Entitlement reform would indicate maturity
By Russ Roberts
The opinions expressed are his own.
Reuters invited leading economists and writers to reply to Larry Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Roberts’ reply. Laura Tyson, James Hamilton, Donald Boudreaux, Robert Frank, Benn Steil and James Pethokoukis as well.
Summers begins with a refreshing instance of honesty about the effect of the debt deal:
Despite claims of spending reductions in the $1 trillion range, the actual agreements reached so far likely will have little impact on actual spending over the next decade.
It is hard to reconcile this likely truth with the accusations coming from the left that Obama has caved and the Republicans are “terrorists” for “slashing government spending” but such is the nature of political life these days. Summers is also right about the importance of the baseline. When is a cut not a cut? When it’s a reduction from an artificially high baseline. There is very little austerity in the debt deal.
Summers next claim is harder to swallow:
The deal confirms the very low levels of spending already negotiated for 2011 and 2012, and caps 2013 spending about where most would have expected this Congress to end up.
Spending in 2011 is estimated to come in at $3.8 trillion or just over 25 percent of GDP. That’s the highest ratio since 1945 — in 2005, the ratio was under 20%. Calling $3.8 trillion dollars “very low” is very hard to understand, unless you see a crying need for an even larger number. And that brings us to the essence of Summers’ worldview, a view that is summarized in the title to his piece: A Debt Deal That Solves the Wrong Problem. The key problem, says Summers, isn’t that we spend too much, it’s that we spend too little to reduce the unacceptably high level of unemployment. According to Summers, growth is driven by aggregate demand and aggregate demand is driven by government spending.
What is the evidence that increases in government spending lead to growth? Very little, unfortunately. Defenders of government spending like to point to CBO estimates of 3 million jobs created by the stimulus package. But those estimates are not real estimates. The CBO did not look at the actual path of the economy and compare it to the path in the absence of increased spending. They confessed that that task was too difficult. Instead, they used past econometric relationships between government spending and employment, assumed that those relationships were unchanged, and mechanically entered the levels of government spending to yield estimates of job creation. That is the essence of assuming the answer you’re trying to discover.
Perhaps the recent stimulus was too small? Always a possibility, but hard to test. Was it poorly designed? Surely it was. Even proponents of large increases in government spending say now that it was poorly designed — the tax rebates were saved and the transfers to the states were ineffective. That accounts for about 2/3 of the money.
It’s hard to understand how these two arguments make the case for a new burst of even higher spending. It’s like hiring a contractor to build a house and discovering that he has underestimated the cost of the project and squandered much of the money that you gave him in advance. Would you give him the new amounts he is requesting?
What about the evidence on government spending from the historical record? There are two great natural experiments — WWII and its aftermath. True, measured GDP boomed during WWII when government spending surged to build tanks, planes and bombs. But the vaunted Keynesian multiplier should have stimulated the private sector. That didn’t happen because the private sector was starved and rationed — the military was using too many people and too much steel and other raw materials. Wartime was a time of austerity. When the war ended the Keynesians predicted a depression worse than the Great one. But the economy thrived and private sector employment took off despite the drop in government spending.
The problem we face isn’t inadequate government spending. The problem is that the private sector is profitable but cautious. How do we regain that confidence? One route is for Washington politicians to act like honest grown-ups instead of dishonest children. Serious entitlement reform that reduces the long-run budget pressure would indicate maturity. That’s a better strategy than spending more money in the short run.