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    55th Chrono-Deficit Financed Growth PDF

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    xan30tos

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    of 16
    The Levy Economics Institute of Bard College Strategic Analysis ‘April 2004 IS DEFICIT-FINANCED GROWTH LIMITED? Policies and Prospects in an Election Year DIMITRI B. PAPADIMITRIOU, ANWAR M. SHAIKH, CLAUDIO H. DOS SANTOS, AND GENNARO ZEZZA Introduction Wynne Godley, our Le ¥ Institue colleague, has warned since 1999 thatthe falling personal saving and rising horrowing trends that had powered the US. economic expansion were not sustainable He also warned that when these trends were reversed, as has happened in other countries, the expansion would come to a halt unless there were major changes in fiscal poli. Not fong ago, offical circles insisted that monetary poliey was the most effective tool, and that fiscal deficits were not only unnecessary but also harmful (Economic Report of the President 2000, pp. 31-4; Greenspan 2000). Some economists, notably Edmund Phelps of Columbia University, went so far as to suggest that the economic expansion was not caused by rising demand, but eather because growth had become “structural” (Phelps 2000). Yet fiscal policy has made a swift and major comeback, not simply as tax cuts and military ‘expenditures, DUC also as huge budget deficits, Three years ago, at the beginning of 2001, there ‘was government surplus of $113 billion One yeat later this had become a deficit of $292 billion, According to the latest available figures, by the third quarter of 2003 the deficit had grown to 604 billion The historical events that gave cise to this change in practice are well known, But they may aso signal a growing recognition of the limited effect of monetary policy. Many col: leagues at The Levy Economics Institute have long argued that government deficit, albeit of a dierent composition, would be negessary to sustain economic growth when private sector bor rowing reached its limits (Godley 1999; Papadimitriou and Wray 2001; Godley and lzurieta 2001), At the same time, we have emphasized the limits ofthis reconrse, for deficits are aleays linked to debts This is the theme we explore: AAs me expected, veal GDP gio tesponided chamaically to the rise in government deficits: in 2001, growth stood at 0.5 percent in 2002, it was 2.2 percents and by the fourth quarter ‘of 2003, it was 4.1 percent, having previously reached a peak fof 82 percent in the third quarter of 2003. In this process profite and productivity have soared, Until very recently, however, employment and wage ‘incomes have lagged far behind, Job growth was weak through ‘out 2003, despite high rates of output growth, Offical statistics based on payroll surveys indicate that 1.89 million jobs have ‘been lost since President Bush took office three years ago, Those statistics also show that only 8,000 jobs were created in ‘December 2003, 97,000 in January 2004, and 46,000 in February 2004, Official views have acknowledged this discrepancy between output growth and employment growth, which they have attributed to an extraordinary surge in productivity. The rate of growth of ral GDP per employee stood at 7.7 percent in the third quarter of 2003. While this rate af growth was high, such quarterly productivity growth rates are by no means usual, al ane typtally Followed by sharply Tower es (see Figure 7). Indeed, by the fourth quarter of 2008, productivity growth had fallen to 1.9 percent. What is relevant to employ- _ment prospects is the average rate of growth over longer pet ‘ods, whic we analyze in the next section, this Strategic Analysis Tn any cat, the latest figures appear to tell « dramatically different story: according to the payroll survey, nonfarm jobs grew by 308,000 in March. This recovery of employment is in line with our analysis of the eflects of the greatly expanded budget deficits, which we discuss below. But itis important to place this in context. Some 134,000 new jobs must be created every month just to absorb the growth in the workforce? From this point of view, total job creation from Desember 2003 to March 2004 wus still 7,000 short ofthe number needed jst to absorb new entrants, Moreover, there is continuing dispute over the actual ‘numbers of jobs created, because the two different methods employed by the ent resulls, The payell survey indicates that jobs rose from 46,000 in February to 308,000 in Math, AC he sau Gi, the household survey indicates a virtually constant level of job ean of Lahor Statisties (BIS) giv dite. ‘creation, 146471 in February and 146,650 in March. Nor have 2 Static Analyse, Api 2008 employment measures and unemployment rates moved together. For instance, the March surge in payroll job estimates has actually been accompanied by a slight rise in the unem ployunet rat, Gina 5.6 percent in Reba any 85.7 pesca Despite the murkiness ofthe jo picture it is widely agreed that new jobs increasingly encompass low-quality, low-wage ‘employment. According to the lead author of a recent stady ‘on employment measures, at “na other point in the nation's last fi recovery periods have so many poople been employed as independent contractors, a8 temporally self-employed, oF pad under te table” (Andrew M4 Sum, as ced in Ucttle 2004, p. 2). Furthermore, as shown by the “Employment Situation” report recenly released by the BLS, more than 49 milion persons curently want jobs, nation tothe 83 mil ion unemployed (BLS 2004) The weaknesin the labor market slo shows up in the virtua ‘which have eecently grown “at the slawest pace ever recorded! (Goldman Sachs 2003.2). Real hourly eamings ie, the dolar mount of earnings adjusted forthe cos of living, have actually begun to fall (BLS 2004), Similar, total employee compensa tion hasalso hep to al. hot dollar and inlation-adjusted teem, Ths, while the present recovery has been very good for profit i has yet Wo have « positive ipa and wages In any ease, the administration and Federal Reserve tagnation of houely caenings, Chairman Alan Greenspan remain optimistic about growth and employment over the near term, and do not seem alarmed by the sharp rise in government and current aevount dicts 1 horizon. Over the longer run, however, even they express concems about series of potential prob lems. These include an inevitable rise in the real federal funds rate to a“more neutral level, a grovsing pressute to bring fiscal ‘budgets back into line by cutting government spending or by raising taxes, and a growing pressure to curtail the current account deficit, Others, such as the International Monctary Fund (IMP), are openly pessimistic, and have recently warned thatthe lage cursent account and government budget deticits may drive up both global and US. interest rates, crowd out private investment, and erode productivity growth (see discus- sion helow). The markets aee aleeady signaling this concern ‘one day after the March job growth surge, the yield on the “Treasurys 10-year note june frou 3.88 perce 10 4.15 pet= ‘ent. This was the largest one-day run-up sine March 1996 (Puerbringer 2004), ‘Our focus in this and previous Strategic Analyses has been om the mevkinm term, In previons policy reports, we sp- gested that because the pr Finacial alan, it would take large fsa det the fel needed to jump-start and maintain economic grovth, [Bat we warned that leaving matters alone would lead to kage fiscal deficits paired with equally large current account deficits. In October 2002 we considered a depreciation of the currency to be an essential element of the overall policy pre- scription, and traced out the impact ofa 25-perceat decline in the beoad index of the dolar. In our subsequent report of (October 2003, we noted that the exchange rate had already depreciated by 6 percent. Large budget deficits have come to pass, as have concomi- ‘ant increases in the current account deficit. At the same time, fe. Its broad index has vate sector was moving toward lw provide the currency has continued to depres declined a further 2.7 percent since our previous Strategic Analysis, and in the words ofthe European Central Bank pres ident Jean-Claude richet, its decline against the euro has been “brutal” In the next section we examine the cnrrent state of the economy in some deta the ‘Then, in the final section, we assess plicatio {rece econmic events For te Fane pall of the economy. We find that while present monetary andi fis- cal policy stances are likely to Tead to robust growth and improved employment, this would come only at the expense of high government deficits, record foreign deficit ratios of government and forsign dabt relative to GDP. Even and rising ‘under the best of circumstances, with constant interest rates, this scenario is unsustainable. It would be even more so if interest rates rose, as projected by the Congressional Budget Office (CBO) and now anticipated by many observers. We therefore consider two alternative strategies for halving the government deficit in five years: curtailing government spend- ing, which is the path favored by the present edministeation; and rolling back recent tax culs, Our model shows that the la ter yields substantially higher growth and substantially lower ‘unemployment, The Current State of the Economy "The return of large id grit ing element of recent times, As @ matter of accounting, the “internal” financial balances (receipts minus nonfinancial Fiscal tii isthe ist seh Figure 1 Three Financial Balances in Historical Perspective ‘Tse Bn E ccoversiet Baas Pecentageof GDP 198 158D 1964 Tos TORE 1890 1957 198 199 1988 DOO) 2002 ‘Suuges BEA and aor aculaton (as cbsrvation 20084) Fiqure 2 Growth in Real GDP (Quarter by Quarter, at Annualized Rates) 4 Suu BEA (st observation 20084) ‘The Levy Eeonamios Istituto Berd Collage Figure 3 Real Corporate Profits = Source BEA and ator clans (st bterention 2005) " Eercentage Ports 6 fos. 1058 oon 09 Sua: BEA flat obra 203) 4 Statapic Anata, Api 2008 ure 4 Corporate Profit Share in GNP 8 expenditures) ofthe private sector plus the government sector ros equal the Soxternal” financial halance—that is, the rent account balance. The private sector encompasses house Wold and Us oe jut Few year asi as cing ange deficits, but as we have been projecting in previous reports (Papadimitriou etal 2002; Shaikh et al. 2003), ithas been rap ily reversing itself. At present the overall balance has even moved to a small surplus, because the fnanctal surplus of the business sector has more than offet the deficit of the house. hhold sector. Consequently, the current account deficit now Imirrors the government deficit. Neary twin deficits are back, as Figure 1 displays, In Figures | through 9, the shaded area represents the time in office ofthe cursent administration, As the unprecedented private sector deficits have receded, their place has been taken by large and growing budget deficits, These have auecceded in pulling the economy out of the 2001 downtuen and sustaining current growth, As shown in Figare 2, the growth rate ot the economy has risen rapidly in response to the burgeoning fiscal deficits. With this higher ‘growth has come greatly enhanced profitability, for not only «lo deficits increase personal-sector disposable incame (sine the income created by the government exceeds taxes collected voicrever there ina dei but they diteuly all (o soxporate profits (Papadimitriou and Wray 1998), Figure 3 depicts total real corporate profits! which in a ‘hort space of time have already surpassed the peak they had previously achieved atthe height of the stock market bubble Alternatively, Figure shows that the share of profits in total GDP behaved ina similar manner, although itis sil just short “ofits previous peak, Similar benefits have not yet been conferred on labor, Figure 5 displays total nonfarm employment, which began to fallin 2001 and has only just begun to rebound. As we noted

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