Are Jobs Really Being Held Back by Deficit Uncertainty?

This theory looks pretty good on paper, but it's not rooted in reality

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If you ask an economist why we have such high unemployment, you're likely to hear a number of answers. Many will say that businesses aren't sensing strong enough demand by consumers to warrant additional hiring. Others will claim that regulatory uncertainty is preventing more aggressive expansion. Some will say the taxes are just too high. A few might point to structural problems in industries like construction or financial services. But could the problem be uncertainty about how the U.S. will close its deficit in the future?

The Theory

This is a contention made in a Bloomberg op-ed by Glenn Hubbard, former Council of Economic Advisers Chair under President George W. Bush and current advisor to Mitt Romney. Much of the piece is quite good. He says that additional short-term stimulus won't help, if it's financed by raising taxes in the short-term. That's correct. He goes on to argue that any additional stimulus should include a plan to offsets that new spending in future years. That's also sensible.

But here's where he loses me:

This observation points out two problems with the case for stimulus being made by Obama. The first is that near-term and temporary support for household incomes does little to counterbalance the chilling effect of announced future policies. Uncertainty becomes the enemy.

This is particularly true for the president's proposal to reduce the employer portion of the payroll tax for small- business owners, while proposing to raise marginal tax rates on those same business owners. The president's advocacy for higher marginal tax rates on the well-to-do dampens both job creation and asset prices.

And, it is a collapse in job creation that lies at the core of the present unemployment problem. Uncertainty over future tax and spending policy -- How much will taxes need to rise to finance rising spending? If spending is to be cut, how and on whom? -- weighs heavily on household and business spending decisions.

The second paragraph above is correct -- ignore that one. But in the first and third me makes an unusual assertion: he's saying that a key factor holding back job growth is fear about how the government will finance its borrowing. This sounds good in theory, but it isn't rooted in reality.

Why Firms Aren't Hiring

It's pretty easy to understand why firms aren't hiring -- you just need to ask them. In fact, plenty of surveys do. Here's one that asks small businesses (.pdf). Here's another focused on middle market companies.

Firms consistently provide the same set of answers for why hiring is so subdued. The most important is that the economy still stinks so sales are very low. Since they're unimpressed with the recovery, they don't feel much urgency to bring on additional staff until things improve.

Uncertainty is a problem -- but it's an issue as it relates to regulation, like health care costs and new financial rules. No survey I have ever seen has indicated that firms are choosing not to hire people now because they're worried about future spending cuts or tax hikes.

Similarly, it is not particularly likely that these fears have consumers spending less either. Like firms, their sentiment is based mostly on the weak economy. With unemployment struggling to make its way below 9%, strong economic confidence remains elusive. They're also trying to get their fiscal houses in order after expanding credit way too much over the past decade or two, so they're saving.

Would Certainty on Deficits Help?

The behavior of consumers and businesses would be virtually unchanged if, tomorrow, Congress provided a clear, complete explanation of how the U.S. would remain fiscally sound over the next 50 years. This isn't an obstacle holding back a recovery. You might see a slight uptick in confidence if such a plan were released and agreed upon, but it's just as likely that confidence could decline: the reality might be worse than the uncertainty.

There are surely some, if not many, Americans who fail to understand the serious fiscal challenges that lie ahead for the U.S. over the next couple of decades. If the government tells people that they're going to get less from Medicare, that some Social Security benefits will be cut, and that taxes will rise across-the-board, in what way would that new encourage people to spend? If anything, this greater certainty would make people realize that they must save more now, because the future looks pretty grim.

Of course, at some point the government needs to deal with its deficit problem. But now is not the time for a huge, sweeping plan to fix the problem. Frankly, we don't even know what a stable U.S. economy looks like anymore, so we can't really create realistic estimates about future tax revenues and spending anyway. Smaller deficit reduction plans will bridge the gap for now. Then, once the U.S. economy is back on its feet, the federal government can get to business on a comprehensive plan and deliver Americans the bad news when they're better able to stomach it.

Image Credit: REUTERS/Jason Reed