stimulus

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What Happens Next?

There is no news today, so the sluggish economy is matched by the sluggish flow of data. Things will perk up later in the week, but now seems like a good time to try to envisage what happens next.

The economy has undoubtedly bounced up from the deep trough it hit last year. A whole slew of the big picture type of reports and statistics tell us the same thing: sometime late last year enough activity turned upward to end the recession and get the economy growing again. But so what? In a number of very substantial ways, not least the job market, the economy remains stuck firmly in neutral if not reverse. For every month the goes by without a strong surge in growth to kick start things, the risk increases that we will fail to generate much of a recovery. The much talked about and feared ‘jobless’ recovery is becoming a very real possibility. This is something we need to avoid at all costs.

The reason that such a scenario is so feared is not just because of its overt economic consequences, slow employment growth, weak wages growth, poor profit and growth prospects for business and so on, but because of the deeper rooted social and political problems that are usually associated with it. In particular periods of prolonged unemployment and underemployment have a very serious impact on social discourse: the tone of politics becomes strained and the invective rises to crowd out sensible debate; reasoning gives way to raw emotions; violence increases; politics becomes heavily populist and extreme; and alienation from family, government, and other institutions rises. In short society gets nasty quickly.

The primary cause of this ‘nastiness’ is unemployment.

There is ample evidence that students who graduate in a poor jobs market never catch up – they remain stigmatized as ‘under performers’ because they show none of the ‘normal’ growth in their early careers. Their incomes lag behind other graduation cohorts, and they risk becoming a ‘lost generation’. At the same time those graduating from ‘top’ schools suffer far less. On the contrary they may face even more intense competition for their services since businesses concentrate their hiring attention on fewer schools during recessions. As a consequence income inequality increases and exacerbates the problems that existed before the recession.

Keep these kinds of things up for any length and society begins to fray.

I am not arguing that this necessarily bleak future is baked into our current outlook, but the risk is there. Which is why making headway on employment is so crucial to us all.

A corollary to all this is the impact that the finance industry has had on society over the last twenty to thirty years. After the deregulation of banking and the increasing concentration of the industry amongst fewer and much larger players, finance contributed an ever increasing share of GDP and corporate profits. At one point that share had doubled and was as high as 43%. The relevance of this is, again, a deeper issue.

The social purpose of finance is to move money around the economy so that society as a whole uses it as efficiently as possible. On a small scale this means acting as a depository system so that people don’t have top keep cash piled up at home; it means running a payment system so that we can use things like checks rather than cash to pay for things; and it means taking our cash and lending it out so that investors, small businesses and entrepreneurs can generate profits, jobs and opportunities that we, individually could not finance. In other words finance acts as an intermediary enabling the economy to move and grow in ways not possible without it.

The problem arises when banks and finance companies stop moving money around, but keep it for their own uses. Since deregulation this switch to ‘proprietary’ trading has happened in spades. The reason is that a worldwide glut in savings generated far too much capital compared with the demand for investment in ‘real’ things like factories and inventions. That glut spurred efforts within the financial industry to invent new ways to trade, invest, and move money that had no impact on the real economy. Gradually the returns in this financial realm overtook those available in the real economy, and so money was increasingly concentrated in pure finance rather than being used to fund productive capacity like new factories, schools, entrepreneurs etc. Finance uncoupled itself from the real economy and became a world unto itself. As its profits soared so did the rewards it could pay to its employees: one of the wonders of finance is that it can create huge profits with a relatively small workforce, so pay per worker can rise above other ways of making a living. This attracts talent and drains brain power from manufacturing and other parts of the real economy. Eventually everything becomes focused on the financial world: society obsesses over stock prices; houses are viewed as investments; debt levels rise as new ways of borrowing cater to more lifestyles; and finance dominates the way in which businesses value and manage themselves.

The longer term problem with all this is that finance is inherently unstable. It always suffers from bouts of over-reach where debt repayments are not made from sustainable cash flows but from inventive refinancing and mortgaging of assets. Inevitably those assets drop in value rendering whole swathes of the economy insolvent. Asset values then spiral down and, as the bubble bursts, the real economy finds itself suffering huge penalties imposed upon it by the financial sector as the latter seeks to right itself. This process was accurately described by the economist Hyman Minsky, with the infamous tipping point at which asset markets implode now referred to as a ‘Minsky moment’.

There are two parts of this latter story that relate to my opening comments on unemployment and social division.

First: finance has, in the scenario I just mapped out, acted in a strongly anti-social manner. It has stopped playing a supporting role – which is its true place in the hierarchy of production – and is now the end in itself. This means that socially beneficial allocation of money is no longer taking place and the risk of collapse has grown. Long term productivity has been sacrificed for short term gain in obscure and volatile financial markets. The economy has been starved, while finance has bled out profits for itself.

Second: directly as a consequence of this, the long term potential of wealth generation in society has been reduced. New factories have not been built to replace old ones. New machinery has no been added. Training programs have been cut. The future has been gutted to pay the present.

Which returns us to the ‘jobless’ recovery. One main contributor to this malaise is the anti-social role played by finance. As long as the financial industry continues to dabble in proprietary activities rather than acting as an intermediary and expeditor the longer our capital base is distorted and the fewer new pathways to wealth are explored. One only has to look a the dearth of engineers and scientists we train as compared to the number of financial wizards graduating from our universities to realize that the distortion runs deeply backward into every aspect of our economic system. We rely on importing talent for our factories and laboratories. I doubt that’s because we have insufficient students. It is because our students all want to make a killing in finance.

At a policy level the options are clear: we need to reorient finance back on its more modest, but vital, role of non-proprietary capital allocation; and we need to fend off unemployment by whatever means we can. There are very few options to choose from and all require spending by the government. While that must be extremely distasteful for many, fiscal conservatives especially, the alternative is even more distasteful: a full blown ‘Japanese decade’ of deflation, underinvestment, and lost opportunity. Japan muddled through the last two decades, and has not recovered – even today it announced it had dropped back into deflation – but its social structures were rigid enough to prevent extreme consequences. America would not be so resilient: we rely on being the land of opportunity. Extinguishing opportunity here for any length of time would place a far greater strain on our politics and society at large.

So it comes down to balancing long term costs against short term costs; and specifically the cost of limiting the damage that our over emphasis on finance has done.

My own guess is that we have spent about half the amount necessary to get our economy growing at anything close to the speed we need if we are to avoid a lost decade. The sooner we all realize that the better. Time is not on our side.

So what happens next?

Our choice.

Does that make you feel better?

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Midweek Mash-Up

The winter blues have hit, not just in the form of a big snow storm, but also in the form of a steady drizzle of mediocre news. There is nothing much to report, so let me collect a few small items into one.

  1. House Prices: There are reports from around the country, most notably on internet real estate listing sites, that home prices are headed down again. This is after a few months of firming. This cannot be a surprise, yet it is being greeted by the financial media as an ominous sign of imminent worsening throughout the general economy. That’s not true. The cause and effect runs the other way round. It is because the general economy remains sluggish that the firming trend in home prices is giving way. I have been talking about this for months. Here’s the story: last summer and fall the housing market revived slightly because of the stimulus package – there was a ‘first time buyer’ tax credit. That brought a steady trickle of buyers onto the market at a time when they probably would not have been there without the stimulus. Demand was artificially bumped up from whatever its ‘natural’ rate was. That little boost to demand was sufficient to arrest the slide in home prices and even reverse it in some places. But the underlying, non-stimulus, price movement remained downwards. I suspect there was also a short burst of ‘pent-up’ demand – people who had money and had postponed moving while they waited to see if prices dropped some more. When these people saw prices firm they jumped into the market and bought. All that ‘pent-up’ demand does is to move the transaction from one time period to another – it does not add to total demand. With both these effects exhausted, and with aggregate demand in the economy still weak due to laggardly employment and wage experiences, there is only one way for prices to go: down again. And that’s what I expect to happen as we move into spring. Whether the normal spring surge in home buying materializes is the key factor we all now watch for. If it does prices will stop falling. If it doesn’t prices will drop throughout the year.
  2. Trade: The trade deficit widened in December. That will take a bite out of fourth quarter GDP growth, when it revised later this month, and is the most likely trend this year for trade. Our basic problem: oil imports, re-emerged as the driver of rising imports. Both the price and consumption of oil rose sufficiently to overcome a 3.3%increase in exports. Overall, imports rose by 4.8% to $189.2 billion, with crude oil imports rising 9.2% by volume and about 1.0% in price. Exports reached $142.7 billion. Our problem now is the turmoil in Europe and its knock-on effects on world trade and currency movements. Throughout 2009 trade had been a very positive factor for GDP, and now it looks very much as if that trend will flatten out if not reverse. This means that our reliance on imports could dampen growth significantly this year making GDP growth of over 2% difficult to maintain.
  3. Interest Rates: I must admit the nonsense spoken about interest rate can get tedious. All weekend long and throughout this week so far there has been talk of the Fed’s imminent release of its ‘exit strategy’. This is the magical plan that will, according to the pundits, set out the way in which the Fed undoes all the support that it gave the economy in 2008/2009. Don’t forget that to most of these pundits we are in dire danger of a massive burst of inflation due to the huge injection of cash that resulted from the Fed’s support. That overhang of cash is thought to be waiting in the wings to flood the economy and drive up prices unless the Fed can drain it beforehand. Setting aside the theoretical issues I have with this notion, the threat of inflation is so remote currently that I find it odd we even have to have this conversation. But such is the prevalence within the financial markets of the incorrect thinking underlying fears of inflation that the Fed seems compelled to announce such a plan. Guess what? Bernanke says that his concern is too little growth not much and that we will maintain low rates for the foreseeable future. Well duh! People who fear inflation have to be the same ones who imagine a rapid recovery. Since such a recovery is unlikely – I would argue it’s impossible – inflation simply will not be a problem this year or next. In fact there are still traces of deflationary pressures lingering – notably the enormous unused capacity overhang yet to be re-absorbed by growth. Until that overhang is gone businesses in most industries will have very little opportunity to pass along price increases to consumers. Therefore any price increases at the wholesale level will have to be absorbed by reducing profits. Besides I see no evidence of a boom in final, and especially consumer, demand. As Bernanke says: the threat is of too little activity, not too much. So short term rates are likely to stay flat. As for the longer term rates: the punditry is talking up the prospect of a bond market revolt over our budget deficit. If such a ‘revolt’ takes place we should see a sharp drop in demand for US bonds and hence the need to raise rates to offset that drop. So far there is no sign of such a movement. In fact US bonds are selling well. Why? Because everyone else is in the same hole. Which means that US bonds retain their relative – rather than absolute – attraction. So look for long term rates to stay where they are for a while, but also be aware that the trend will be upwards as the economy improves.
  4. GDP Growth: Lastly, I should update my forecast for the year. The last quarter of 2009 saw a sudden burst of GDP growth, most of which was due to one time effects like the inventory switch I spoke about at the end of the year. Those one time movements have all washed through the numbers and some of the more lasting trends such as the trade improvement I mentioned above are due for a downward revision. It will be no surprise if the fourth quarter figure is reduced somewhat as better data is collected. Such revisions are normal and are particularly likely at times of changes in direction. Looking forward we must all disregard last year’s odd fluctuations and ask what growth is sustainable. The answer seems to be ‘not much’. As long as consumers continue retrenching their balance sheets by reducing debts, and the drop in consumer debt loads is now the biggest in history, I see very little impetus for strong growth. Ours is a consumption economy. Indeed our entire culture is built around consumption. We are not about to change that sufficiently to alter the shape of the economy in aggregate – it will take years to instill a thrift based mentality here. So if consumption fails to ignite so does the economy. While there are signs of the severe drop in demand of 2008/2009 ending there are no signs of acceleration either. With credit markets weak as the banks rebuild capital and avoid making bad loans, with state governments cutting spending in order to balance local budgets, and with trade flattening out or even weakening, projecting GDP growth of over 2% becomes very difficult. Odd movements in inventories could occur, but the underlying economy looks set for a very slow year. So I am sticking with my forecast of 1.5% to 2.0% growth for now.

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The Unemployment Rate Drops

Well it drops a little: from 10.0% to 9.7%. Today’s report from the Bureau of labor Statistics is chock full of information – 42 pages of it – and after having read through it I end up pretty much where I began.

Here are the headlines:

Obviously it is good news that the unemployment rate fell, which leaves us with 14.8 million unemployed workers. Or at least that’s the number of people who say they are unemployed and have been trying to find work sometime in the past four weeks. Basically what seems to be happening is that the economy has bounced slightly up from the bottom it hit late last year and is now inching sideways. We are essentially back where we were last August. Remember that the unemployment rate is calculated from a survey of households conducted every month – it is not a survey of businesses, so it reflects what workers say and think about the job market rather than attempting to count actual jobs.

The reason I say we are inching sideways and not growing is because the establishment survey the BLS publishes at the same time tells us that we lost 20,000 jobs last month. This is the attempt at counting actual jobs and the report is based on the annual survey the BLS performs of business payrolls.

So the two data points appear to be in conflict until we realize that they are both samples drawn from different populations. That one says we are improving while the other says we are declining is simply a statistical quirk with no real meaning.

I realize that makes it all sound rather murky – and it is.

So what do the numbers mean?

That the outlook in the job market is still poor, but that it is no longer deteriorating. The rot of last year appears to have ended and we are now taking the first hesitant steps towards recovery. The drop in payrolls is too small to mean much – recall it is based on a sample – so we can state with confidence that nothing much happened on the payroll side.

On the household side thing seem to have perked up just a bit, but there are very worrying numbers lurking beneath the surface.

The number of long term unemployed workers continues to rise and is now 6.3 million which is an increase of 5 million since the recession started. This is the real figure we need to work on since long term unemployment is where most of the economic damage to a household can occur – skills degrade, experience is lost, and finances ruined. So as we go forward we all need to pay particular heed to this number.

Also worrying is the figure of 2.5 million workers who regard themselves as ‘marginally attached’ to the workforce. This odd phrase is used to describe people who are either discouraged and no longer looking for work at all or those who are looking less actively than in the past. Clearly this is also an ominous number we need to keep a close eye on.

On a slightly brighter note, the number or workers who were working part time involuntarily – they had been forced into part time status by their employers – dropped quite sharply from 9.2 million to 8.3 million. This suggests that there is enough activity throughout the economy to encourage plenty of employers to re-instate full time work hours. Again, we need to see this number drop much further before pressure on businesses forces them to hire new workers rather than simply relying on their existing workforce.

Overall the data shows that the bottom has been reached and that the very first stirrings of a comeback are underway. We should not declare victory yet – all the signs are for a very slow recovery and we need more effort to break the back of unemployment more quickly.

Nonetheless today’s figure is mildly encouraging.

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Federal Budget Woes

Everyone, it seems, is now alert to the state of the federal budget. Apparently we are drowning in a sea of red ink, and, according to some, the deficit presages the decline of American influence and power.

I don’t see it that way. Our decline, if there is any, has a very different source.

  • We have had awful fiscal policies for years. Our problem is not new it has been ongoing. Why the sudden conversion to fiscal rectitude? One word: politics. The root of our current deficit, the part that is really difficult to fix and even more difficult to discuss, is the revenue shortage created by the tax cuts of 2001 and 2003. Scream all you like, object all you want, but facts are facts. This morning’s New York Times talks about decades of ‘red ink’ as if we haven’t already just lived through one. The deficit yawned wide way back after those tax cuts and hasn’t closed since. This is not a new problem.
  • Has our ‘power and influence’ declined since those tax cuts? Not much. And, if it has, that decline was more due to our policy of going it alone rather than being multi-lateral. Our foreign policy and our behavior has more to do with whether we maintain influence than our budget.
  • Having said that, the budget matters. But it matters more domestically. A major budget problem such as ours constrains domestic policy options far more than foreign policy options. It creates a cramped space within which we feel as if we can no longer afford certain programs. It makes us question the advisability of things that, were the budget balanced, we would never discuss.
  • There is also a myth about our dependence on the Chinese. It is a myth. Why? Because they cannot offload their investments here without taking a huge loss. They don’t want to do that. It is their interest that we keep our currency and economy strong. They need us as much as we need them.
  • Besides, there has been a huge plunge in private sector borrowing in the US. All that has happened recently is that the government has been borrowing instead of the private sector: the marginal amount of foreign investment has not sky rocketed the way in which we are led to believe by the hysterical media. The largest investor in America remains America itself. That is you and I through our retirement plans. We are lending to ourselves.
  • The current crisis has blown the ratio of national debt to GDP all the way up to over 70%. That’s high, but not catastrophic. We can manage it easily within our budget, as long as we curtail and reduce the deficit in the medium term.
  • But not the short term. We simply must avoid drastic short term action while the economy is still fragile. Let’s be honest and admit we are still on life support: the stimulus and an inventory adjustment are all that stood between us and a depression last year. Now is not the time to cut government spending. Actually, now is still the time to increase it.
  • Lastly: let’s not get hyper-ventilated over the size of the federal budget. Media types keep throwing around huge numbers in a vacuum. The American economy is vast. It represents about 20% of the entire world economy. We create about $ 14 trillion a year. A deficit of a billion or two is big but cannot overwhelm the entire US economy. The trick is to contain it and stop it running out of control.

My take on all these doom laden stories and media conversations is somewhat different.

Yes we have a budget problem. It is a long term issue and has been one for decades.

Yes we need to control it and reduce it. That has to be done with the minimum of disruption to our current recovery from crisis.

That means spending cuts in the medium term and tax increases as well. In particular it means allowing the 2001 and 2003 tax cuts to expire and go away. But it also means getting control of the two fastest growing sectors of our budget: defense and health care. To do that we need a calm and sensible discussion about our policy options and the choices we need to make.

We do not need invective and hysteria. Nor do we need to panic or to misrepresent the facts.

This morning I was unfortunate enough to watch a few minutes of a CNN ‘analyst’ talk about the stimulus effect on New Hampshire – apparently Obama is en route there. I was appalled at the complete distortion of the facts being discussed. At one point a graphic was put up on screen showing the rates of unemployment for the past three years, unemployment in New Hampshire has doubled in that time from around 3.5% to just over 7.0%. This fact was presented as support for the argument that the stimulus had failed. Nothing could be further from the truth. The relevant discussion is what would unemployment have been without the stimulus? Nowhere was that mentioned. The presumption that the 2007 rate of 3.5% would have remained is obviously preposterous. And, yes, despite the stimulus unemployment rates have risen rapidly. The point being that they would be much higher without the stimulus.

At another point the CNN ‘analyst’ spoke about a $2 million school project having created only two new jobs – both teachers. The inference being that each job ‘cost’ $1 million. This is simply to misunderstand the entire project. Building a school and hiring two new teachers is a very small part of the story: what about the construction crew? What about the construction company’s profits? What about the small business owner who survived a tough winter with a new project? What about all the local vendors who sold products to the construction crew? How about all the suppliers of chairs etc? The central premise of a stimulus is that it has multiple effects throughout the entire economy. In fact those knock on’ effects are far more important than the simple result of the project itself. This is basic economics, not sophisticated reasoning. Yet it eluded our expert ‘analyst’. The public was sold short and left not uninformed, but misinformed.

Shoddy and wafer thin analysis is doing more damage to our country than I care to imagine. If our voters cannot get access to proper analysis – thinking that is more than skimpy – how can we enter the debate that we need to have about priorities and choices?

No.

It is not the budget that will undermine American power and influence. It is the nation’s apparent inability to think clearly and articulately about big issues.It is the country’s elite that is the problem: the media and the communicators; the politicians and the business people; and the academics. The country is being under-served by the very cohort upon which it relies for leadership and direction.

Our inability to confront bad fiscal policy and to discuss change is symptomatic of a deeper cause of decline: our political system is antiquated and our leadership fractured and shallow.

Our problem is definitely not the budget because we can fix that if we want to.

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The Deficit: Background Information

One of the most annoying things I come across as I talk about the economy is just how little the average voter knows about it. We are asked to form opinions and then vote of policy options based upon a very flimsy understanding of what the situation is. In the current fraught political atmosphere, and in the even more dangerous economic circumstances we have created for ourselves, opinions need to be supported by more fact. There will always be differences of opinion with respect to policy choices, at least I hope so, but we should all have a common grounding in the situation we are trying to fix.

“Credible conversations about cutting the deficit have to focus on the long term problem. It is unfortunate that our current crisis came after a period in which our long term situation had already deteriorated very badly. The crisis clearly aggravated an existing very serious problem. But it did not create that problem.”

In the spirit of neutrality I want this week to distribute some simple facts about the federal budget. The need for this is simple: there is a great deal of public talk about our ‘awful’ deficit, and a growing urgency to close the gap. If this is to be a serious discussion we all need to start from the same place:

What do we spend our money on?

The latest figures for federal spending are these:

  1. The largest single item in the budget is defense spending, at $625 billion. This is 21% of all spending. It includes the costs of all the wars we are waging, plus the operations of the defense department generally.
  2. Next largest is Social Security, at $617 billion, which also rounds out to 21% of the budget. The average monthly payment in 2008 was $1,041 and was paid to about 35 million retirees.
  3. Medicare, Medicaid, and CHIP – the three government run health care programs – account for $599 billion or 20% of the budget. Approximately 45 million receive Medicare supported health care and cost about $391 billion. The rest of the money goes to the Medicaid and CHIP programs that cover about a further 55 million people at any given time.
  4. The next largest category of spending in the budget is a group of ‘safety net’ programs such as child care assistance, food stamps, supplemental income programs and so on. Together these amount to an annual $313 billion or 11% of the total.
  5. The next largest item in the budget, and on being much discussed, is the interest paid on the national debt. In 2008 this amounted to $253 billion or about 8% of the total budget.
  6. The remaining 20% of spending is spread across a wide variety of smaller programs: veterans benefits – 6%; scientific and medical research – 3%; transportation infrastructure – 3%; education -2%; and non-security international spending such as aid – 1%. The final 5% is made up of things like the justice system and government offices.

All the above figures are drawn from the 2008 budget and give a glimpse into what we spend our money on.

A more interesting insight is the change within the budget over the last few years.

The fastest growing category in the list above is defense spending which has been growing at an average annual rate of 9.1% since 2001. Other categories have grown much less rapidly: Social Security, Medicare and Medicaid combined grew 3.8% over the same time; other mandatory programs grew 3.0%; and the discretionary programs grew only 1.3%. The average for all categories was 4.6%, so we can see that only defense has grown at a rate above average.

Finally we should look at the revenue side which in this case I will do by noting federal revenues as a percentage of GDP. Because of the recession and the huge drop in taxable incomes caused by it, federal revenues plunged in 2009 to below 15% of GDP which is almost an all time low. This drop was ‘cyclical’ in that it will automatically go away – without any policy changes – once taxable incomes recover as the economy starts to grow again. Remember that government spending tends to increase, not decline, in recessions as many of the safety net programs kick into gear as people lose jobs etc. So as revenues decline spending increases making the deficit widen dramatically. Of the current deficit about 35% to 40% of it is due to this cyclicality.

The remainder of the current deficit – in fact more than half of it – comes from ‘structural’ or long term problems in the budget. The government takes in less than it spends on a regular basis. This problem has been particularly pernicious since the mid 2000’s.

Let me give you some comparative data:

In 2000, government spending was 18.4% of GDP while revenues were 20.9%. This produced a budget surplus of 2.5% of GDP. By 2004 this situation had changed dramatically: spending has crept up to 20.0% of GDP – with the onset of the Iraq war – but revenues had dropped to 15.8% creating a deficit of 4.2% of GDP. In other words in just four years the budget had swung from solid surplus to growing deficit.

The federal revenues recorded in 2004 were the lowest as a percentage of GDP since 1950 and the drop is entirely accounted for by the two waves of tax cuts introduced in 2001 and 2003. The philosophy behind those tax cuts was that the stimulus of the tax refunds would generate sufficient GDP growth that normal tax rates on that extra growth would offset the drop in revenues caused by the tax cut. Thus, the theory was, growth would eliminate any deficit caused by dropping federal revenues.

This has not happened. So we are left with a structural funding gap that we fill currently through borrowing.

In the light of these facts it is important for us all to separate the two sources of deficit:

  • The current crisis management or cyclical deficit
  • The longer term or structural deficit

Credible conversations about cutting the deficit have to focus on the long term problem. It is unfortunate that our current crisis came after a period in which our long term situation had already deteriorated very badly. The crisis clearly aggravated an existing very serious problem. But it did not create that problem.

Consequently the discussion we now need to have should have two basic themes:

  1. How much of GDP should flow through the government? This is a vital part of any discussion. We need to settle on a rough range within which we can contain government spending. By comparison with other industrial countries the portion of GDP we allocate to the government budget is quite small – much less than, say France or Japan. But there are clearly pressures on the budget that keep it growing.
  2. Which is the second theme. We need to make choices, not avoid them. The main problem with recent fiscal policy is that it tried to have it both ways: cut taxes and yet not cut spending. We fell into a huge hole because of that avoidance of the issue. If we are to get out of a long term deficit problem, and I think it wise we do, then we need to be straight forward with ourselves about what the implications are for each choice.

I tend towards a fiscally conservative position: I would advocate getting the budget as close to balance as possible within a medium term period – say five to ten years. The reason that the adjustment cannot be achieved more quickly is the disruption caused by closing the gaps. Any solution to our difficulty will entail new taxes, and that will slow growth in the short term, so they need to be phased in gradually. Similarly program cuts need to be deep in some areas, and that is also anti-growth since it means taking government spending out of the economy. Obviously in our current weak state doing either is risky, so both need to be phased in properly so everyone has time to adjust with minimal impact. Hence the medium term focus.

Finally for the record: there is no data I am aware of that says a low tax environment automatically implies faster growth. Indeed all the recent evidence is the exact opposite. The fastest post war growth periods have all been associated with higher taxes! Since I don’t like paying taxes, I would dispute the cause and effect in these cases, but advocates of tax cuts have an even harder case to prove: they have no evidence at all on which to base their case.

In any case we are about to enter a vital discussion. We all need to be well versed on the facts, and the real causes of our problems. It will be tempting for some to focus on short term political point scoring and thence to make the case that the current deficit is entirely the result of profligate bail-outs and stimulus spending. This is categorically not the case. I wish it were, because that would make solving our problems more easy.

As it is we need to be grown up and recognize the real issues and their long term and deep rooted nature. Only then can we get the budget under control and back to a modest surplus, which is where it should be in years of growth.

Addendum:

Here is a good discussion – at the Baseline Scenario site – of the budget. The chart halfway down the post tells the entire story. The big problem is the lost revenue from 2001 and 2003. If you cut revenue that much you need to have the courage to cut spending too. The Republicans don’t have that courage. Instead they punted the problem forward, making it worse. That was an act of extraordinary cynicism and frankly was, to use one of their favorite words, ‘unpatriotic’. Fiscal conservatives should be revolted at the distemper and lack of ideas coming from the right.

The country is in crisis and we need leadership not smug naysaying.

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