CORRECTION: An earlier version of this story incorrectly stated the position of the Republican report, which argues that lower private-sector wages will increase employment.
In a little-noticed economic report distributed by the office House Speaker John Boehner last week, the Republican staff of the Joint Economic Committee attempted to refute criticisms that the GOP’s economic agenda would deliver too much pain too fast.
The paper makes the party’s anti-Keynesian case that fiscal consolidation (read: spending cuts) can spur immediate economic growth and reduce unemployment. But in making that case, the Republicans may also have given Democrats some political ammunition.
For example, the paper predicts that cutting the number of public employees would send highly skilled workers job hunting in the private sector, which in turn would lead to lower labor costs and increased employment. But “lowering labor costs” is economist-speak for lowering wages — does the GOP want to be in the position of advocating for lower wages for voters who work in the private sector?
The report also touts the value of cutting “transfer payments,” or subsidies, to private firms, suggesting cuts to Amtrak and ethanol support. But many Republicans back both of those objectives, and the GOP has long been a staunch defender of corporate subsidies through both spending and the tax code, including direct payments to agricultural firms.
With those prescriptions somewhat at odds with Republican policy — not to mention the atypical praise for government policy in countries with strong social democratic influences like Sweden and Canada — the report provides an unusual window into Republican economic thinking.
After the study was released last week, Boehner, along with the entire House Republican leadership, urged the White House and legislators from both parties to consider the report’s findings.
“JEC’s study provides the facts to back up what the American people know: Washington Democrats’ spending binge has made it harder to create jobs, and cutting spending will reduce uncertainty and encourage the private sector to make investments that will grow our economy,” Boehner’s spokesman Michael Steel said when asked for comment on specifics in the report. He declined to offer more detail.
Many economists in the Keynesian tradition, from Federal Reserve Chairman Benjamin Bernanke to some members of the Bowles-Simpson deficit-reduction commission and the Bipartisan Policy Center’s budget-reform task force, follow a basic set of assumptions about the interactions between spending, tax cuts, deficits, and growth.
Those approaches assume that, in general, spending cuts bring short-term pain because they reduce demand and involve laying off workers. But over the medium- and long-term, those economists contend, the economy benefits because lower deficits and debt lead to lower interest rates and less crowding out of private investment.
That’s why many of the budget-reform proposals now circulating in Washington put top priority on a credible plan to gradually reduce deficits and reform entitlements over time and call for maintaining government spending at about current levels for another year or so, until economic growth returns to more normal levels.
Republicans argue that massive short-term cuts are needed — the House Republicans’ 2011 spending bill would immediately cut $59 billion from domestic discretionary spending, roughly 9 percent of what the government now spends on those programs.
The Republican report is designed to respond to critics, including many economists on Wall Street, who predict that the GOP’s proposed cuts would slow growth and cost jobs over the next year or two.
Their answer is that “non-Keynesian” effects — increased business and consumer confidence that their taxes won’t rise as a result of government retrenchment—will provide immediate positive results across the economy.
To establish that spending cuts can lead to near-term growth, the study looks to the experience of several small European countries. Some economists say the nations cited don’t provide a useful model to the United States because those countries took steps to blunt the impact of cuts — such as devaluing their currency to promote exports — that are improbable in America, especially with monetary policy already stretched to the limit.
“Much of this study relies on the growth performance of a few (very) small open economies — Sweden, Canada, New Zealand, notably — after 1994,” said University of Texas economist James Galbraith, who was executive director of the JEC in the early eighties. “It’s easy to look good if you are a small country with a freshly devalued currency selling into a world boom. The ‘lessons’ will not apply to the United States, which cannot just contract domestically, devalue the dollar (sacrificing our reserve-currency position) and expect the rest of the world to bail us out by buying our exports.”
The GOP argument “would have more force if the economy today looked more like the economy in the 1990s expansion — the longest in our country’s history and the last time we had a balanced budget,” Chad Stone, chief economist for the Center on Budget and Policy Priorities, wrote in response to the JEC report. “In today’s economy, weak demand, not competition for funds, is the much more plausible explanation for inadequate investment.”
As the Republican report itself acknowledges, economists at the International Monetary Fund — no shrinking violet when it comes to prescribing harsh spending cuts — have contended that many of the studies cited in the report are flawed. In the October 2010 World Economic Outlook, IMF researchers asserted that cutting spending “typically reduces output and raises unemployment in the short term,” even if the non-Keynesian effects cushion the blow slightly.
What the GOP report does establish is an economic consensus that in a case of fiscal crisis, as seen in Greece or Ireland, a consolidation effort would be wise to rely on spending cuts rather than tax increases, because the latter have a tendency toward recessionary effect. The United States, however, is not likely to default unless Congress refuses to raise the government’s legal borrowing limit before that ceiling is bumped in April or May.
Ultimately, the argument comes down to what policymakers see as the key problem in the economy. Is growth slow because businesses and consumers fear higher taxes or because businesses don’t have enough demand for their products to expand? Republicans are arguing the former, but many economists — and the bond market — believe the latter is closer to the truth. Moody’s bond-rating agency warned on Thursday that the U.K. is in danger of having its debt downgraded due to worries about slow growth resulting from consolidation.
This article appears in the March 25, 2011 edition of National Journal Daily PM Update.