Entitlement reform would indicate maturity

August 3, 2011

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 HamiltonDonald BoudreauxRobert 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.



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Posted by Summerstime | Report as abusive

With nearly 1/3 of US Government spending going for the support of the current government in Israel, it is irresponsible to suggest entitlement reform can solve our problems. American citizens have been paying “premiums” for social “insurance” for over a half century on the assurance that the country would make good on their claims in old age or catastrophic disability. The USA has a very large multiple of the assets needed to pay these claims. Why is it necessary to default on obligations to taxpayers while we spend nearly 1/3 of the budget supporting a country that has paid nothing into our country? How can abandoning our own elderly and disabled be less important than supporting a country that has given us little or nothing?

Posted by txgadfly | Report as abusive

[…] Russ, James Pethokoukis, and I were each asked by Reuters to contribute short responses to Larry Summers’s reflection on the debt-ceiling resolution. […]

Posted by Summerstime | Daily Libertarian | Report as abusive

@txgadfly – 3 billion a year is not 1/3 of the federal budget.

@ the author:
What sort of entitlement reform do you have in mind? No one who talks about it dares to get specific. That’s the biggest problem with politicians. They love euphemisms.

It’s easy to target the disabled, the retirees, and those on welfare. Or are you talking about people who you don’t think need it because they have substantial means? That may be more of a myth than you realize. But I can think of a few exceptional cases where you might be right.

So many entitlement payments are recycled within the public housing system, the nursing home industry, the medical industry etc. and even in support of higher rents for what are never the best apartments or even good apartments in most towns or cities. Has the author ever seem low-income housing? I’ve seen subsidized apartments in a northeast city and in NYC and you don’t (rather the gov’t) doesn’t get much for the money even with some tenant contribution in many cases. If one could see some real figures about the true size of unemployment in this country it could be a substantial number of people who might find they can’t afford their homes and apartments. That would further undermine the housing and real estate market. Unless cities and towns were willing to change occupancy requirements – that could mean a nightmarish situation of millions of homeless people.

Suburbs will balk at increased density in single-family homes, condos and apartments because so many of the middle and upper income people like communities that are pristine and guarantors of their investment. They won’t bend to relax rules for those who seek market rate housing through landlords who always factor in extra rent for occupancy that exceeds the terms of the lease, even for extended families. It could also transfer the burden of housing subsidies to cities and towns that are already strained.

This is a very different period than the WWII era. The fact that gold is climbing is some kind of indication that many people are very well off and hoarding their money in unproductive bullion. The savings that many people had accumulated during the period of war rationing fueled the post war boom. Since it was illegal to own gold it went to savings bonds and bank accounts and supported the public debt and the currency. That’s what kicked in after the war and helped fund the baby boom years.

BTW – it’s one thing to say “get a job”. It’s quite another finding one.

Posted by paintcan | Report as abusive

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Posted by James Pethokoukis | Analysis & Opinion | Reuters.com | Report as abusive

Just look at another Big Issue all the pols keep bringing up: the high cost of college. Obama talks about it all the time. 3 things. One, we probably have too many college graduates anyways. Two, more colleges could go co-op, I went to Northeastern and it took me 6 years but I paid a good part of my own way. Third, I suspect that college assistance is the reason tuition fees and college salaries of staff are so high and that it is government assistance that makes colleges expensive, if anything is. August 2 was very depressing.

Posted by threeRivers | Report as abusive

txgadfly: you’re not alone in the mistaken perception that Social Security is a form of insurance, where policy holders pay premiums that go into a big pot of capital reserves regulated in size so as to pay out forecast claims according to actuarial predictions.

It’s actually a Ponzi scheme. The first crop of people to get money from the Social Security system paid little to nothing (just like Bernie Madoff). The money they received came from younger people, who hoped that when they when they became older people, the younger people entering the system would then pay them. This works until the new money coming in becomes less than the money going out, which is what eventually happens in all Ponzi schemes. The Baby Boom generation is big. The generations behind it are smaller. The math is very straightforward. Absent some action, Social Security will collapse, just like the many smaller Ponzi schemes out there have.

Posted by Realist99 | Report as abusive

funny how this guy doesn’t mention how much the economy has shrunk since 2005, affecting the percantage of government spending versus GDP. typical economist who only spouts off half the numbers to make their point

Posted by jwws9999 | Report as abusive

The link to Larry Summers’ op-ed is broken. Please fix it or remove it.

Posted by dstrube | Report as abusive

@jwws9999 : Yes the economy has shrunk. But Government has not. And Government spending has gone up. At best, you are helping prove that the Government is irresponsible. Everyone else is losing their jobs, tightening their belts, yet the Government continues to grow and grow.

Posted by mjmayerjr | Report as abusive

Anyone who believes this pack of trollops in Washington and many of our State Houses will responsibly address the current fiscal situation our nation faces has either been oblivious or is deluded. The concept or even perhaps the definition of statesmanship escapes this current class of elected representatives. Our political parties are only concerned with maintaining or grasping power(getting reelected). What they say and do is little more than smoke and mirrors.

Posted by coyotle | Report as abusive

I just checked on online college degree program with a very obscure college. They want about $26,100 for a 13 to 16 month 90 credit per hour bachelors degree working at home with one’s own computer.

Entitlement reform won’t indicate maturity anymore than those who grabbed the inefficiently loaded lifeboats of the Titanic indicated public spiritedness.

It is simply that those in the boats have to spend a great deal of time for the rest of their lives arguing with themselves that their own welfare was somehow better for society as a whole. Good Luck trying!

There will be many more riots in the street. Its very difficult not to when one find oneself freezing to death.

Posted by paintcan | Report as abusive