WASHINGTON BATTLE IS A DIVERSION / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

August 2, 2011 8:25 pm

Washington’s battle is a diversion

By Martin Sandbu

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The US, home to Hollywood and the inventor of televised politics, could be counted on to produce a cliffhanger of a show around the debt-ceiling debate. The prospect of default and down-to-the-wire deficit negotiations riveted the nation like a TV drama – and was, like most TV dramas, an escapist distraction from things that matter more.

Amid nail-biting over where the cuts will fall and fretting over what might happen in financial markets if the US loses its triple A rating, the latest economic growth figures were published. If America’s leaders had not been too busy to look, they would have found much more to worry about there.

The US economy grew by 3 per cent in 2010 – not overwhelming, but decent. In the first two quarters of 2011, however, the average annualised pace of growth was only 0.8 per cent. Assuming that the 2010 growth rate should still have been achievable in 2011 – surely a safe assumption given the quantity of human resources idling in US unemployment rolls – more than 2 per cent of annual output will be wasted on current 2011 trends.

Consider what this means in dollar terms. Had the US grown as fast in the first half of 2011 as it did in the same period in 2010, it would have produced about $225bn worth (in real 2011 dollars) of goods and services more than it actually did. For all of 2011, the difference between maintaining the 2010 growth rate and growing as slowly as in the first six months is almost $350bn. These are staggering amounts.

Even if the economy picks up, the US’s annual gross domestic product will remain permanently smaller, unless growth accelerates enough to make up for the lost time. Extend the first-half loss to the 10-year period envisaged in the deal voted through, and you get $2,250bn, almost what US politicians have ostensibly vowed to excise from the federal budget over the next decade.

In other words, six months of normal growth would have created enough value to pay for all the spending Congress has now agreed to cut. This unrealised value will now benefit no one. For politicians instead to pour their energy into unnecessary debt-ceiling negotiations comes close to criminal negligence.

If they asked what caused the US economy to slow down so fast, they would have to admit that the fault is part theirs. The climate of uncertainty created by the inability of America’s so-called leaders to agree on something – anything – has paused the single most likely driver of growth: business investment.

Given that the US foreign balance did not change much in the crisis years, the ballooning public deficit is mirrored in improved private sector balances: in particular, corporate profits. Apart from a nosedive at the end of 2008, after-tax corporate profits have held up amazingly. They are now about a third higher than in 2007. Although sitting on piles of cash, businesses hesitate to deploy it.

When the public deficit comes down, so will profits (barring a miraculous improvement in the US current account). The open question is what will shrink them: a stagnant economy in which companies do not make any money, or a buoyant one that justifies spending more on new hires and investment?
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The goal of economic policy should be to encourage the latter outcome and avoid the former. How much the deficit is reduced over the next decade is of secondary importance in this regard. Much more significant is what the spending that will take place is spent on.

The squabblers in Washington show little sign of realising this. On the contrary: their “solution” to the debt-ceiling impasse sets up a perfect plotline for frequently recurring conflicts around the size of government borrowing. This almost guarantees further distraction from the content of spending, rather than its quantity.

A grown-up political debate would turn on what kind of spending it is best to keep – or even increase – as well as what kind it is best to cut. Some differences on this matter are irreconcilable. But even Tea Party Republicans would surely prefer to cut in ways that are more conducive to growth (and therefore to smaller deficits and lower government debt, all else equal) rather than less.

Framing the question this way has three advantages. First, it draws attention to the fact that it is the composition of the federal budget, not its size, that restrains growth. The debt-ceiling pantomime played out in a country whose physical – and increasingly, educational – infrastructure is crumbling. Spending in these areas should be prioritised, not because they create jobs (though this is a bonus) but because they boost productivity growth.

President Barack Obama does talk about his vision for investments to propel the US economy into a green, high-tech future. But if big visions are all he has, he must translate them into action or they mean little.

Second, there is a lot of popular support for this sort of spending. Democratic and Republican voters want greater infrastructure spending by large – and equal – margins. The support of both camps for higher education spending is even stronger.

Third, a process of finding growth-friendly spending and tax policies would quickly reveal spending and taxes that are bad for growth. This, one might think, should make it easier to agree on a sensible deficit-cutting programme. But then that would not make good TV.

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Copyright The Financial Times Limited 2011.