Fiscal austerity slowing recovery in US

THE ECONOMIC news is looking better lately. But after previous false starts – remember “green shoots”? – it would be foolish to assume that all is well. And, in any case, it’s still a very slow economic recovery by historical standards.

There are several reasons for this, with the most important being the overhang of household debt that is a legacy of the housing bubble. But one significant factor in our continuing economic weakness is the fact that government in the United States is doing exactly what both theory and history say it shouldn’t: slashing spending in the face of a depressed economy.

In fact, if it weren’t for this destructive fiscal austerity, our unemployment rate would almost certainly be lower now than it was at a comparable stage of the “Morning in America” recovery during the Reagan era.

Notice that I said “government in the United States”, not “the federal government”. The federal government has been pursuing what amount to contractionary policies as the last vestiges of the Obama stimulus fade out. But the big cuts have come at the state and local level. These state and local cuts have led to a sharp fall in both government employment and government spending on goods and services, exerting a powerful drag on the economy as a whole.

One way to dramatise just how severe our de facto austerity has been is to compare government employment and spending during the Obama-era economic expansion, which began in June 2009, with their tracks during the Reagan-era expansion, which began in November 1982.

Start with government employment (which is mainly at the state and local level, with about half the jobs in education). By this stage in the Reagan recovery, government employment had risen by 3.1 per cent; this time around, it’s down by 2.7 per cent.

Next, look at government purchases of goods and services (as distinct from transfers to individuals, like unemployment benefits). Adjusted for inflation, by this stage of the Reagan recovery such purchases had risen by 11.6 per cent; this time, they’re down by 2.6 per cent.

And the gap persists even when you do include transfers, some of which have stayed high precisely because unemployment is still so high. Adjusted for inflation, Reagan-era spending rose 10.2 per cent in the first 10 quarters of recovery, Obama-era spending only 2.6 per cent.

Why did government spending rise so much under Reagan, with his small-government rhetoric, while shrinking under the president so many Republicans insist is a secret socialist? In Reagan’s case, it’s partly about the arms race, but mainly about state and local governments doing what they are supposed to do: educate a growing population of children and invest in infrastructure for a growing economy.

Under president Barack Obama, however, the dire fiscal condition of state and local governments – the result of a sustained slump, which in turn was caused largely by that private debt explosion before 2008 – has led to forced spending cuts. The fiscal straits of lower-level governments could and should have been alleviated by aid from Washington, which remains able to borrow at incredibly low interest rates. But this aid was never provided on a remotely adequate scale.

This policy malpractice is doing double damage to the United States. On one side, it’s helping lose the future because that’s what happens when you neglect education and public investment. At the same time, it’s hurting us right now, by helping keep growth low and unemployment high.

We’re talking big numbers here. If government employment under Obama had grown at Reagan-era rates, 1.3 million more Americans would be working as schoolteachers, firefighters, police officers, etc. than are currently employed in such jobs.

And once you take the effects of public spending on private employment into account, a rough estimate is that the unemployment rate would be 1.5 percentage points lower than it is, or below 7 per cent – significantly better than the Reagan economy at this stage.

One implication of this comparison is that conservatives who love to compare Reagan’s record with Obama’s should think twice. Aside from the fact that recoveries from financial crises are almost always slower than ordinary recoveries, in reality Reagan was much more Keynesian than Obama, faced with an obstructionist GOP, has ever managed to be.

More important, however, there is now an easy answer to anyone asking how we can accelerate our economic recovery. By all means, let’s talk about visionary ideas; but we can take a big step toward full employment just by using the federal government’s low borrowing costs to help state and local governments rehire the schoolteachers and police officers they laid off, while restarting the road repair and improvement projects they cancelled or put on hold.