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Robert Johnson: Austerity and stagnation real risk to debt-to-GDP ratio

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ROB JOHNSON: I believe there is a lot of rage in our society. I believe there is a lot of valid rage in our society. On July 31, the Pew Research group put out a poll about how Americans felt about the budget and the bailouts. Democrats, Republicans, and independents were almost identical in their response. Did the bailouts help poor people? No. Did the bailouts help the middle class? No. Did the bailouts help wealthy people? Yes. Did the bailouts help large financial institutions? Did the budget help large corporations? Yes. So I–and this is not the Pew language; this is my own. When the American people are enraged and they’re afraid, they believe (this is my conjecture) that they’re being given a choice, and the choice is whether to cut off funding of what you might call insuring and protecting elites, or whether to allow their shoulders to bear a tax burden in the future to protect those elites. I don’t think that’s a difficult question for them. The use of their fear about the budget deficits and about the use of public funding is being largely misdirected, and as Tom emphasized in the beginning of our presentation, fears of magic thresholds like a 90 percent debt-to-GDP ratio or mythologies that have to do with the painlessness of cutting deficits are playing on those fears, but they’re not sending things in a proper direction. I’ll talk a little bit about where I think fears are founded, but first let’s take a look at the Congressional Budget Office (CBO) and how, we believe, not only do they state the problem, but in some sense (this is Congressional Budget Office, which is paid for by taxpayers) has contributed to the amplification of these fears and some of the misdirection. As Tom in our research found, the CBO baseline at the end of 2009 was a debt-to-GDP ratio about 53 percent. We do not add in and they do not add in contingent liabilities, and there’s some argument that there will be losses associated with contingent liabilities and guarantees that the government has made. When I talk at the end of this talk about the cost-benefit analysis, where austerity versus stimulus are reintroduced as possibilities, the existence of those contingent liabilities will reinforce the case for stimulus. The CBO talks about, in a surprising development in August in a small table, that somehow previously in their budget profiles, their debt-to-GDP profiles, they hadn’t included the financial assets that the government holds. These assets offset the liabilities. Most people [who] go to business school or take economics learn that there are assets and liabilities on a balance sheet, and some of these assets are interest-bearing, and therefore reintroducing them is proper. And therefore the debt-to-GDP ratio net of asset holdings is somewhat less threatening than we had been led to believe in the January budget. And as–I’ll come back to the notion that–how growth and austerity can contribute to problems of debt and deficit, but let’s–. These are just the raw numbers. And you can see the profile between 2009 and 2020. The first column is the August and also January baseline, which shows the 2020 debt-to-GDP ratio getting up to about 69 percent. Net of financial assets, it gets up to 61 percent. And you can see the third column is the difference that the financial assets represented. By the way, CBO put this out, and they put it out in a table, but they didn’t exactly amplify or publicize this restatement of their numbers. And I really–I guess they left that to Tom and I, and we’re grateful for that. Finally, they have the President’s budget, the next column, which shows us magically touching on, in 2020, the 90 percent threshold, which we don’t think particularly matters. And I’ll come back to the high and low-growth scenarios in a moment.


I want to start with the think tank at the Brookings Institution, the Hamilton Project. And aside from the fact that I’ve always been confused because that group tends to emphasize free trade (and anyone who reads Alexander Hamilton’s report on manufacturing would be confused as to why they chose the label), I’ll pick on former director Peter Orszag, who is emphasizing that in 2050 we might see a 1 percent of GDP change because of the dynamics of Social Security and our debt-to-GDP ratio. And I will note that 19 very well known financiers fund the Hamilton Project, and in 2007-8 they did not see the financial crisis that raised the debt-to-GDP ratio in the United States by roughly 40 percent over the trajectory we expect to happen between now and 2015. So I am a little bit concerned that I’m supposed to go to bed at night and be fearful of the growth of Social Security in 2050 in the mind of experts who couldn’t, two years in front of them, see something that doubled our national debt as a proportion of GDP. But I’ll leave that to you to determine whether that fear is valid. Senator Simpson, on the Deficit Commission, talks about budget minnows and budget whales. And I guess I’m nominating Social Security as a minnow, as a non-issue, and I don’t think we’re going to gain very much. As a matter of fact, I used to work in the hedge fund industry, as many of you know, and when people talk to me and I hear people like John Podesta and others talking as though cutting Social Security in 2037 and beyond is going to add to credibility in the bond market, if I had a bond trader come up to me in a hedge fund and say that he really believed that, I’d probably fire him. And I’ll get to why I would fire him in just a moment, which is, if you’re doing a whale watch, the Moby Dick of the American budget problem has to do with Tom’s specialty of money in politics, concentrated interests, what Mancur Olson called the logic of collective action, and the people who are drawing on our budget and historically, throughout the history of industrial countries, have really blown out budget. What are the two things that blow out budgets? Financial crisis and wars. And when you look at the United States in this period where money politics is so rampant, as Dean Burnham and Tom described, the American people, if you properly measure the military, which is not just the defense budget but intelligence budgets, Energy Department budgets, Homeland Security Budgets, and everything else, are spending a much larger percent of GDP than any other country in the world. The United States, according to the late Chalmers Johnson, who I greatly admire, spends more than the rest of the world combined on defense. Now, we’re providing public goods for the world. I’m not going to get into plus and minus about that or this is a dreadful imperial thing. Leave that all aside. This is just a fact. The American people carry that on their back. And most of the people I know–. I was a graduate student–I was an undergraduate, excuse me, at MIT. I took courses from Dean and Tom at that time, and some of those on defense analysis. Many of the graduate students I knew at that time now work in defense planning. What do they tell me? Military budgets are not prepared primarily about threat structure and the need to build a force structure. They’re about pork and congressional districts and logrolling and moneymaking, they’re part of the money politics system, and our defense budget is way off course. Secondly, the financial industry, as Tom mentioned, in the aftermath of the Dodd-Frank bill, in the–with the continued persistence of too-big-to fail, with the continued lack of credibility regarding the ability to resolve and close large institutions, I think we’re in a position where the prospect of a contingent liability, another bailout, maybe not next year but sometime in the next 20, of large magnitude, with all the spillover costs that affect the cycle, create a downturn, trigger automatic stabilizers, lose tax revenue, could be a major factor in our budget dynamics, and we should be afraid of that. Anybody who calls themselves a deficit hawk should have been and should continue to be a financial reform hawk. Finally, the health-care industry. If I had one magic wand to wave over what to do about the budget, the thing that makes me scared, it would be we need very, very significant antitrust enforcement, single-payer, or maybe just Medicare for all, to reduce the cost of health care in the United States. When I look at the CBO budget, we borrow a table from Dean Baker, and they show the profile of the out years, something to be really scared of in health care. As Dean says, well, let’s just say the United States spent the same amount as these other industrial countries on health care–mind you, the United States spends more than double what the OECD average is on health care right now, and the World Health Organization ranks the United States 37th in quality–which is, by the way, well below each of these three others that are emphasized in Dean’s chart. If you’re going to be afraid at night, the thing you have to be afraid of, in my view, more than anything else, even more than a financial industry contingency, more than the military, is that the United States will not practice antitrust enforcement, make markets be markets, as Erica and I and others emphasize with regard to financial reform. We are not–what we are doing is letting oligopolies be oligopolies in the health-care industry, and that is the center of the problem. Finally, I come to this question, and you–looking at the two columns on the right-hand side. Starting with the debt-to-GDP ratio from the August baseline, forgetting about for the moment the net of financial assets, I did the experiment, which I said, if you were to raise productivity–. I thought CBO kind of shaded their estimates of productivity on the low side. But whether they’re right or wrong, I said, as an example, first of all, let’s say we add 0.5 percent a year to productivity growth and play it out. The GDP gets larger ’cause of the cumulative growth. I worked very hard with the people at Economic Policy Institute in using CBO rules of thumb to come up with what happens to the debt-to-GDP ratio, and it essentially drops by roughly–between 9 to 10 percent. At the terminal point 2020, what you see is a $23 trillion economy, which essentially says roughly 10 percent of GDP. You have $2 trillion that you could use in the coming 5 to 10 years to engage in a public investment program, and that public investment program’s spurring growth and spurring that productivity. That’s the bet I’m making. I’m not saying what truth is. What I’m saying is, do you think if we spend $2 trillion on education, infrastructure, and various other productivity enhancements, basic science research, in the United States, we could produce 0.5 percent higher and essentially come up with the same debt-to-GDP ratio as we have with the CBO baseline right now–which, by the way, in Tom’s and my view, is not in a danger zone? Alternatively, my low-growth scenario is one where I say the economy doesn’t migrate rapidly back to full employment, and without any further stimulus or infrastructure build-up, we sit in a place where the unemployment rate stops at 7.5 percent. Once again, it’s just a scenario, but when you trace out the implications of unemployment now in the mid-9’s coming down to 7.5 and staying there, you see that the debt-to-GDP ratio rises by 10 percent. So toleration of stagnation leads to a higher debt-to-GDP ratio than the baseline by roughly $2 trillion, and a vigorous investment program that is successful, produces a reduction by 10 percent in that debt-to-GDP ratio. Now, I don’t think the debt-to-GDP ratio is the be-all and end-all of our society’s goals, but I do conclude from this exercise–. First of all, I didn’t see CBO publish an exercise like this, which bothers me ’cause I used to work on the Senate Budget Committee and I used to think that there was an awful lot of fair play involved. There may still be; I just don’t see it in their reports right now. And secondly, I conclude that the risk to the debt-to GDP ratio is much higher with austerity than it is with productivity growth. I do note that CBO in their models wouldn’t find this result, because they attribute no productivity growth to public investment. But let’s take something very simple which we emphasize in our paper. The pharmaceutical industry benefits from research at the National Institute of Health, and they essentially, somehow, through magical process, espionage, and hiring, get most of the patents and turn them into products, into this–at a social level we all benefit. That’s listed as private productivity for the pharmaceutical industry, but the investment initiated in the public sector. So even if you don’t want to measure public sector as the productivity, public sector activities do augment what we might call crowd in and inspire private productivity. The–so I guess if I were a bond speculator I’d be worried if we don’t invest in America; if I were a citizen I’d be worried if we don’t invest in America. I wouldn’t believe in any of those ratios. And the thing I would fear most is that we don’t bring the health-care industry back into line with competitive principles in the market. Thanks.

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Dr. Robert A. Johnson - Executive Director of The Institute New Economic Thinking (INET) and a senior fellow at the Roosevelt Institute. Dr. Johnson served on the United Nations Commission of Experts on International Monetary Reform under the Chairmanship of Joseph Stiglitz. He is also the Director of Economic Policy for the Franklin and Eleanor Roosevelt Institute (FERI) in New York. Dr. Johnson was previously a managing director at Soros Fund Management where he managed a global currency, bond and equity portfolio specializing in emerging markets. Prior to that time, Johnson was a managing director of Bankers Trust Company managing a global currency fund. He also served as Chief Economist of the U.S. Senate Banking Committee under the leadership of Chairman William Proxmire (D. Wisconsin) and before that, he was Senior Economist of the U.S. Senate Budget Committee under the leadership of Chairman Pete Domenici (R. New Mexico).