Friday, November 28, 2014

America’s Three Deficits

BERKELEY – This year began with a series of reports providing tantalizing evidence that economic recovery in the United States is strengthening. The pace of job creation has increased, indicators for manufacturing and services have improved, and consumption spending has been stronger than anticipated. But it is too early to celebrate.

Output growth in the US remains anemic, and the economy continues to face three significant deficits: a jobs deficit, an investment deficit, and a long-run fiscal deficit, none of which is likely to be addressed in an election year.

Although output is now higher than it was in the fourth quarter of 2007, it remains far below what could be produced if labor and capacity were fully utilized. That gap – between actual and potential output – is estimated at more than 7% of GDP (more than $1 trillion).

The output gap reflects a deficit of more than 12 million jobs – the number of jobs needed to return to the economy’s peak 2007 employment level and absorb the 125,000 people who enter the labor force each month. Even if the economy grows at 2.5% in 2012, as most forecasts anticipate, the jobs deficit will remain – and will not be closed until 2024.

America’s jobs deficit is primarily the result of inadequate aggregate demand. Consumption, which accounts for about 70% of total spending, is constrained by high unemployment, weak wage gains, and a steep decline in home values and consumer wealth. The uptick in consumption in the last months of 2011 was financed by a decline in the household saving rate and a large increase in consumer credit. Neither of these trends is healthy or sustainable.

With an unemployment rate of 8.5%, a labor-force participation rate of only 64%, and stagnant real wages, labor income has fallen to an historic low of 44% of national income. And labor income is the most important component of household earnings, the major driver of consumption spending.

Even before the Great Recession, American workers and households were in trouble. The rate of job growth between 2000 and 2007 slowed to only half its level in the three preceding decades. Productivity growth was strong, but far outpaced wage growth, and workers’ real hourly compensation declined, on average, even for those with a university education.

Indeed, the 2002-2007 period was the only recovery on record during which the median family’s real income declined. Moreover, job opportunities continued to polarize, with employment growing in high-wage professional, technical, and managerial occupations, as well as in low-wage food-service, personal-care, and protective-service occupations.

By contrast, employment in middle-skill, white-collar, and blue-collar occupations fell, particularly in manufacturing. Hard-pressed American households slashed their savings rates, borrowed against their home equity, and increased their debt to maintain consumption, contributing to the housing and credit bubbles that burst in 2008, requiring painful deleveraging ever since.

Three forces have driven the US labor market’s adverse structural changes:

·         Skill-biased technological change, which has automated routine work while boosting demand for highly educated workers with at least a college degree.

·         Global competition and the integration of labor markets through trade and outsourcing, which have eliminated jobs and depressed wages.

·         America’s declining competitiveness as an attractive place to locate production and employment.

Technological change and globalization have created similar labor-market challenges in other developed countries. But US policy choices are responsible for the erosion of America’s competitiveness.

In particular, the US is underinvesting in three major areas that help countries to create and retain high-wage jobs: skills and training, infrastructure, and research and development. Spending in these areas accounts for less than 10% of US government spending, and this share has been declining over time. The federal government can currently borrow at record-low interest rates, and there are many projects in education, infrastructure, and research that would earn a higher return, create jobs now, and bolster US competitiveness in attracting high-wage jobs.

President Barack Obama has offered numerous proposals to invest in the foundations of national competitiveness, but Congressional Republicans have rebuffed them, claiming that the US faces an impending fiscal crisis. In fact, the federal deficit as a share of GDP will shrink significantly over the next several years, even without further deficit-reduction measures, before rising to unsustainable levels by 2030.

The US does indeed face a long-run fiscal deficit, largely the result of rising health-care costs and an aging population. But the current fiscal deficit mainly reflects weak tax revenues, owing to slow growth and high unemployment, and temporary stimulus measures that are fading away at a time when aggregate demand remains weak and additional fiscal stimulus is warranted.

At the very least, to keep the economy on course for 2.5% growth this year, the payroll tax cut and unemployment benefits proposed by Obama should be extended through the end of the year. These measures would provide insurance to the fragile recovery and add nothing to the long-run fiscal gap.

So, how should the US economy’s jobs deficit, investment deficit, and long-run fiscal deficit be addressed?

Policymakers should pair fiscal measures to ameliorate the jobs and investment deficits now with a multi-year plan to reduce the long-run fiscal deficit gradually. This long-run plan should increase spending on education, infrastructure, and research, while curbing future growth in health-care spending through the cost-containment mechanisms contained in Obama’s health-reform legislation.

Approving a long-run deficit-reduction plan now but deferring its starting date until the economy is near full employment would prevent premature fiscal contraction from tipping the economy back into recession. Indeed, enactment of such a package could bolster output and employment growth by easing investor concerns about future deficits and strengthening consumer and business confidence.

Painful choices about how to close the long-run fiscal gap should be decided now and implemented promptly once the economy has recovered. But, for the next few years, the priorities of fiscal policy should be jobs, investment, and growth.

Read more from our "America's Precarious Recovery" Focal Point.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (3)

    Please login or register to post a comment

    1. Commentedparthasarathy Shakkottai

      Bushido, the warrior code says:
      1. Think of what is right and true.
      2. Put the science into practice.
      3. Become acquainted with the arts.
      4. Understand the negative and positive qualities in everything.
      5. Learn to see everything accurately.
      6. Become aware of what is not obvious.
      7. Be careful even in small matters.
      8. Don’t do anything useless.
      This is about items 4, 5, 6, 7, and 8 for people who dabble in economy like me.

      The biggest problem in public analysis is the economic illiteracy of mainstream media, congress, president and neo-liberal economists who confuse the budgets of USA (the currency issuer) with budgets of everybody else (currency users). Scare words like “unsustainable debt”, “living beyond our means”, “debt crisis” etc. are used and comparisons made to household budgets, a totally incorrect analogy. The dollar is basically a token that keeps the economy running.
      Modern Monetary Theory is true. Lots of data is conformity with it. Deficits are good, surplus is bad, govt debt implies private sector wealth, national debt need not be paid back, USA does not need taxes to spend, the debt/GDP does not mean anything for a monetarily sovereign nation, China does not fund our economy, inflation is not a risk until full employment is reached, USA can afford to bailout the states and stop all austerity. Almost everything said in the mainstream media is wrong. The congress and the president repeat talking point economics as does Fox News. It is a shame!
      Income taxes play a minor role in macroeconomics. There is no urgency in fixing taxation. It is a major distraction to allow any useful action. Immediate deficit funding is what is required. Taxation has a role in income equality and inflation control and can be attended to later because right now the plutocracy is in control. Government creates money and the economy uses it.
      a) Federal Deficits – Net Imports = Net Private Savings is strictly true.
      Government creates money and the economy uses it.
      a) Federal Deficits – Net Imports = Net Private Savings is strictly true. Govt “debt” is the sum of all deficits and appears on one side of the equation whereas the private sector “debt” means negative savings. Govt deficit is the source of money.
      Govt “debt” is the same as private savings. These are in the form of the govt bonds held by citizens, pension funds and so on. If the national debt is paid off lots of citizens will be unhappy. The interest also flows into the private sector. The two key equations in economics which apply to any system of govt are a) and b):
      A numerical proof of (a) is shown in figure 4 of
      b) Gross Domestic Product = Federal Spending + Private Investment + Private Consumption + Net exports.
      The GDP has been approximately 5 times govt spending. Actual data is in shows deficits have been quite common (58 deficits out of 70 years)
      The household net worth of USA is $58.5 Trillion. The national debt is $14 T. GDP is about the same, $14T/yr. The ratio of GDP/yr to govt spending/yr has been about 5 over the years. The same ratio holds for household net worth to national debt.
      The currency issuer is the monopoly producer of money and, just as every asset has a liability, also results in government liabilities. The issuer's liabilities, or "debt", is a digital account of the currency supply used by the currency users. To a fiat currency issuer, the currency supply is a digital accounting tool, not an asset in and of itself. The currency supply is simply the bookkeeping records corresponding to all the currency users’ savings in banknotes, deposits, and treasuries.
      Money functions as both a store of value and a medium of exchange. When users acquire dollars they can spend them for items in the marketplace or choose to save them as banknotes, deposits, and treasuries.
      The more users choose to save the more "debt" the issuer takes on. A common misconception is that currency issuers "borrow" money. The issuer does not borrow because it is the monopoly producer of the currency - the money that currency users spend or save. This is simply double entry accounting.
      Savings by currency users, domestic or foreign, is a straightforward concept on an individual level but becomes counter intuitive on a macro level." from”
      Which has nice sketches to explain MMT.

    2. CommentedWilliam Wallace

      Spot on. The real question that plagues us, however, is how to make political and economic debate rational again, else ideas such as these will remain stellar, yet unheeded, blog posts.

      I fear that until the Citizens United decision is reversed, and media de-oligopolized, we're going to have a hard time of it.

    3. CommentedPaul A. Myers

      I would like to see a broad-based progressive policy debate in the United States by economic progressives centered on an immediate $1 trillion public works program as part of a multi-trillion dollar, multi-year investment approach to more research, more investment in educational skills, and progressive employment practices that ensure low-wage jobs carry reasonable health insurance.

      Strong arguments should be taken to the American public that taking on public debt to build public assets is the "smart play" to gain future competitive advantages for the American economy, to make sure America comes out the "winner" in the future competition with the new emerging countries.

      A clear argument needs to be made that the only way to turn around the decade-long decline in average median wages, and the decline in purchasing power for the majority of American households, is through first massive investments in public infrastructure that impact private sector productivity and then improved skills-based education in the medium term--smarter plumbers, smarter physicists.

      A clear argument needs to be made that improving average real wages and family real incomes does not come from tax cuts at the top, that a billionaire-based economy is not a middle class economy.

      It is long since past time to take the progressive arguments straight against the economic reactionaries and brand the economic royalists for what they are.

      And since the economic royalists are running their poster boy for president this year, what better time to take the good arguments, the sound reasoning to the American public.

      And can we stop talking about the debt we're going to leave to our children and start talking about the assets and opportunities that we are going to bequeath to them.