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Spending Cuts May Be Answer to Slow Economic Growth

A Commentary By Michael Barone

Thursday, March 07, 2013

The Dow set a new high on Tuesday, but the larger economy is a different story. What if today's sluggish economic growth turns out to be the new normal? That's the unsettling question asked by some of our most creative economic thinkers.

And the people asking it are not necessarily partisan opponents of the Obama administration. They argue that economic growth rates were disappointing even before the financial collapse and recession of 2007-09.

Take Tyler Cowen, author of the e-book (belatedly published in print) "The Great Stagnation." Economic growth is the product of increases in the labor supply and productivity, he argues uncontroversially.

But the U.S. labor force -- even assuming we get back to full employment -- is not increasing as rapidly as it did when baby boomers and Gen Xers were reaching their working years.

As for productivity, Cowen argues that we simply haven't had the kind of innovations in technology or means of production that we saw in the late 19th and early 20th centuries.

Advances in information technology, he writes, have produced nothing like the productivity gains produced by the development of electricity, the synthesis of ammonia, the invention of the internal combustion engine and the development of new metal production technologies -- gains documented in Vaclav Smil's book "Creating the Twentieth Century: Technical Innovations of 1867-1914 and Their Lasting Impact."

In response to Cowen, Megan McArdle of The Daily Beast writes, "We are not prepared for low growth: culturally, economically or psychologically."

In a fast-growth economy, it makes financial sense for young people to borrow and for government to transfer money from current earners to the elderly.

That's why we had government policies subsidizing people borrowing to buy homes and pay for college.

Unfortunately, those policies produced windfall gains for unscrupulous mortgage originators and university administrators. And they produced the housing bubble that burst in 2007 and the higher education bubble that is in the process of bursting now.

Politicians have been searching for policies to restore the status quo ante bubble.

But in a slow-growth, new-normal economy, it doesn't make sense to borrow to buy a house whose value will only stagnate. It doesn't make sense to take out college loans for degrees that won't get you a job.

Recent data indicate that young people are taking on less debt than in the recent past and that applications to many universities are sharply down.

And the policy of transferring money from current workers to retirees -- Social Security, Medicare -- simply isn't sustainable if current workers aren't going to be producing and earning substantially more than those they're subsidizing.

As McArdle writes, "Government accounting is explicitly based on the assumption that spending grows, in real terms, every year -- difficult to achieve unless the economy grows at least as much."

Which suggests a question: Is new-normal slow growth inevitable? Even if you accept Cowen's argument that productivity-enhancing innovation occurs sporadically, can't America do better than it has in the past five (or, if you like, dozen) years?

Barack Obama has been trying to stimulate the economy with record-high government spending funded by higher tax rates and Fed Chairman Ben Bernanke's low interest rates.

But as Stanford economist Michael Boskin points out in The Wall Street Journal, "Japan tried that, to little effect, in the 1990s." Slow growth has become the new normal there.

There are alternative policies. One is to cut government spending, or cut it more than you raise taxes. As Boskin points out, the Netherlands in the mid-1990s and Sweden in the mid-2000s "stabilized their budgets without recession (with) $5-$6 of actual spending cuts per dollar of tax hikes."

And he notes that Canada reduced government spending in the mid-1990s and early 2000s by an amount equal to 8 percent of gross domestic product

Those cuts weren't painless, but they put Canada on a trajectory different from ours. Canadian voters value budget surpluses, and Canada managed to avoid almost all the bad effects of the 2007-09 recession.

Of course policies can't be transported mechanically from one country to another. Circumstances and customs inevitably differ.

But a strong case can be made that our current policies threaten to make slow growth the new normal. And that would be profoundly painful in ways we are only beginning to imagine.

Republicans are being attacked as irresponsible for allowing the relatively small sequester cuts to occur. But maybe that was the responsible thing to do. Maybe it would be responsible to cut spending even more.

Michael Barone, senior political analyst for The Washington Examiner (www.washingtonexaminer.com), is a resident fellow at the American Enterprise Institute, a Fox News Channel contributor and a co-author of The Almanac of American Politics.

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