Monday 16 Jul 2018 | 19:07 | SYDNEY
Monday 16 Jul 2018 | 19:07 | SYDNEY

Ways out of the US economic crisis


Stephen Grenville

15 August 2011 14:10

This morning's post looked at the confused and tentative tone of debate on what to do about the US economy. Now for some suggested ways forward. 

First, there is a need to distinguish between the urgent short-term objective of getting the economy moving and the medium-term problems of fiscal sustainability. Government debt is heading in the wrong direction, but it can't be put on a sustainable track by cutting expenditures, with years of slow-growth attrition. The budget deficit is large because a stagnant economy cuts tax revenues and expands social expenditures. When the economy is back to full capacity, a surplus is feasible: after all, budgets were in surplus as recently as the Clinton presidency.

A new round of well-targeted budget stimulus would almost certainly help. With the ten-year bond yields at around 2.5%, more spending would not crowd out private sector expenditure. A speedy return to full employment would do much of the work of fixing fiscal sustainability, but not all. It is both consistent and good policy to expand budget expenditures now while at the same time making a definitive credible commitment to shift the medium-term structural budget into surplus.

Part of this process will be for the Democrats to acknowledge that not all societies' problems can be solved by government intervention. Importantly, health care costs have to be contained (as they have been in a number of other countries). But the job can't be done without substantial revenue increases. Tax revenue is currently 14% of GDP. No advanced country can operate with expenditures restricted to this level.

The foolish notion that government revenues cannot be increased has gathered momentum because some see no better way of addressing wasteful government expenditures: the strategy is to 'starve the beast'. If the Democrats can show that they are willing to contain expenditures, the silliness of the Tea Party position can be exposed.

Which taxes should be raised? There seem plenty of opportunities to create a system which is both more efficient (preserving incentives) and gathers more revenue. The US has no VAT at the federal level. Petrol is still cheap, thus there is room for an energy tax. Ending the Bush tax cuts for the rich would take their formal rates up to levels which most of the rest of the world would regard as moderate (the top marginal rate would be 45-50%).

More importantly, the myriad loopholes introduced by Congress to help their favoured constituents need to be put under the microscope. What about that subsidy for ethanol, which has resulted in the huge distortion of turning 40% of the corn crop into inefficient fuel?

Inaction cannot be the optimal answer. What is happening in the US is not comparable to the UK's current bold experiment (Sir Humphrey would call it 'courageous') to tackle the debt position through painful budget austerity. All the early evidence is that this isn't working and last week's riots give the debate another dimension. 

Whatever the outcome of the UK experiment, the US policy paralysis is not a balanced mixture of austerity and tax increases (the UK VAT is in the process of going up to 20%). Instead, the current US position is an accidental byproduct of dysfunctional politics. 'Starve the beast' is not a recipe for reform, but for years of stagnation. The commendable objective of reducing government waste is not sensibly achieved by a random reduction of funding.

The debt-ceiling arm-wrestle has left the protagonists exhausted, political capital and goodwill used up and doctrinaire positions more deeply entrenched. This leaves the US unable to address the serious fundamental economic issues it faces. With its own house in disarray, it is unable to lend a hand with Europe's debt mess.

Without the ongoing growth of the emerging economies, the world outlook would be dismal indeed.

Photo by Flickr user enamic5.