Former director of the Office of Management and Budget in the Obama administration Peter Orszag has an op-ed at Bloomberg that has parts or movements. The first movement is slow, meticuluous, and sobering, the second light and fanciful. In the first part Dr. Orszag makes a very convincing case that economic growth in the United States will be very much slower for the foreseeable future. That movement closes with this passage:
Even without long-lasting effects from the crisis, the official projections may be on the rosy side. An analysis by John Fernald, a senior research adviser at the Federal Reserve Bank of San Francisco, is largely agnostic about whether the impact from the financial crisis will last. But Fernald also raises another troubling point: that productivity growth had been slowing even before the crisis hit in 2007.
Fernald estimates that, as a result of the slowdown in productivity growth (along with an aging population), in the long run we should expect annual growth to average only 2.1 percent. Yet government forecasts are higher. The White House is projecting long-term growth of 2.5 percent per year, and the CBO puts it at 2.4 percent.
These differences may seem small, but don’t forget the power of compound interest (which has large consequences for income) or the budget deficit’s sensitivity to growth (which is surprisingly acute). Over the next decade, if Fernald is right, the deficit will be about $1 trillion larger than official projections suggest. Keep in mind, his analysis takes a benign view on whether the crisis itself will further diminish income in the long run.
Very slow real economic growth has a number of implications. For example, it casts real doubt on the 8% nominal growth assumed by many public pension plans. Most of all very slow real growth, at or near zero, means that cuts mean real reductions. The customary Washington usage of cuts meaning “reductions in the rate of growth” won’t work.
Here’s the allegro giocoso:
Which brings me back, once again, to the idea of a barbell fiscal policy. Policy makers in Washington should couple substantial upfront stimulus spending with even bigger, but delayed, deficit reduction. Both ends of this barbell are crucial: The stimulus can help to reduce the lasting effects of the crisis, and, given that the official deficit projections may be too sunny, the austerity will help prevent a future fiscal crisis. Furthermore, the combination is more politically feasible than either component alone.
I think that Dr. Orszag forgets that politicians are deaf in one ear. With their good ear they’ll hear “upfront stimulus” but “bigger, but delayed, deficit reduction” will fall on the deaf ear because, as noted above, in a period of very slow or no growth, cuts mean actual cuts.
What’s the solution? As I have been saying for some time, we need stimulus without deficits as proposed by Paul Samuelson many years ago, effected by replacing relatively nonproductive spending on agriculture, defense, healthcare, and education with more productive stimulus. I’ll leave what those might be to the reader but my favorites are things like energy production, improvements to the power grid, and telecommunications improvements, measures that will aid the economy of the future.