Hate Big Government? Oppose Deep, Immediate Spending Cuts

Ideological views must be put aside for the time being, in favor of practical alternatives to achieve the best economic outcome

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I believe 2009's $787 billion stimulus package was a disgrace. It consisted of far too much garbage spending, meant to satisfy political interests, and not enough provisions to create shovel-ready infrastructure jobs or to cut taxes to have a more immediate impact on the struggling economy. I prefer smaller government in general and would enjoy seeing several major federal government agencies be eliminated entirely. But as the U.S. begins its deficit reduction push, unlike some in Washington who hold these views, I do not believe deep, immediate cuts are the right solution to solve the U.S. deficit problem. Such an approach would make matters worse.

Although some degree of austerity is necessary to fight rising deficits, timing matters. State and local governments have already shown the harm that spending cuts can have on economic growth and jobs. Too much austerity too soon could shatter the fragile recovery altogether, sending the economy back into recession. That would result in a worse outcome for those who want small government, as it would force government to spend even more to combat unemployment over a longer period. It would also result in lower tax receipts, lengthening the time it takes to pay down the debt.

U.S. Austerity Won't Be Pleasant

The U.S. will derive no short-term benefit from immediate spending cuts. Investors are not calling for cuts in the near-term; indeed, the demand for Treasuries remains very high and yields are very low. As a result, short-term austerity won't help the U.S.'s financial situation. The money that is used to pay down debt will merely be extracted from the U.S. economy, whether through spending cuts or tax hikes. In either case, we'll have less economic activity, fewer jobs created, and weaker growth.

That matters a lot more now than it would if unemployment was 6% and GDP growth exceeded 4%. Currently, growth and hiring are both trending down. The potential cost for austerity right now is extremely high, and the benefit is nil. The best solution would be a long-term deficit plan, where austerity measures -- including spending cuts -- are put in place but not executed for a few years, when the U.S. economy is in better shape to withstand their impact.

Calling for Delayed Austerity Doesn't Mean You Like Big Government

Did you read that last sentence? Spending cuts can, and arguably should, still occur -- just not now. This point is a practical one: as the U.S. economy struggles to recover from a very deep recession, ideological views need to be tempered with practical realities. No matter how much you or I might desire smaller government, now simply isn't the time for it.

Let's say we eliminate 100,000 government workers. What happens? Most of them will go on unemployment for an extended period. Some of them will find jobs in the near- to medium-term, which means that some of the other millions of Americans who can't find work won't get those jobs. Ultimately, you've got more Americans out-of-work and more collecting unemployment.

How is this better than if we maintained current levels of spending temporarily to ensure that these jobs stuck around for a couple of more years? If there are too many teachers, cops, firefighters, bureaucrats, etc. then by all means cut jobs -- but there's little harm in waiting a few years to do so, while there could be significant harm in laying off these workers immediately.

Consequences of a New Normal for Unemployment and Growth

If austerity begins too aggressively too soon, then the U.S. will face what looks like a new normal for unemployment and economic growth. Government job cuts could create a significant headwind for net hiring. For example, if the private sector hires 250,000 workers and the government eliminates 125,000 in a given month, then the unemployment rate will likely remain unchanged (about 125,000 are needed just to keep up with workforce growth). The headwind created by public sector job cuts would significantly delay the time it takes for the labor market to recover.

On the growth side, you'll see something similar. As federal, state, and local spending falls in the name of austerity, you won't see a proportional increase in private sector growth. If that slices off, say, 1.2% per quarter from growth, then we could go from a moderate 3.1% growth rate to an anemic 1.9%. This is precisely what we saw in the first quarter.

As hiring and growth appear stagnant, investment will move overseas. The U.S. will likely find itself in a sort of lost decade, where it takes a very long time to return to full employment. Over this period it will also be much more difficult to pay down the deficit, because tax receipts will be relatively low as growth and employment remain weak.

Other Miscellaneous Arguments for Austerity Now

Despite all of this sound, practical reasoning, there are some objections that those blinded by partisan politics will likely continue to make. So let's dispose of them real quick:

It's Now or Never

One commenter says, "The problem is that it will never be a good time to cut spending." That's true: spending cuts will always hurt when unaccompanied by a tax cut. But there are some times when the resulting pain will be more tolerable than others. This happens to be a very, very bad time to cut spending, no matter how much we might like to.

In order to ensure that Washington doesn't ignore austerity in future years if measures aren't taken right away, a long-term plan could be created with economic triggers for when spending cuts (or tax increases, depending on which side of the aisle you sit on) can automatically take effect. For example, once the national unemployment rate is at or below 7% for two consecutive quarters, the federal budget could be slashed by $1 trillion. Once the unemployment rate hits and remains at or below 6%, cut another $ 1 trillion could be cut.

You get the idea. These sorts of measures can, and should, be put in place in the near-term. But an austerity plan needs to be back-loaded so it doesn't kill the little economic activity we're currently seeing.

Private Sector Jobs are Better Than Government Jobs

You're not going to hear any argument from me here. But you know what public sector jobs are better than? They're preferable to no jobs at all when underemployment is near 16%. And that's the alternative. When a public sector job is cut in the name of austerity, it will not be replaced by a private sector job -- it will be replaced by an unemployment check, which will have the added side-effect of dulling the impact of this cut to austerity.

Again, it's important to remember here that the money not being spent by the public sector will not be provided to the private sector in the short-term. It will require additional borrowing that will have to be paid in the future, but when unemployment is close to the natural rate and growth brisker, the economy will better be able to afford it.

Government Wastes Money

I would not wish to disagree with this one either. I don't think you need to look further than the $787 billion stimulus to see how poorly the government manages to put money to work for economic progress. The impact of the 2009 stimulus was minor at best, and its price tag was enormous.

Some of the spending we're talking about keeping in place might not be the most efficient or effective. But there's something worse than money imperfectly injected into the economy when growth is anemic and unemployment is high: that money being withdrawn from the economy. If government contracts are slashed, contractors won't need to hire. If infrastructure projects are cancelled, the firms that would have run them will have lower profits.

And unfortunately, not very much money is saved in the short-term by cutting government jobs. This can be easily seen by the data from that post from last Friday. There, I explained that in five quarters, GDP had declined by $8.8 billion due to local and state spending cuts, while jobs had fallen by 326,000. This isn't a perfect measure of cost savings and not every penny in budget cuts resulted in a job cut. But if you make that conservative assumption, then the cost-saving breaks down to less than $23,000 per job. If we're talking about $4 trillion cut, a number often tossed around, then the number of layoffs could easily be in the millions (of course, this would include more than just government employees, as contractors and other workers would be indirectly affected).

There's Just No Alternative

Remember, this isn't a call for additional government stimulus: it's a call for government spending to be left intact temporarily -- until the economy can better endure shrinking it. There is one potential alternative here that allow government to shrink: for taxes to proportionally decline. But in the context of austerity, it's highly unlikely taxes could be cut. If taxes fell while spending fell, then little deficit reduction would be achieved. So this isn't a realistic option to neutralize the economic impact of deep spending cuts.

To make matters worse, there's some doubt about whether a tax cuts will have much effect in creating jobs right now. As long as consumers believe the economy is weak, they won't spend as much and will save more. If the unemployment rate remains high due to government job cuts, then this mindset won't change. And as long as consumer demand stays low, firms won't hire more aggressively. Instead, they would use the extra tax cut money by completing acquisitions or building up their cash reserves.

As a result, whether we like it or not, the best way to prevent the government from continuing to grow is to allow it to remain stable for the time being. Causing a double dip recession through too much austerity too soon will just make digging out from our mountain of government debt even harder. But if the economy gets back on its feet, tax receipts will rise and paying off that debt will become easier. At that time, spending cuts won't hurt as bad and the private sector will be better able to create jobs to accommodate those public sector employees who are laid off.

Image Credit: REUTERS/Larry Downing