All We Need is Growth

Economic growth alone won’t cure America’s debt problems. Megan McArdle reports.

Another day, another article arguing that we shouldn't be focused on deficits when the real problem is economic growth. EJ Dionne argues, drawing on Bruce Bartlett, that much of our deficit is driven by "one time factors" like the Bush tax cuts and the financial crisis. Return to economic growth, and our problem goes away.

The logic is, of course, absolutely correct. Though I try not to use too many household metaphors when talking about national finance, here's one that fits. There are two ways to pay off $30,000 worth of credit card debt on a $40,000 income: radical austerity, or increasing your income. Of the two, adding income is probably less painful, which is why Dave Ramsey frequently advises listeners to pick up a newspaper route or deliver pizzas for a while.

With robust economic growth, our debt-to-GDP ratio will start to decline, our tax revenues will start to rise, and the rolls of programs like unemployment insurance and food stamps will start to fall. All sorts of problems start looking easier with robust economic growth.

So why are people focusing on the tedious and painful business of austerity, when growth would be so much better? For the same reason you've probably opted to pay off the Mastercard, rather than waiting until you have time to publish a bestselling novel: it's not so easy to deliver robust economic growth on demand. Whatever you may have heard, no one has a plan in their pocket to increase the trend rate of economic growth--indeed, so far we've failed to get it back to the levels that preceded this "one time factor". Telling budget wonks that "we need more growth" is a bit like telling a cancer patient "you need more health". I mean, yes, Dr. Insight, but can you be more specific?

To be sure, we do know how to boost growth in the short run: borrow a bunch of money and throw it into the economy. But this is exclusively a short term strategy. Moreover, stimulus doesn't fix our budget problems; it increases them. The current federal tax take is somewhere south of 20% of GDP. That means that for stimulus to pay for itself, budget-wise, it needs to have a multiplier of 5--which is to say that every dollar the government spends must generate $5 worth of GDP growth. Recent estimators of the multiplier during the Great Recession were more like 1.5, which means that for every dollar we spent on stimulus, we generated an additional 10 cents in tax revenue. This is not a financing strategy that can be kept up forever. A lot of liberals seem to be thinking of stimulus the way that some conservatives think of tax cuts: as a sort of perpetual motion free money machine. There is no such thing.

Of course, we don't have to; at some point, presumably, we return to higher growth rates. But there are still reasons to worry:

1. Every year that we delay returning to trend growth (hopefully by way of a few years worth of above-trend growth), makes future finances considerably worse. We are currently in the demographic equivalent of our peak earnings years: most of the baby boomers are still at the height of their earning powers, and most of them are still in the workforce. Ideally, we'd be growing fast now, to cushion against the inevitable slowdown. But we're not. So this "one time factor" has lasting impacts.

2. The Bush tax cuts are no longer a "one-time factor": most of them were made permanent, as both Democrats and Republicans wanted. That is going to add a permanent $300 billion, and growing, to our annual deficit. No one has proposed any way to pay for this.

3. There's always a risk of another "one time factor". No one saw this one coming. If we have another, the debt we're accumulating now will leave us in a worse position to pay for it. Of course, we could have a happy growth surprise too--but it's not unreasonable to say that we should prepare for emergencies, not unexpected growth. Presumably, if it materializes, we'll have little trouble spending it.

4. High levels of debt (and the taxes needed to pay for it) have a negative effect on growth. By the end of this year, the federal debt held by the public will probably be something like 78% of GDP. That may not be high enough to exert a serious drag on growth, but it's getting pretty close.

5. Just an aside, because I know what you're thinking: infrastructure! But at this point, infrastructure isn't going to turbocharge growth, because we already have a lot of infrastructure. In Vietnam, putting in a paved road and a modern port facility can easily pay for itself in higher growth, because right now, it's very hard for goods to move or factories to be built. But the United States already has paved roads and modern port facilities. Infrastructure investments here are often repairs or replacements, not radical capacity improvements. That's not to say that we shouldn't do them. But this spending is in the category of "keeping ourselves from getting poorer", not "making ourselves richer"; we shouldn't expect it to raise the trend growth rate. Even things that could actually improve productivity, like some of the smart grid innovations, are not going to deliver an extra 1% of trend growth every year. That doesn't mean that we shouldn't spend money on needed infrastructure. But we should not act as if this is a substitute for sensible budgeting. It isn't--any more than buying a house was a good substitute for saving in 2005.

I believe, along with a lot of economists, that there's no particular reason to hurry austerity. The US still borrows on easy terms, so we can afford to ease into it while the economy recovers.

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However, I also believe, along with a lot of economists, that eventually, the US needs to get its books in order. And the easiest way to do that is to start planning now. If we wait until the market forces us into it, all the ugly adjustments that we'd rather not make will have to be undertaken at the maximally painful time, in the most brutal possible way.