Pethokoukis, Economics, U.S. Economy

The dodgy austerity economics of the tea party GOP

Image Credit: shutterstock

Image Credit: shutterstock

A big reason most tea party Republicans — and there were exceptions, unfortunately — didn’t fear a debt ceiling crisis was not because they thought default inconsequential. They realized missing debt interest payments would be a big deal but thought Treasury had the ability and resources to make good.

What didn’t seem to scare TPRs, however, were the sudden and severe budget cuts that would have ensued had Congress failed to increase US borrowing authority. Just the opposite: those budget cuts would actually have boosted growth, they argue, by reducing the level of economic resources Washington was siphoning from the private sector. Wall Street’s take — that such austerity would eventually tank the economy — didn’t cut any ice.

Now there is evidence smaller government is good for growth over the longer run. But flash austerity would be quite an economic — and political — gamble to take when the economy is only growing at 2%ish, inflation is moribund, and unemployment remains highly elevated. And while TPRs think they have economic history on their side, that’s unclear.

1. TPRs point to the short and sharp 1920-21 depression as an example of a refreshing downturn, one where a fast recovery followed a needed liquidation after an inflationary wartime debt binge. Although the economy shrank by nearly 10% and unemployment rose from just over 1% to nearly 12%, the downturn was followed by the Roaring ’20s.

But more recent scholarship pegs the depression as really more of a bad recession with output falling by 3.5% and unemployment rising from 3% to just under 9%. More importantly, the Fed eventually responded with interest rate cuts. American University economist Daniel Kuehn: “The contribution of the Federal Reserve to the economic recovery follows unambiguously from comprehension of its contribution to the onset of the depression.” Would tea party Republicans want the Fed to respond to sudden fiscal austerity with more quantitative easing? Unlikely.

2. TPRs also point to US economic performance at the end of World War II. From 1944 to 1948, spending as a share of GDP plunged to 9% in 1948 from 44% in 1944. Devout Keynesian Paul Samuelson predicted such shock austerity would cause “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” It didn’t happen. While unemployment did rise from artificial wartime lows, George Mason University economist economist David Henderson of the Hoover Institution and Naval Postgraduate School points out that during the years from 1945 to 1948, it reached its peak at only 3.9% in 1946, and, for the months from September 1945 to December 1948, the average unemployment rate was only 3.5%. The private-sector gained as government retreated. While total output fell by 12% in 1946, private-sector GDP rose by nearly 30%.

As I have written before, such analysis provides useful insight into how free-market economies can adjust to shocks if government gets out of the way. But does the 2013 US economy — where net national savings as a share of GDP is close to zero — really look like the 1945 version? During the 1941-45 war years, over 22% of disposable income was saved, according to UCLA business professor Richard Rumelt. Not only did rationing limit consumer choice, but Americans were paying down depression-era debt and buying War Bonds. Rumelt:

When hostilities ended in 1945, many expected that an expanded civilian work force, plus reduced federal deficits, would bring back the depression of the 1930s. There was indeed a brief recession in 1946, but as production was rededicated to consumers and rationing was lifted, people rushed to replace rusted-out automobiles and broken-down refrigerators. The returning soldiers got jobs, moved to newly constructed housing in the suburbs, and the postwar boom was on. And it was greatly accelerated by households’ renewed capacity to take on debt.

3. TPRs also cite the 1990s economic boom. After the Cold War ended, overall federal spending fell to 18% of GDP in 2000 from 22% in 1991. Real US GDP, however, grew by 40% with an average annual growth rate of 3.8%. Case closed? Keep in mind that a) the spending reduction was only as a share of GDP — it rose in both inflation and non-inflation adjusted terms, b) took place over the course of a decade, and c) happened at the same time as a private-sector productivity boom. Of course, Henderson speculates that perhaps the decline in defense spending freed up knowledge workers to help make technological miracles happen in the private economy.

Maybe. But I don’t find this smattering of historical evidence persuasive enough to endorse sudden and severe budget cuts with interest rates at historical lows.(Even Rand Paul’s austere budget plan wouldn’t balance until 2018.) Given that the average US debt-to-GDP ratio was 37% from 1957 through 2007, a better policy goal would be to immediately shift — via entitlement reform and pro-growth polices rather than more discretionary spending cuts — the debt-to-GDP ratio onto a downward trajectory back toward that 37% level, if not lower, over the next two decades. That would be a far smarter and feasible agenda for Republicans and conservatives and libertarians of all types.

32 thoughts on “The dodgy austerity economics of the tea party GOP

  1. You should also point out they’re in favor of cutting government spending, but only to the extent that it is someone else’s spending that gets cut. They’re not willing to give up their Social Security payment, their farm subsidies, the money that goes to maintaining the highways in their state, the Medicare money that covers their mom and dad’s health care, and so on.

    As to their claim that government spending is crowding out private investment, that holds only in a world of limited dollars. In a world where the Fed is printing money at will, that really isn’t the case. Private sector projects that are deemed worthwhile (defined as the ability to repay the loan/investment) still get funded. Project that don’t show potential don’t get funded. Any cuts in government spending won’t change that dynamic, it isn’t as if people with cash are going to throw their money into, for example, solar companies like Solyndra in lieu of buying treasury bills.

    • “Private sector projects that are deemed worthwhile (defined as the ability to repay the loan/investment) still get funded.”
      The Federal “spending” and Fed “printing” has distorted what is worthwhile. As long as government and quasi-government agencies select winners and remove hazards from “investing”, there will be people that oppose it, just like there will be economists and commenters that favor it.

    • Your characterizations are much too simplistic re: Social Security and Medicare. The government did not “suck” the American people into this morass over a couple of years and there is no way out over a few years either. Many Tea Partier’s know this. As a Tea Party supporter and Social Security and Medicare “beneficiary”. I would gladly be willing to be “bought out” by the feds. However, you don’t get to take my money for 45 years of work and career and then decide you don’t owe me anything. Give me my money back with 30 year T bond interest and I’ll gladly opt out.

      In fact, had you given me that choice around age 55 I would have taken that deal too. So your straw man choice of cutting spending for those in these programs who are 55 and over is just that, a straw man argument. Reforming those programs for the under 55 however would, I believe, work for everyone’s benefit.

      What Tea Party people want, I believe, is to reform the entitlement programs over a number of years, which also includes disability, food stamps or SNAP, and other welfare programs. And to begin to move the federal government back closer to its’ Constitutional enumerated powers.

      As for your contention re: govt. spending crowding out private, I’ve not seen any Tea Party material I receive state that as a Tea Party position. Again, in my opinion, private investment is being greatly hampered, but by a bad tax code, and the tremendous uncertainty created by Dodd-Frank and Obamacare. Yes, we want the roads maintained, but “investing” in all manner of liberal favorites such as Solyndra, Light rail, and ethanol is not fixing the roads.

      • I’m in total agreement with you. IMO Pethokoukis and the Establishment just want to get rid of the Tea Party because they like earmarks, corporate welfare, and the political game of horse trading.

        • Pethokoukis really is an unrequited Keynesian of the worst sort. Always defaults to the statist position….but then again who @ AEI is not a Corp/Gov shill/supporter?

  2. Not EVER a good word to say for the one group of Americans calling for fiscal restraint.

    Good work James.

    The banks and EBT card users appreciate your support!

    • Bravo.
      In the real world, 70% of registered voters want major spending cuts. And the large majority oppose Obamacare. How awful of the tea party to speak up for what the vast majority want. I think DC addles the brain and makes the inhabitants hate what the vast majority of normal Americans want. It is just common sense.

      • Speaking up and throwing a tantrum are not quite the same. Center right Rs hate Teabaggers because they’re sabotaging what modest leverage the Rs have on budget policy. http://www.people-press.org/2013/10/16/tea-partys-image-turns-more-negative/

        Now the Rs don’t really believe Teabaggers ARE Rs (read the poll) but voters are not so discriminating, and Rs took an equal beating from the shutdown. So your choices are: Form your own party and turn over control of govt to the Ds for the foreseeable future, or accept that politics is the art of compromise.

        • What budget policy, moron?

          The Senate passed its first budget in 5 years this year, because Scumbag Harry Reid wanted to maintain the stimulus spending as baseline, so he broke the process (illegally) and forced a series of CRs.

          Jesus Turd, you’re ignorant.

          • Thanks for making my case. By forcing a shutdown over ACA rather than the budget, the teabagger nutcases made Boehner’s position even weaker.

          • What bizarre alternate reality do you inhabit, Turd? Do you even think before typing?

            Dumbass, the shutdown was ostensibly over funding of the ACA in the budget for FY 2014. The Repugs funded everything BUT ACA, and even passed a number of individual bills to keep things operating.

            Hairy Greed and Barry Oblunder decided that wasn’t enough, and shut everything down. That is what happened. That is a perfectly constitutional function of the House.

            Don’t like that? You want a rubber stamp? Then win the House. Elections have consequences.

            For the record, I thought the strategy wasn’t well thought out and doomed to fail, which it mostly did, but I am sympathetic to any effort to shut down this government.

            Now, it should be mentioned that thanks to John Roberts’ creative (and poor) jurisprudence, we’re still having this argument, so he is at least partially responsible for this mess.

          • Keep spinning. There may be an independent voter in South Dakota who doesn’t recognize extortion when he/she sees it,

  3. Leaving aside that there is no austerity, and no planned austerity for the foreseeable future, what you need to look at is the economic inertia exploding the debt-drivers, specifically entitlements. That is what most Tea Partiers are worried about (at least the ones I talked to, and no, I’m not a member).

    Once you reach a certain debt threshold, it is virtually impossible to “go back.”

    Here is the best explanation of this theory –

    http://www.cyniconomics.com/2013/10/17/fonzie-or-ponzi-one-theory-on-the-limits-to-government-debt/

    Once we have crossed from the Fonzie to the Ponzi, it’s over.

    I’m pretty sure were already past that point.

  4. Why call it austerity economics? It is not. Austerity is the combination of spending cuts and tax increases. The Republicans were not calling for tax increases. I find it amazing that there is no mention of the Democrats desire to increase taxes during a feeble recovery as dodgy economics.

    What the debt ceiling would provide is an instant balancing of the federal budget: with no borrowing tax revenues would equal spending. Going from a massive $700 billion deficit to zero would be politically infeasible.

    By the way, regarding your link to the Citi’s gloomy forecast: don’t you think Citi has a vested interest in not hitting a debt ceiling because they are a Primary Dealer in treasury securities?

  5. Good blogging…I would point out that immediate postwar prosperity was accompanied by an expansive Fed…a lesson for today’s timid and irresolute Fed…indeed, the USA economy of the 1940-1980 period had many more structural impediments and was thus more inflation-prone than today…why the Fed is so tight today is an interesting question for sociologists, or maybe sociopathologists.

      • But he is certainly like Obama in another regard: he loves to slay strawmen“…

        Only strawmen Obama likes to slay are those that are generated in his imagination…

  6. Nobody thinks that hitting the debt ceiling is the optimal way to curb spending. But, the current levels of deficit spending cannot go on forever. And, therefore, won’t. Something must be done before it is too late. It would be nice if our politicians would take affirmative steps to address the problems facing our nation. But they won’t. And, in that case, I can forgive people for being willing to accept a bad and painful solution now over catastrophe later.

  7. “But does the 2013 US economy — where net national savings as a share of GDP is close to zero — really look like the 1945 version? During the 1941-45 war years, over 22% of disposable income was saved,”

    Of course it doesn’t. What is the impetus to save? CD rates are near zero and if I run out of money there any number of government programs available (unlike 1945) to help me. In fact, as the rhetoric to means test SS heats up there becomes a great disincentive to save. Why should I scrimp and save to fund my IRA to an adequate level only to see my SS benefit reduced. All the while my neighbor vacations on his home equity line and then lives on an ever more generous SS benefit.

    And don’t even mention austerity. When the government reduces it’s spending in actual dollars then you can mention it.

    I would almost expect to see an opinion like this on the Huffington Post rather than AEI.

    • OK, now that you’re done bloviating, does it look like 1945 outside? Is the average car 12 years old and sitting and four bald tires? Are we playing catch-up on five years of household formation?

      If you think the grasshoppers are winning, then obviously you would support a program of forced savings. Like SS for example.

    • OK, now that you’re done bloviating, does it look like 1945 outside? Is the average car 12 years old and sitting and four bald tires? Are we playing catch-up on five years of household formation?

      If you think the grasshoppers are winning, then obviously you would support a program of forced savings. Like SS for example.

  8. James (if I may),
    Thanks for mentioning my study and linking to it. Those who want to see how I handle the issue of pent-up post-World War II demand should read the study and go to the end where I deal with that issue.
    Oh, and I’m not a George Mason University economist, not that that’s an insult. I’m an economics professor at the Naval Postgraduate School and a research fellow with the Hoover Institution.
    Finally, one thing I notice is that while you have criticisms of each of the cases others and I give where spending was cut a lot and the economy didn’t tank, you don’t actually give examples where spending was cut a lot and the economy did tank. I’ve been looking for those and can’t find any. Do you have any?

  9. Hmmm. Jim complains about “austerity” (what ever that means in a world of 17T debt and multi hundred billion annual deficits) and then quotes unrepentant Keynesian cultist Daniel Keuhn.

    How long before he starts writing for Brookings?

  10. You can all debate the number of angels that can dance on the head of a pin until the cows come home. Try a little dose of reality. In 1980, the two countries that adopted neoliberalism and supply side economics the earliest and then went the furthest under the Reagan/Thatcher “revolution” were Britain and England. Thirty years later they are the two modern economies with the worst distribution of income, the widest disparity between the richest and poorest and the fastest declining middle class. In addition to those “achievements” they are also the only two modern economies headed in the wrong direction with regard to a skilled workforce according to the recently released OECD report: http://skills.oecd.org/skillsoutlook.html. If the Tea Party prevails again at next election, I wonder where America will be in another 30 years? Is supply-side economics actually the “Mother” of All Ponzi Schemes. Is “Koched” really a verb meaning “screwed by a billionaire.”

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