By Lawrence Summers
Jan 22 (Reuters) - Since the election, American public policy debate has been focused on prospective budget deficits and what can be done to reduce them. The concerns are in part economic, with a recognition that debts cannot be allowed, indefinitely, to grow faster than incomes and the capacity repay. And they have a heavy moral dimension with regard to this generation not unduly burdening our children. There is also an international and security dimension: The excessive buildup of debt would leave the United States vulnerable to foreign creditors and without the flexibility to respond to international emergencies.
While economic forecasts are uncertain, the great likelihood is that debts will rise relative to incomes in an unsustainable way over the next 15 years without further actions beyond those undertaken in the 2011 budget deal and the end of year agreement that averted a fall over the “fiscal cliff.” So even without the risk of self-inflicted catastrophes - like the possible failure to meet debt obligations or the shutting down of government - it is entirely appropriate for policy to focus on reducing prospective deficits.
Those who argue against a further concentration on prospective deficits on the grounds that - contingent on a forecast that assumes no recessions - the debt to gross domestic product ratio may stabilize for a decade counsel irresponsibly. Given all uncertainties and current debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.
Reducing prospective deficits should be a priority - but not an obsession that takes over economic policy. This would risk the enactment of measures such as pseudo-temporary tax cuts that produce cosmetic improvements in deficits at the cost of extra uncertainty and long-run fiscal burdens. It could preclude high-return investment in areas such as infrastructure, preventive medicine and tax enforcement that would, in the very long term, improve our fiscal position.
Economists have long been familiar with the concept of “repressed inflation.” When concern with measured inflation takes over economic policy and drives the introduction of price controls or subsidies to hold down prices, the results are perverse. Measured prices may not rise and so the appearance of inflation is avoided. But shortages, black markets, and enlarged budget deficits appear. The repression is unsustainable. When it is relaxed, measured inflation explodes, as in the case of the Nixon price controls in the early ‘70s.
Just as repressing inflation is misguided, so also repressing budget deficits can be a serious mistake. As with corporate managements judged only on a single year’s earnings take perverse steps that are ultimately harmful to shareholders, government officials in the grip of a budget obsession repress rather than resolve deficit issues. When arbitrary cuts are imposed, government agencies respond by deferring maintenance leading to greater liabilities later. Or compensation is provided in the form of promised retirement benefits that are less than fully accounted for, with the ultimate burden on taxpayers increased. Or measures like the recent Roth IRA legislation are enacted, encouraging taxpayers to accelerate their tax payment while reducing their present value.
As important as avoiding the repression of budget deficits is insuring that focus on the budget deficit does not come at the expense of other equally real deficits. Interest rates in the United States and much of the industrialized world are remarkably low right now. Indeed in real terms the government’s cost of borrowing has recently been negative for horizons as long as 20 years. No one who travels from the United States abroad can doubt that we have an enormous infrastructure deficit. Surely even leaving aside any possible stimulus benefits, current economic conditions make this the ideal time for renewing the nation’s infrastructure. Given a near-zero real rate, such investments need not increase debt-to-GDP ratios if their contribution to economic growth raises tax collections.
Infrastructure deficits are only the most salient of the deficits the United States faces. We clearly are living nearly six years after the onset of financial crisis with substantial jobs and growth deficits. Consider this: An increase of just 0.15 percent in the growth rate maintained over the next 10 years would reduce the debt-to-GDP ratio in 2023 by about 2.5 percentage points, an amount equal to the much debated end of year tax compromise. Increasing growth also creates jobs and raises incomes.
By all means let’s address the budget deficit. But let’s not obsess over it in ways that are counterproductive, and let’s not lose sight of the jobs and growth deficits that will ultimately have the greatest impact on how this generation of Americans lives and what it bequeaths to the next one.