Can We Cut Our Way to Prosperity?

February 28th, 2011 at 11:40 pm | 31 Comments |

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One economist from a moderately respected firm has made headlines with a report claiming that reduced government spending along the lines Republicans propose will cost about 700,000 U.S. jobs. In a narrow sense, of course, this is beyond dispute; in a broader sense, the reasoning behind the report is seriously faulty.

Let’s start where it’s right. If government spending declines, of course, the government will employ fewer people and pay less in wages. This will, of course, ripple through the economy and reduce non-government employment as well.  Insofar as government jobs do things that are economically productive on their own–maintain roads, running airports–there’s at least some chance that cutting spending will harm the economy in the short run. (And all this puts aside the necessity of investing in things like defense and education that pay off only in the long run.)

But, right now, there’s little evidence that the U.S. seriously underinvests in any of government’s truly productive functions (and some evidence that necessary functions like defense are bloated).  There is significant evidence that a big government and giant debts are holding back the economy by misallocating funds that the private sector could make better use of than the government. Although some countries–China–have, indeed, spent their way to significant economic growth, the best economic turnarounds have happened in places like Canada and New Zealand that have stabilized spending and kept it at reasonably low levels.

So yes, reducing government spending in the wrong way–theoretically–could hurt the economy but, on balance, evidence shows that a nation can, indeed, cut its way to prosperity.


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31 Comments so far ↓

  • PatrickQuint

    “Canada … [has] stabilized spending and kept it at reasonably low levels.”

    I… I just don’t know what to say. There is no emoticon to express how flabbergasted I am that a contributor to a conservative American website has claimed that Canadian spending levels are “reasonably low”.

    So what you’re saying is… the US should be more like Canada? Fiscally? Like… on a serious?

    Now, I’m not one for purity tests but there are Democrats who would go white at the idea of fashioning American policy after Canada.

    Canada got out of trouble more quickly because it limited exposure to junk mortgages (at least partially through smart regulation). The problem was never as big.

    • forgetn

      BTW Canada is no paragon of virtue here! The only reason it looks so good, is that the rest of the world looks so bad. Canada did most of the heavy lifting in the late ’90s where the rest of the world economy was on fire.

      The big difference is that Canadian don’t believe that tax cuts are the solution to all our problems! Although there have been concerted efforts to reduce taxes over the past 15 years, its no panacea.

  • balconesfault

    There is significant evidence that a big government and giant debts are holding back the economy by misallocating funds that the private sector could make better use of than the government.

    Where’s the evidence? When tax rates were cut to historic lows during the Bush Administration, the economy responded by collapsing in a historic way.

    Perhaps you’re learning the wrong lesson here.

    • KRH67

      I was literally in the middle of writing out that exact same comment when I refreshed and saw yours.

      However, I don’t think taxes are necessarily what he’s talking about… rather, debt load/gov’t expenditures.

      The point remains, however… what evidence? Outside of theory, of course.

  • mickster99

    Rightwing mythos:

    Cutting government spending is the way to prosperity?
    And when was this policy actually implemented and proven to work?
    Anybody?
    Reagan? No.
    Bush I? No.
    Clinton? Maybe.
    Bush II? No?

    And we should also include tax cuts pay for themselves?

    Mr. Lehrer works for a rightwing thinktank. He has a master degree and wrote this thesis on FEMA and insurance practices.
    So he’s an expert on economic policy now?

    Where’s the proof.
    Goldman Sachs predict the rightwing budget cuts will reduce the GDP by 2%.
    Add 900,000 to the unemployement lines.

    Again where’s the proof?

    You haven’t a leg in the real world. You are dreaming up fairy tales to make the tea baggers feel good. So 42, 000 poor families loose health insurance because the Governor of Indiana doesn’t possess the cojones to raise taxes.

    The think tank of mr. Lehrer is becoming a stink tank really.
    No thinking is really go on there.
    Just doing the trench work for rightwing sounds bites.

    He is no a credible speaker on the economy.
    W was about as credible as Lehrer.

  • Rabiner

    “But, right now, there’s little evidence that the U.S. seriously underinvests in any of government’s truly productive functions ”

    Actually there is a lot of evidence that the U.S. seriously under invests in infrastructure: roads, rail, damns, levees, airports, internet, electric, all of it. Each of these types of infrastructure are outdated in the United States.

  • Juggernauzt

    Agreed we don’t underinvest in infrastructure but we do overpay for roads, bridges, defense sector everything and of course we overpay for the cost of medicine, medical products and equipment. If we dicuss cutting any of the those, expect contractors and corps to threaten layoffs to keep the money flowing. So we have to expose the real cost of goods and demand they sacrifice for the greater good of the country.

  • Xunzi Washington

    [quote]But, right now, there’s little evidence that the U.S. seriously underinvests in any of government’s truly productive functions (and some evidence that necessary functions like defense are bloated). There is significant evidence that a big government and giant debts are holding back the economy by misallocating funds that the private sector could make better use of than the government. [/quote]

    Rabiner is right – infrastructure? And beyond that, what is the metric to determine whether we are “underinvesting” such that you know we are not? And where is your evidence that we are holding back the economy in other areas? Since there is “significant evidence” you’d think you could share some.

  • ottovbvs

    “In a narrow sense, of course, this is beyond dispute; in a broader sense, the reasoning behind the report is seriously faulty.”

    The conclusion is correct but the reasoning is faulty…Okaaaay

    “but, on balance, evidence shows that a nation can, indeed, cut its way to prosperity.”

    Would you like to give us some actual evidence. I don’t know too much about NZ but I can’t wait for you to explain how Canada which didn’t have a housing bubble and was largely unaffected by the financial meltdown “cut it’s way to prosperity.” Of course on the othe hand we have the UK, Greece, Ireland, Portugal all making massive cuts and all in the tank.

    How old is Lehrer, and does he actually have any economic education?

    And what evidence is there the govt is holding back funds. US corporations are sitting on the greatest cash pile in their history. Financial institutions are loaded with cash and are having to park it in low yield t bills.

  • Stan

    We’re headed for a repeat of the 1937 Roosevelt recession, and we’ll get it for the same reason: sharp budget cuts at a time of high unemployment, weak demand, and the inability of the Federal Reserve to increase business spending by lowering interest rates. Is there anybody in the Republican party with any knowledge of economic history who might talk sense to his party colleagues?

  • Rob_654

    Goldman Sachs also released a report that the Republican plan will reduce US economic growth and I would hardly consider Sachs a “moderate” voice…

  • Non-Contributor

    “evidence shows that a nation can, indeed, cut its way to prosperity.”

    Same comment as above.

    What evidence? Again, nothing at all is presented other then a tangential relationship to an obscure undefined solution. Canada and New Zealand please explain that relationship?

  • Elvis Elvisberg

    Eli Lehrer doesn’t care about black people.

  • Tempest in a Frumpot

    From today’s New York Times story about how school budget cuts are forcing boys out of athletics and into boxing:

    He used to play football and run track at Robinson Middle School here until both teams were disbanded for austerity reasons. On a recent snowy Monday, he flings a wild right hook at the punching bag, steps back and takes a self-conscious look around Bang ’Em or Hang ’Em, a gym that is suddenly overflowing with young, sweaty boxers.

    “Every time my nose gets hit, it starts bleeding,” the fighter, Antonio Ellison, says quietly, rubbing his face gently with his boxing glove’s padded red knuckle. “I’m really scared for my first fight.”

    Antonio, 14, is among the hundreds of Toledo youths who have discovered boxing this year after the public school system, facing a $39 million deficit, cut its athletics budget. It is a scenario that is being played out across the country, as high unemployment, falling home values and declining tax revenues continue to batter school finances. …

    • think4yourself

      Tempest, I’m not sure how your post relates to the article. The schools are cutting football and track so the kids go to public gym to learn boxing – how is this bad in and of itself? I wouldn’t say that boxing is any less redeemable sport than football and Antonio can learn to box without having to compete as a fighter. Football is a hugely expensive sport and generally designed to weed out the kids (at the parents & schools expense) to find the few that can go pro. I would rather see a school invest smaller amounts of funds on a well-designed physical education program that leads to better health for all of it’s students then spend millions on football and track programs designed to create hero’s out of a few students.

      As to the article itself, no I don’t believe you can cut your way to prosperity. On the other hand, you can’t spend your way there either. We are currently spending more every year than we take in, not counting extra-ordinary expenditures such as Iraq/Afgan wars and short term stimulus. So you need to have enough money coming in to cover basic costs. That will mean cuts. The challenge is how to make the right cuts, since if I cut something of yours, you lose it, even if it’s not to society’s benefit that you have it (case in point most agricultural subsidies).

  • JimBob

    Yes we can!! Canada spends 11 percent of GDP, down from 17.5 in just 8 years. Under the Chicago street hustler spending as a percent of GDP has risen to 25 percent of GDP. In 2009 Barry Hussein was urging Europeans to follow his lead and crank up spending levels. England and France did. But Angela Merkel in Germany looked at Hussein like he was nuttier than a fruitcake and held the line on spending. Germany’s economy is the healthiest in Europe.

    Go back to 1920 and the forgotten depression. Unemployment went from 4 percent to over 12. GNP declined 17 percent. Instead of an economic stimulus, President Harding slashed and burned the budget by half from 1920-22. He also slashed tax rates and reduced the national debt by 1/3. By 1923 unemployment stood at 2.3 percent.

    Bush the Democrat controlled congress and Barry Hussein have done everything wrong. The evidence speaks for itself.

  • Saladdin

    No, in fact wasn’t Greenspan screaming that budget surpluses were bad for the economy? Therefore, no, we cannot cut our way to prosperity. Like anything, there has to be a mix of ideas, some tax increases and some tax cuts would be ideal.

    Interesting read about the Bush tax cuts

    http://www.thefiscaltimes.com/Columns/2010/09/17/Bush-Tax-Cuts-No-Economic-Help.aspx

  • Saladdin

    England and France did. But Angela Merkel in Germany looked at Hussein like he was nuttier than a fruitcake and held the line on spending.

    JimBob, you’re wrong:

    In January 2009 the German government under Angela Merkel approved a €50 billion ($70 billion) economic stimulus plan to protect several sectors from a downturn and a subsequent rise in unemployment rates.[38] http://www.france24.com/en/20090106-germany-agrees-new-50-billion-euro-stimulus-plan

    Germany exited the recession in the second and third quarters of 2009, mostly due to rebounding manufacturing orders and exports – primarily from outside the Euro Zone – and relatively steady consumer demand.[34] from the CIA factbook.

  • JoeWalton

    The writer discusses public worker employment but ignores two other huge ways that government spending supports private-sector employment:

    1) As a customer. Government purchases a tremendous amount of both goods and services from private firms.

    2) Transfer payments that put money in people’s pockets, enabling them to spend more than they otherwise would. Examples are social security, food stamps, subsidized housing, and AFDC.

    The countries like Germany and Canada that weathered the financial crisis well without a huge increase in public spending had this in common:

    1) Financial regulations in these countries were in place that reduced the size of the housing bubble and the size of the crash. These countries did not experience the evaporation of wealth and subsequent contraction in private spending that we did. For them, the main problem of the crisis was the contraction of spending by their customers in other countries.

    2) Countries like Germany and Canada provide – in good times and bad – social services that support demand and ameliorate poverty. They didn’t have to do something extra because of the crash, because they already had the policies in place to handle it. There really is only one developed country in the world where an accepted policy response to a period of abnormally high unemployment involves: 1) denying health insurance to the poor, 2) denying income support to the unemployed, and 3) cutting a large number of state and local public workers.

    The huge and temporary contraction in private spending caused by the crash can only be counteracted by:

    1) Government purchases of goods and services from private firms to support private-sector employment.

    2) Government transfer payments that enable people to spend more to support private-sector employment

    3) Cutting taxes. Tax cuts affect demand like transfer payments, putting more money in people’s pockets. Tax cuts can also be targeted to reduce the cost to employers of hiring additional workers, which will also support private-sector employment.

    All three of these responses increase the deficit. Big as the numbers are, we shouldn’t be spooked by them because they are temporary. It is the long-term numbers that we need to worry about.

    The writer states that government spending will misallocate funds that the private sector could use more efficiently. This is mistaken. During a time like this, the problem is that the private sector won’t invest enough because it doesn’t see enough demand for its products. If government doesn’t borrow the capital available for investment, it will just sit around doing nothing. In recessionary times, government does not compete with the private sector for capital.

    Finally, the writer doesn’t see any evidence that government is under investing in public facilities. Hurricane Katrina and the bridge falling down in Minneapolis might be considered such evidence. While our more upscale localities are probably well supplied with public goods and services, the schools, roads, police, and public transportation in our poorer localities could all use an upgrade. Taken as a whole, I suspect that U.S. infrastructure does not compare well with Germany’s or Canada’s.

  • Saladdin

    During a time like this, the problem is that the private sector won’t invest enough because it doesn’t see enough demand for its products. If government doesn’t borrow the capital available for investment, it will just sit around doing nothing. In recessionary times, government does not compete with the private sector for capital.

    Joe Walton, amen. This is a demand issue, not a supply issue.

  • Saladdin

    I suspect that U.S. infrastructure does not compare well with Germany’s or Canada’s.

    The state of our railroads will tell the story. With trains running on 100 year old tracks, there’s going to be a bad accident at some point soon.

  • Pericles

    John Taylor addresses this very point (and suggests that David is wrong that the GOP’s efforts to get the budget in line is not an “economic program” that will increase economic growth and employment):

    http://johnbtaylorsblog.blogspot.com/2011/02/goldman-sachs-wrong-about-impact-of.html

    Too much unproductive capital being wasted on government is always a drag on the economy. This is something David needs to re-learn from his own brilliant book Dead Right.

    • Stan

      If government spending is crowding out private investment, this must mean that interest rates are high and that corporations are starved for cash. Is this what’s happening, Pericles?

  • Pericles

    Stan,

    Your comment about interest rates and corporations starving for cash assumes a stable monetary policy. Meanwhile, in the real world, the printing press is running non-stop. It also assumes no worries about the future.

    To paraphrase the dude in the movie “The Graduate”, I have one word for you son: debt.

    Read your John Taylor:

    http://online.wsj.com/article/SB10001424052748704268104576107951413818460.html?mod=googlenews_wsj

    • Stan

      Pericles, I didn’t assume a stable monetary policy when I wrote my most. In fact, I didn’t assume anything. I’ve read repeatedly that corporations have lots of cash they aren’t spending because they don’t think there’s sufficient demand for their products to justify expansion. I can see for myself that interest rates are terribly low. I infer from this that the big problem we have now is low demand due to high unemployment. The post by John Taylor doesn’t answer my question. It merely repeats the opinion of an economist who you agree with. My worry is that the spending cuts you favor will lead us to a repeat of the 1937 Roosevelt recession. When you come up with an article with some substance that supports your point of view, let me know.

  • Can We Cut Our Way to Prosperity?

    [...] Eli Lehrer, vice president of DC operations for The Heartland Institute, examines this debate and discusses the role of spending cuts and their effects on the overall economy. While spending cuts may hurt the economy in the short term, Eli contends, these cuts benefit the [...]

    • Stan

      Pericles, I agree that in the long run the budget should be balanced. That’s why I opposed the Bush tax cuts on dividends and capital gains and why I thought Bush’s Medicare D bill should have been funded by a new tax of some sort. These are issues that affect the structural deficit, along with Medicare, Medicaid, and Social Security. When your side comes up with something sensible that bears on the long term deficit, I’ll pay attention.

  • Joe In NH

    I agree as to the many comments as how we can not cut our way to prosperity. What I find disturbing is the focus on cutting spending in the middle of a downturn while we should be looking to grow revenue by growing the economy. That’s the way out of this mess. Of course you are going to run a deficit when tax revenue is down and demands for things like unemployment insurance, social security (people giving up on working and retiring early) goes up. I also find disturbing the focus on the deficit and little attention to the debt which will require significant structural changes. The deficit is different from the debt.

  • Saladdin

    The deficit is different from the debt.

    Yes, Joe it is… you can lead a horse to water…