There has been growing talk of the need to reign in reckless government spending. Regrettably, this talk is not based in any knowledge of economics or history.. Let me explain why.
A Brief History of the Deficit
According to the Bureau of Public Debt, the US has been running a structural deficit for the last ten years, not just the last year. Here is a chart of the total amount of federal debt outstanding at the end of each federal fiscal year for the last ten years:
09/30/2009 $ 11,909,829,003,511.75
09/30/2008 $ 10,024,724,896,912.49
09/30/2007 $ 9,007,653,372,262.48
09/30/2006 $ 8,506,973,899,215.23
09/30/2005 $ 7,932,709,661,723.50
09/30/2004 $ 7,379,052,696,330.32
09/30/2003 $ 6,783,231,062,743.62
09/30/2002 $ 6,228,235,965,597.16
09/30/2001 $ 5,807,463,412,200.06
09/30/2000 $ 5,674,178,209,886.86
The reason for this yearly increase of at least $400 billion in net new federal debt/year is simple: the US cut taxes but didn’t make a proportionate cut in spending. As a result, total debt outstanding increased.
If the austerity movement was really about the increase in federal debt, it would have emerged sometime after 2004-2005 when the US’ structural deficit issue started to emerge in the data.
A Brief Explanation of GDP
Gross domestic product is comprised of four elements. Consumer spending (C) + Investment (I) + Exports (exports-imports) + government spending (g). Here is the equation:
C+I+X+G = GDP.
According to the Congressional Budget Office, government spending has accounted for about 20% of US GDP since 1970.
In other words — government spending is always part of the national economic equation.
A Brief History of Austerity
Other countries have tried it.
Neil Shearing, economist at Capital Economics in London, said the real lesson from the region was that, “aggressive fiscal consolidation at a time when the private sector is also retrenching is likely to lead to much weaker levels of activity and a surge in unemployment”.
Much like Spain, Ireland and the UK, the Baltic states were badly hit by the bursting of a credit bubble in 2008 that sent their economies into freefall and their budget deficits soaring.
While others cushioned the impact with stimulus spending, the Baltic trio plunged straight into austerity. As a result, they suffered the deepest recessions in the European Union last year, with Latvia’s economy shrinking by 18 per cent.
The region has since stabilised but, for many ordinary people it still feels like a depression. Wages have plummeted while unemployment has rocketed, with more than a fifth of the Latvian labour force out of work.
As Europe’s major economies focus on belt-tightening, they are following the path of Ireland. But the once thriving nation is struggling, with no sign of a rapid turnaround in sight.
Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes, the type of austerity measures that financial markets are now pressing on most advanced industrial nations.
“When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”
Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.
Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.
In other words, the policy of austerity is an abject failure.
And what about the countries that use massive government stimulus? China spent $586 billion on their stimulus plan to thwart the Great Recession. Now they are having to put the brakes on their expansion to prevent overheating.
So what have we learned?
1.) This new found love of lower government spending is politically motivated. It has nothing to do with altruism or love of country. It’s about the November elections. Period.
2.) Government spending has been and always will be part of the the GDP equation
3.) Countries that tried austerity are worse off for it.
4.) Countries that inject massive amounts of the proper stimulus (such as infrastructure spending) grow at high rates.