other words we will want to invest in the labs private businesses run, the research and library facilities at universities, and I the biology and physics lessons taught to high school students, and math lessons taught to children in a kindergarten class. We want people who ask questions related to why or how something works, or why not create a better way to do something, to have the tools to pursue solutions.

The point here is that to promote sustained economic growth over a long period of time the best way to do so is through a combination of smart private and public investment in the current and future labor force (education and job training), capital, infrastructure, natural resource and energy development efforts, and technology. What do you think?