Deficit hawks are once again circling the Capitol, spreading fiscal terror among the lawmakers. The bizarre result is that in the face of widespread unemployment, still mounting mortgage foreclosures and eroding real incomes for the vast majority of the country’s voters, the policy class has made concern over deficit ten years from now more important than job creation now.

President Obama has already proposed a freeze on domestic discretionary spending and ordered agencies to plan for cuts. And in February he appointed a high-level National Commission on Fiscal Responsibility and Reform to devise a plan by December to cut the fiscal deficit to three percent by 2015.

Given the checkered history of Washington commissions its specific recommendations may end up in a file drawer after the elections. But its impact is not likely to be in the budgetary details, rather in the way it reinforces or challenges the destructive myths that today dominate the national debate in Congress, the media and the polls.

The current within-the-beltway discussion about economic policy is driven by a misdiagnosis of the crisis in three ways:

• · The notion that the central problems of large-scale unemployment and deteriorating incomes have been resolved and that government should not expand its economic stimulus, but instead contract it in order to reduce future deficits.
• · the idea that austerity is needed to assure long-term prosperity.
• · The often deliberate effort to use the legitimate issue of deficit reduction to shrink the civilian public sector. As a result, “everything” is not on the table, as Obama has claimed, and the public remains confused about the real trade-offs.

Individually, most members of the Commission might not entirely subscribe to this misdiagnosis, but the obsessive focus on the long-term fiscal imbalance is dangerously limiting the political options for addressing the country’s immediate economic needs. Since effective policy solutions have to get the description of the problem right, the Commission’s first responsibility is to get the American people clear on the following:

1) The economy needs more stimuli, which requires a larger deficit now.

LAST YEAR’S $789 billion government stimulus commitment “worked.” It halted the drop in unemployment and growth, breaking the free-fall in the wake of the financial collapse. But by any reasonable measure, it was not enough to get the battered job market growing again.

Fifteen million Americans are out of work. Roughly 10 million more can only find part-time jobs or have disappeared from the labor force. State and local governments are shredding the social safety net. In a nation where the vast majority live paycheck to paycheck, 45 percent of the jobless have not worked in six months. And the fierce competition for jobs is shrinking the paychecks of those who still have them.

The basic economic problem is not very complicated: if no one spends, no one works. Since the financial market crash in late 2008, consumers, businesses, and state and local government have cut back on their spending. In order to keep people working, as the Great Depression taught us, the federal government must therefore compensate by increasing its own fiscal deficit. As jobs return, consumers resume buying, businesses respond by investing, and state and local government revenues grow. When we’re back to full employment, the federal budget should return to balance.

But its spending has to continue long enough to restore confidence among private investors that there will be enough income in the pockets of their customers to justify new investment, which will set off a new cycle of growth. Premature efforts to withdraw deficit support can abort the recovery. Thus, in 1937 Franklin Roosevelt’s advisors moved to balance the budget prematurely. The result was to spin the economy back into depression, from which it was only rescued by the spending of World War II

Serious people can have different opinions of the magnitude of what is needed. In my view, it is a minimum of $400 billion, which could generate over 4 million new jobs and put us on the road to recovery.

Yet, despite the polls showing that the chief concern of voters is unemployment, as of this writing Congress has been so frightened by the exaggerated threat of future deficits that it has not been able to muster the votes needed to sustain minimum parts of the safety net, such as extended unemployment compensation and aid to state and local governments who are eliminating assistance to the unemployed.

Don’t worry about unemployment, say the pundits of this new austerity consensus. It’s a “lagging indicator.” A hiring upturn is only a matter of time.

How much time?

The assumptions upon which the administration based its ten year budget projections show the unemployment rate remaining over 9 percent next year. By 2014 it’s still at 6 percent, leaving some 3 million more people out of work than before the current crisis began. In 2020, assuming ten years of steady economic growth without another recession, the unemployment rate is still expected to be higher than it was in 2007. Every administration wants to show an upbeat future, so if anything these numbers are optimistic. (Goldman-Sachs, mark Zandi and other private forecasters say the jobless rate will actually rise in 2011.)

Moreover, these figures appear inconsistent. For example, they assume that recovery will be driven by consumer spending. But in an era of prolonged unemployment and depressed wages, consumers can only spend significantly more by going further into debt. Yet the CBO/OMB models tell us that interest rates will rise, which, as economist Jamie Galbraith has noted, generates the explosive deficit projections for the future.

In effect, at roughly 10 percent official unemployment, the new “Washington Consensus” is calling for both a restrictive fiscal and monetary policy. This, at a time when the theory that monetary policy would have been sufficient to solve our problem has already been tested and failed. Exhibit A is that, as a result of the bailout and interest rate subsidies, banks’ reserves have risen from some $21 billion in 2007 to roughly $850 billion. Yet the financial system is still withholding credit. This is not because bankers do not want to lend or investment companies do not want to float bonds. It is because they have not seen any profitable business propositions—aside from increased merger activity—due to the low level of economic activity.

Federal Reserve chair Ben Bernanke has expressed the inevitable consequences of this policy: we will see high levels of unemployment for a “significant amount of time.” Unfortunately, that prospect is not sufficiently ominous to bring forth a change in strategy.

2) Austerity will not produce growth, it will undercut it.

The rationale for giving deficit reduction primacy over growth is that the bond markets’ fear of inflation must be placated. But as many people have pointed out, there is no evidence that the bond markets—as opposed to people who claim to speak for them—are worried about inflation. And the experience of the last two years should certainly have taught us the dangers of economic policies guided by those who confidently predict what these markets will do.

If anything, the evidence shows that Hoover-ist cutbacks in government spending during times of high unemployment have the opposite effect on financial players. Thus, in order to attract global investors, the Irish government tightened its spending. The predictable result was a slowdown in growth. This made Irish business prospects more risky and less profitable, with the result that international investors now demand a roughly 3 percentage point premium on their loans in that country.

President Obama has said, “We cannot rebuild this economy on the same pile of sand. We must move us from an era of borrow and spend to one where we save and invest; where we consume less at home and send more exports abroad.”

He is right. But finding consumers somewhere else is easier said than done. For thirty years, the United States has been outsourcing production and buying more from the rest of the world than it is selling. We have financed the resulting trade deficit by borrowing to the point where we are the world’s largest debtor nation. The list of products we no longer make in this country is a mile long.

Whatever one thinks about the wisdom of new agreements with Korea, Columbia, Panama, and others to expand trade, history is clear: exports may rise, but imports will rise faster. For the United States there is no other equivalent consumer of last resort willing to run large chronic trade deficits to facilitate our export-led growth. Europe is going through its own austerity program. Japan is not about to give up the trade surplus that has kept the country afloat during its own long recession. And China’s leaders are unlikely to sacrifice export industry jobs in order to reduce unemployment among Americans whose living standards are so much higher.

Thus, applied to the United States in 2010, the combination of domestic austerity and export-led growth almost certainly means Americans competing in the world on the basis of a drop in wages and living standards much more dramatic than anything that America’s leaders have been willing to admit. If so, the Commission has a responsibility to make clear the logical consequences of refusing to regenerate growth now.

Even over the longer term, without substantial changes in policy the United States will no longer be competitive enough to both expand trade and maintain living standards. Chief among those changes is large-scale sustained investment in human and physical infrastructure and incentives to develop new cutting edge technologies into products and services that can create jobs in the United States. This will require more, not less, domestic federal spending in these areas.

Given the low savings rate, today the money has to be borrowed. And if not now—with interest rates low, when?

In that context, the phrases “long-term” and “short-term” are misleading to much of the public. In macroeconomic terms there is no temporal measure for the moment when we should cut back on a deficit designed to stimulate the economy. It all depends on the economic conditions. Full employment remains the sensible and popularly supported priority goal for federal economic policies. Therefore, the trigger for deficit reduction should not depend on a certain date in the future but on the level and direction of the unemployment rate. John Irons of the Economic Policy Institute has suggested a rate of 6 percent and falling as a reasonable goal. Certainly that should be the earliest point for pulling back on the deficit.

Second, short-term damage to the economy has long-term consequences. In a brutally competitive global economy, we need to constantly train and hone the skills, knowledge, and experience of our work force. Research has shown that long term unemployment atrophies current skills. Given the absence of an appropriately financed world-class training system in America, it also discourages workers from keeping up with new ones.

Today, we have a huge shortfall in the investments needed to make the country competitive—over $2 trillion in infrastructure alone. Bringing our human resource investment anywhere near the level needed would at least double the amount we are now spending.

3) The problem is revenue.

It is no secret that many of those who promote deficit reduction, über alles, want to reduce the role of government in the domestic economy. The Commission should therefore make clear that there is no economic rationale for some superimposed limit on the government share of the GDP. It all depends on the country’s needs at the moment.

But the public has been thoroughly confused by the assertions that we are spending more than we can afford and that there is one kind of spending that is at fault—the so-called “entitlements” crisis.

By any reasonable measure, the citizens of the United States can collectively afford current levels of spending. That they do not tax themselves sufficiently is a result of political irresponsibility—the persistent message sent to the people that we can maintain the level of government spending we want without paying for it. The Commission should therefore use whatever influence it has to expose that fraud and make clear that, in order to do the things that the country needs, we will require more revenues.

Thus, for example, it should clearly reject any discussion over tax policy that seeks merely to shift the burden of taxes from one group to another—such as the increasing calls for a value-added tax on consumers to be used to eliminate or dramatically reduce what is left of the corporate income tax. And it should use its influence and moment in the spotlight to highlight the role of tax expenditures, which are in effect programs that benefit only those with sufficient income to take advantage of them.

Similarly, it should make clear that there is no one sector that is driving the spending side of the federal budget deficit. Through time, the country’s needs change. If for example the demographic shifts require more spending on assistance for the aged, then this is not, strictly speaking, a budget deficit problem. It is a problem of reordering priorities. This is the job of the elected representatives of the people and not the Commission.

The deficit projections no more reflect a crisis of “entitlement” overspending than they reflect a “crisis” in any other category of spending, like military spending or agricultural subsidies. The fact that a program area is expanding does not make it the source of fiscal imbalance.

 

The chances of the Deficit Commission challenging the myths that fostered its creation are not great. The Republican and Democratic co-chairs come to the table with the ideological baggage of business-class centrists Indeed, the Democratic chair recently suggested to his colleagues that they might be inspired by Britain’s new conservative coalition government for whom a ratio of 3 to 1 was a fair split between program cuts and tax invreases.

Still, all must certainly know that the bureaucratic cemetery is full of the reports of high level commissions. And there are probably enough members who agree that while deficits down the road are a problem, premature deficit reduction in an economy so delicately posed on the edge of a deep double-dip recession would be a disaster. Speaking up on that point is undoubtedly the most important contribution to the debate over deficits that they could make.

Challenge Magazine, September 2010.