Marshall Auerback: Even a Deal on the Budget is Bad for the American Economy

Yves here. One of the frustrating aspects of the Great Catfood Debate is that it boils down to not whether, but how much, catfood you get in your future.

Even though the folks that created the deficit hysteria are now depicting a budget deal, meaning austerity lite, as a Good Outcome, and triggering the fiscal cliff is a Bad Outcome, austerity is still austerity. We’ve seen again and again that cutting deficits when the economy has lots of slack only makes debt to GDP ratios worse, but despite the overwhelming amount of evidence, Pete Peterson and his Wall Street allies want to run the experiment again in the hope that we get a different outcome. And the cynics contend that the deficits are merely an excuse: the real goal is to keep cutting taxes, period, that the true aim of the plutocrats is to roll the clock back to before 1900 in term of the gap between the rich and everyone else.

Marshall Auerback explains why any of the proposed outcomes to the budget negotiations will slow growth and possibly produce a recession.

By Marshall Auerback, a portfolio strategist, fellow with the Economists for Peace and Security, and a research associate for the Levy Institute. Cross posted from New Economic Perspectives

Looking at the latest US data, business sentiment and capital spending have been eroding, and given the lagged impact of capex, that trend looks set to continue for the next few months. Against that, a number of consumer sentiment indicators remain upbeat and housing looks like it is in a firmly established uptrend, after a 5 year bear market. In fact, the existing home inventory to sales ratio is as low as it ever gets, and that is with still very depressed sales. If sales pick up further, given low inventories and with new housing starts still below the replacement rate, home prices could lurch forward.

That said, the markets have been fairly upbeat given the rising perception of a deal to avert the US falling off the ‘fiscal cliff’. But even a deal that drains, say, 1-1.5% of GDP will have negative consequences for the US economy. Bear in mind that the U.S. still has a very high ratio of private debt to GDP. Therefore any such fiscal restriction as contemplated by the two parties may result in a significantly lower economic growth rate than the average 3% rate of the last five quarters (which is what the revised economic data of the past few quarters will eventually show).*

Of course, if there is no compromise, the impact could be calamitous. The IMF projects as much as a 4% decline in GDP if there is a full fiscal cliff. In 1936-37 there was a fiscal cliff of almost 6% of GDP. It was followed by a 36% non annualized decline in industrial production in a mere eight months in late 1937/early 1938. More recently, all of the European countries fiscal restriction has had a more negative impact on GDP than had initially been forecast.

So the range of likely outcomes ranges from slowdown to outright recession and the silly thing is that it is all so unnecessary. Social Security, Medicare and Medicaid impose no real burdens, even with a rising proportion of ageing baby boomers. In fact, one could plausibly make the case that an aging society could help to generate favorable conditions for achieving sustained high employment with high productivity growth. As the number of aged rises relative to the number of potential workers, what is required is to put unemployed labor to work to produce output needed by seniors. Providing social security benefits to retirees will generate the necessary effective demand to direct labor to producing this output. Just as rapid growth of effective demand during the Clinton boom allowed sustained growth of the employment rate, even as productivity growth rose nearer to United States long-term historical averages, tomorrow’s retirees can provide the necessary demand to allow the United States to operate near to full employment with rising labor productivity—a “virtuous combination” of the high productivity growth model followed by Europe and Japan from 1970–95 and the high employment model followed by the United States during the 1960s, as well as during the Clinton boom.

Here’s what most members of Congress (and, indeed, the media and the public) fail to appreciate: Policy formation must distinguish between financial provisioning and real provisioning for the future; only the latter can prepare society as a whole for coming challenges. While individuals can, and should, save financial assets for their individual retirements, society cannot prepare for waves of future retirees by accumulating financial trust funds. Rather, society prepares for aging by investing to increase future real productivity. Unfortunately, no such discussions are taking place, which is likely to lead to a bad to horrific policy outcome.

They are transfers in current time. They meet today’s commitments to seniors, survivors, dependents, the disabled and the ill – commitments they have earned through work – providing them with income and services at the expense of others also currently alive. This any community can always do, to the full extent of its will and resources.

The fiscal austerians are literally strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow. All of which exacerbates a problem of economies facing intense global headwinds from private sector deleveraging.

Viewed from that perspective, the terms of the debate have been truly twisted around. Granted, it is obviously more difficult to make the case for more government spending when legitimate distrust reasonably exists of dysfunctional financial and governmental systems. That said, what really matters is whether the economy will be able to produce a sufficient quantity of real goods and services to provide for both workers and dependents several generations down the road. The financial aspects of demographics per se should not play a role in policy formulation.

Any reforms which seek to address growth in the context of private sector debt deleveraging and demographics ought to be made with a focus on increasing the economy’s capacity to produce real goods and services today and in the future, rather than on ensuring positive actuarial balances through eternity. Unlike the case with individuals, social policy can provision for the future in real terms—by increasing productive capacity in the intervening years. For example, policies that might encourage long-lived public and private infrastructure investment could ease the future burden of providing for growing numbers of retirees by putting into place the infrastructure that will be needed in an aging society: nursing homes and other long-term care facilities, independent living communities, aged-friendly public transportation systems, and senior citizen centers.

Education and training could increase future productivity. Policies that maintain high employment and minimize unemployment (both officially measured unemployment, as well as those counted as out of the labor force) are critical to maintain a higher worker-to retiree ratio. Policy can also encourage seniors of today and tomorrow to continue to participate in the labor force. The private sector will play a role in all of this, but there is also an important role to be played by government.

On balance, if we were to focus on only one policy arena today that would best enhance our ability to deal with a higher aged dependency ratio tomorrow it would be to ensure full employment with rising skill levels. Such a policy would have immediate benefits, in addition to those to be realized in the future. This is a clear “win-win” policy, unlike the ugly trade-off promoted by both parties, who only differ in the degree to which today’s workers and future seniors are to pay for the mistakes of the banksters through misguided proposals to “reform” entitlements and put our future on a “fiscally sustainable” path.


* This is not part of the post, but Marshall has been writing his various correspondents about this for some time. From a recent e-mail:

I have been arguing for quite a while now that the U.S. economic data is understating growth in output, income and expenditures. The culprit is the service sector. First pass data on the service sector is largely a guesstimate. All the service sector data has been lagging the employment data and has been lagging hugely the data on expenditures on goods. I have long attributed this to systematic underestimates of the service sector data by our statisticians in response to the Great Recession which they failed to reflect in their preliminary statistics as it unfolded.

As I said earlier, there is a giant discrepancy between the National Accounts measure of the household savings rate and the flow of funds measure of the household savings rate. I am not saying that the flow of funds measure of the household savings rate is correct. Certainly not. But it is probably telling us correctly that personal income and its growth has been understated for some time and the household savings rate is significantly higher than what we see in the National Accounts data. It will take a very long time for statisticians to correct the under reporting due to their bad service sector guesstimates. Therefore, market participants may continue to ignore the anomalies created by this service sector data.

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  1. LucyLulu

    Thanks for this post, Yves. It’s the first time I’ve seen the inability for the govt to sock money away in a piggy bank for later use addressed anywhere. The argument about Americans saving entitlements now for the use of future generations never made sense, while Auerback’s arguments make perfect sense. I was starting to think I was missing an important piece somewhere along the way, since I couldn’t possibly be smarter than the assorted economic policy wonks . Well, I still don’t think I am but it does imply further dishonesty with intent to mislead on the part of TPTB.

    1. Don Levit

      Could you explain how we are saving entitlements now for the use of future generations?
      The excess FICA dollars not needed for current benefits is lent to the Treasury to pay for current expenses.
      Maybe even some of those current expenses go toward future infrastructure as wrtiteen about in the aricle.
      From a paper entitled “Social Security Policy Options,” published by the CBO:
      Page 3 “The cash generated by a surplus in any year is turned over to the Treasury in exchange for special Treasury securities. The Treasury uses the cash to finance the government’s ongoing activities. If the trust funds’ cash receipts are less than their outlays, the Treasury securities they hold are redeemed for cash as needed. The Treasury obtains that cash from other revenues or by biorrowing from the public.”
      Don Levit

  2. don

    A slow economy, return to recession?

    Implicit in this analysis is the premise that perpetual and infinite growth is desirable, and that without it the less well off suffer. But an economic system that by its very nature is dependent on continuous expansion is also that same system that has generated and sustains such disparity in the first place.

    Perhaps its time to fully understand the consequences not only for people but for nature, and move beyond the economic-centered growth fetish.

    “What kind of civilisation can change the climate of an entire planet – as far as it knows, the only planet in existence which sustains life – and yet find the evidence of this so uninteresting that it relegates it, in its hierarchy of ‘news’, below the latest murder, the inevitable re-election of one of its increasingly meaningless political figureheads and a lot of people running around tracks for a week in a big aerodrome?

    “What kind of civilisation can tip the web of life into a ‘death spiral’ and then spend its time arguing about whether or not this is a good thing? What kind of civilisation can embed something it calls ‘economic growth’ so deeply into its sense of self-worth and meaning that when it dimly becomes aware that this growth is turning the Earth itself upside down, it responds with calls for more of it?”

    1. ambrit

      Dear don;
      The hidden assumption I find in your argument is that population growth is the root of all evil.
      How to begin. Well, I could start off by stating that the “State of Nature” is no bed of roses. Rather, more akin to a bed of thorns. Humans have managed this problem, so far, by a resort to thinking, and the tools that spring from it. Economics is one of those tools. Like any tool, it is ethically neutral. Anyone can play, or play around. The presently unraveling neo-liberal strategy is an excellent example of the latter. The musings and counter musings of the econo klatura embody the best aspects of the former. Play is essential to development. Formalized play is called training. But I digress.
      So, if population is still growing, then real world resources must keep pace to prevent catastrophe. I used to root for catastrophe as an emotionally satisfying corrective to the follies of humankind. That is until I realized that catastrophes have no moral or ethical centre. Damage is thrown off like sparks from a grinding wheel. Everyone suffers. Then I thought some more, and realized that growth was no longer inexorably linked to physical commodities.
      Look at the history of civilization. I have recently begun re-reading Bronowskis “The Ascent of Man.” As people made conceptual breakthroughs, material culture followed merrily along. Granted, stewardship is an integral part of the equation. To have said stewardship, one needs resources to manage. This requires both physical objects, and mental constructs to manipulate them with. So, growth is required, physical and mental.
      I am describing a synergy. Remove one leg, and the stool collapses. Mr. Auerbach is, I believe, advocating the re-rationalization of the theoretical and policy dimensions of the process. One cannot remove the other leg, physical resources, without augmenting one of the other dimensions. One either increases the potency of the mental constructs, or decreases the population depending on the other two for survival. Events could well overtake us, they generally do, but I for one, a child of the Technocratic Age, am rooting for knowledge, and a little Wisdom, to pull us through.

      1. don

        No, I don’t think overpop. is the ‘root of all evil’, nor did I mean to imply that. Such absolutes are reductive and simplistic, just as is the presupposition that ever expanding economic growth is everywhere and always a good.

        1. ambrit

          Dear aquifer;
          The only way I can see to shrink each individual persons carbon footprint would be to put enforceable limits on consumption. At present, the late stage Capitalist system does this by ranking people by ‘wealth’ accumulation and using this ‘wealth’ to allocate resources. The problem is, we end up with something like what we have now. The wealth allocation system has no intrinsic ‘ethical or moral’ compass. Like that French fellow said; “Great fortunes start with great crimes.”
          My initial mistake was in not specifying that we have implicitly posited a closed system. But, as you mentioned above, sunlight comes in to our Island Earth from afar. Why not everything else too? That’s why so many of us Technoids dream of the High Frontier. But, for now, that’s literally “Pi in the Sky.” The present struggle is for the control of the planets resources for the near term. I hope it doesn’t take one of those dreaded Catastrophes to nudge us onto the road to survival and, yes, expansion.

      2. Aquifer

        ambrit – I didn’t read a “population” issue into don’s post. I read the real legitimate issue of limits to physical resources – they are finite, no matter how many or how few users of them there are – even with few users, if necessary resources are wasted and not renewed or recycled, oops, game over …

        MN has reused/recycled resources for over 4 billion years and with the only external input that of the sun (although I guess there is some speculation over where water originally came from) has produced a diversity and complexity Hs can only dream of …. but which doesn’t include iPhone5s, e.g. nor so many objects which use fossil fuels (though some microbes do eat them ..)

        So the real issue is, no matter how “productive” and “efficient” we are, if we use up, destroy, or poison resources or dump/incorporate them in places where they are unavailable to be reused in/recycled by new/different products/processes that require them – the jig is up

        This isn’t rocket science, which is why i suppose it is dismissed as “unimportant”

        Sto, in her posts, has raised on several occasions the idea that what we really need is to be LESS productive – i.e. have more people make fewer things, and i absolutely agree – let us figure out the amount of “things” that the planet can produce, with priority given to those things we need, then let us divide the tasks of production up among the number of folks who need to be employed making/fixing these things (my own preference, is for “fixers”). I know this sounds like a “planned” economy – but it doesn’t have to be “strict” – in fact it can/will unleash an enormous amount of creativity in the process of figuring out how to maximize reuse/recycling of material which, IMO, is the sine qua non of hope for any kind of a future …. Necessity IS the mother of invention, and i cannot think of anything more necessary than this …

        There is a story about Milton Hershey when he was building his factory – a foreman approached him and said “Mr. Hershey, come and see this new machine (a steam shovel), it can do the work of 50 men!” Hershey reportedly said, “Get rid of the machine, hire the men.”

        We don’t need more “stuff”, we just need more jobs for folks to do

        1. Heretic

          I partially disagree with your assessment of productivity…. We should produce what we need as productIvely as possible I.e. with minimal application human effort, energy, and pollution. We should distribute the work, so that everyone has some work and much spare time.

          The mistake of France was that they did not cut work hours by enough, nor did they develop systems to allow people to share work.

  3. ambrit

    Nice to see someone put the real dimensions of the debate front and centre. The gentleman seems to be advocating planning for the future in real world terms, not financial smoke and mirrors. Bravo!

  4. Gordon

    financial provisioning vs real provisioning

    The way I see it the reality of the situation is always that, one way or another, each generation of workers supports their parents’ generation of retirees. Whether this transfer happens through government managed tax/entitlements or by private sector investments/dividends changes only the bookkeeping.

    It all comes unstuck if too much of the resource is diverted along the way. On the government side this can happen through military adventures (not to mention generals living in imperial style) or if government morphs into Versailles. On the private side the risk is that too much will be siphoned off as ‘costs’.

  5. Neo-Realist

    Will re-education and re-training make 50 something adults attractive to employers:/?

    I envision the policy that keeps seniors of today and tommorow continued participation in the work force, at least with those that allow them to participate, is reduction of social security, unless Marshall has another policy or policies in mind.

    1. James

      >> Will re-education and re-training make 50 something adults attractive to employers?

      That has not been at all true in my personal experience, although I have engaged in refurbishing the skill sets on several different fronts. Hope I can find one who appreciates my efforts soon, as UI will be running out in a just a few weeks….

  6. Observer

    Boosting employment through investment in infrastructure was an Obama campaign pledge 4 years ago. So how come we haven’t REALLY done it yet? Oh, yeah: That would be Keynesian, and we can’t have THAT. And surely we can’t continue this unproductive spending on social programs for “the takers.” Unless the “takers” are Wall Street banks, of course. And don’t touch our military budget; we’ll need those foreign bases next time we decide to do some nation-building somewhere. What? Build our OWN nation? Why, that’s un-American!

    “Austerity” is just a new word for the same old crap. But now, the PTB can justify it: “Hey, everybody’s doing it; look at the europeans! We’re going over a fiscal cliff!”

    1. TK421

      “Same old crap” indeed. Back when the economy was booming and the government was building a huge surplus, president Clinton wanted to cut Social Seicurity. Now that the economy is sunk and the government is in debt, the call from people like him is: Cut Social Security.

  7. Winslow R.

    The natural alliance between environmentalists, especially those that would like the world to live in the Stone Age, and Austrians needs to be explored.

    Will austerity slow global warming? Will wealth disparity help minimize resource depletion? Can of worms that needs to be opened.

    1. Aquifer

      That is an interesting observation – though i suspect there may be some environmentalists out there who aren’t too fussy about how stopping folks depredation of the planet proceeds, i think that many, myself included, would prefer that it be a result of a planned integrated process and not the byproduct of a bunch of AHs selfish greed …

      1. Aquifer

        To clarify – a result of a process that leaves no one homeless, destitute, hungry, without medical care or education – that leaves no one without a good lifeboat though it may sink a few yachts …

        The only kind of “austerity” we should contemplate is whatever one is required to sustain the habitability of our physical organic environment – not one “required” by a bunch of frickin’ central banks …

  8. charles sereno

    This is what I find missing in the debate. Have we found the “bottom” of well known historical exploitation?
    Take for one example the “Industrial Revolution.” Without the sacrifice of many of its victims, it wouldn’t have happened. That’s the deal — progress with collateral damage.
    So it is today. I pray not, but I fear we have reached the point where further sacrifices are not only considered cost effective but also feasible.

    1. Observer

      What sacrifices do you speak of? Working Americans have already sacrificed their wage increases over the past 30 years, property values over the past 5 years, not to mention their 401Ks and any pensions they may have thought they would have. The richest 10% got richer while everybody else paid the price. Now there’s a crisis and they want to talk about “shared sacrifice.” We didn’t share any riches, so why should we share the sacrifices? If there’s going to be a revolution, it certainly won’t be industrial. French or Russian might be more like it.

      1. charles sereno

        Thank you for your outrage which I wholeheartedly share. I’m lamenting the sad possibility that victimization can still be profitable. It happened before and it’s happening now. How do we bell the cat? That’s what it’s about.

        1. ambrit

          Mr Sereno;
          I think we’re way past the belling the cat stage. Hence the repeated references to famous social revolutions of the near past. Indeed, let us go farther back; the American Revolution and the Cromwellian Protectorate give better guidance since the near term social struggle is coming to look like a competition between rival elites.
          Yes, outrage, good honest outrage is what we need now. No half measures will work today. An example being the neo-con fundamentalist Axis of Evils. A manufactured outrage was successfully used to hijack the reins of power in Washington and Wall Street.
          We need to get to that point wonderfully portrayed in the film “Network.” We need a real life Peter Finch to tell the people to repeat after him: “I’m mad as H—, and I’m not going to take it anymore!” Then the Fat Cats would be well and truly belled.

          1. charles sereno

            “An example being the neo-con fundamentalist Axis of Evils. A manufactured outrage was successfully used to hijack the reins of power in Washington and Wall Street.”

            Do you mean that the cited example is the way to go in tactical terms? I don’t think you do. In any event, the “manufactured outrage,” while successful, more accurately resulted in a mere replacement of drivers rather than a hijacking.
            All of us mice squeaking out our windows will never be able to fend off the Cat. Now, if we were just able to track him…hmm, that would do, wouldn’t it?

  9. Ep3

    “Pete Peterson and his Wall Street allies want to run the experiment again in the hope that we get a different outcome”

    Not a different outcome Yves. They know the outcome. The outcome will be more deficits that we will have to sacrifice more again in 10 years. And again, and again.
    Notice Yves how that has been the given timeline. ‘cuts over 10 years’. And also Yves, the number being throw out is $4 trillion over ten years. Why $4 trillion? When the current debt is $15T? And with it going up at least $1T a year, or with a return to growth of either the Bush 2 era, or very doubtful Clinton years, it seems to me after 10 years we will have only broke even. Of course, I think I have heard the phrase used ‘a down payment’ on deficit reduction.
    God help us all.

    1. James

      Yeah, sounds like 10 years is what they’ve calculated as being their optimum “harvest cycle”. The rich are eating us, over & over again…

  10. dirtbagger

    Is the IMF that Auerback is quoting the same group that has been so brilliant at predicting and solving the European situation. I think the Fiscal Cliff is a MSM scare story -we got them Fiscal Cliff Terrorists threr in Washington. Modest slowdown at the most.

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