Hard Slog -- the Real Future of the U.S. Economy: Peter Orszag
The continuing weakness in the labor market and the saga of the debt limit highlight the dual problems we face: low economic growth right now and an unsustainable amount of debt for the future. Unfortunately, both are probably more significant than policy discussions and official predictions about the U.S. economy suggest.
The history of economies recovering from severe financial distress implies the unemployment rate will remain stuck at elevated levels for years, not quarters. And sluggish growth, in turn, will mean larger budget deficits.
Under a plausible hard-slog scenario, the fiscal gap would exceed $13 trillion over the next decade, without a change in government policies. That’s at least $2.5 trillion more than the deficit with official economic assumptions -- a difference that itself will probably be larger than any deficit reduction that comes from the debt-limit deal. So it’s worth exploring the implications of slower growth in more detail.
One important way in which the official projections may turn out to be too optimistic involves unemployment. The fundamental impediment to getting jobless Americans back to work is weak growth. Yet that is the norm rather than the exception after the type of experience we have lived through. Recoveries following financial collapses tend to be frailer than those associated with other sorts of economic declines.
As a result, unemployment is likely to remain stubbornly high for a significant period. Consider the other advanced economies that have experienced financial implosions similar to the one we had: Spain in 1977, Norway in 1987, Finland in 1991, Sweden in 1991 and Japan in 1992.
The economists Carmen and Vincent Reinhart found that in all five of these countries the unemployment rate has still not fallen back to pre-crisis levels, even today. The peak was reached from three to 10 years after the meltdown. And the median increase in the jobless rate across these countries in the decade following the implosion was, astonishingly, more than five percentage points.
What do our official projections suggest? The Congressional Budget Office, which I have had the privilege of leading and which provides an objective set of economic and fiscal projections, offers an example. For the decade ahead, the CBO expects an average unemployment rate of 6 percent -- up only one percentage point from the average of about 5 percent before the 2008 crisis. Sure, our labor markets are more flexible than those in most other countries, and that should help reduce the jobless rate relatively rapidly here. But given the experience of other countries that have endured similar financial collapses, that performance would still be extraordinary.
The declines in unemployment predicted by CBO, as well as the Federal Reserve and other government institutions, arise because these agencies continue to anticipate growth rapid enough to drive down the jobless rate significantly from its current 9.2 percent level. As time goes by and the expected fast expansion in gross domestic product doesn’t materialize, projections simply delay the robust growth for another year.
The risk in using this methodology is that it misses the deeper structural hurdles our economy faces that can depress growth over a prolonged period -- including the still-depressed housing market and the adverse effects of deleveraging.
If we are in for sluggish growth over the next few years, the labor market won’t be the only aspect of the economy that does worse than official projections; the budget deficit will be significantly bigger as well.
The CBO paints a surprisingly auspicious picture of the fiscal shortfall, averaging 3.4 percent of gross domestic product over the next decade and dipping to about 3 percent by 2020. But this is misleading for two reasons. First, the CBO projections are based on the letter of the laws that Congress enacts rather than on what is likely to occur. For instance, if the law says a tax cut will expire, the CBO assumes it will actually do so, even if it has always been extended in the past. Second, the CBO assumes a recovery more robust than what other nations have experienced following financial crises. (To its credit, the CBO does provide alternative analyses showing slower growth.)
The Washington-based Center on Budget and Policy Priorities, a well-respected progressive research institute that studies budget issues, adjusts these CBO figures based on various assumptions about policy. For example, almost no one expects Congress to allow the Alternative Minimum Tax to hit tens of millions of Americans over the coming decade, yet that is what the official projections assume. The CBPP does not.
It predicts a more realistic deficit for the next 10 years of 5.7 percent of GDP under current policies, and hovering around 6 percent toward the end of the decade. The dollar amount of the cumulative deficit over the next decade is projected to exceed $11 trillion.
The CBPP adjustments, however, change only the policy assumptions embedded in the CBO figures, not the economic ones. And yet the deficit is very sensitive to economic growth. So I asked Richard Kogan, a senior fellow at the CBPP and one of the nation’s leading budget experts, to alter the economic assumptions to reflect a hard-slog scenario.
The CBO assumes economic growth will exceed 3 percent per year from 2012 to 2016 before gradually declining to a bit more than 2 percent in 2021. What if, instead, growth remains at 2 percent to 2.5 percent for the next decade? I asked Kogan to recalculate the budget numbers assuming a constant growth rate of 2.25 percent per year, which seems a plausible hard-slog scenario.
He found that the deficit then averages more than 7 percent of GDP. By 2021, it is more than 8.5 percent of GDP and increasing.
Under these modified growth assumptions, the cumulative deficit for the next decade is $13.7 trillion. In other words, the impact from sluggish growth on the budget shortfall over the same period exceeds $2.5 trillion -- which is more than the roughly $2 trillion in deficit reduction that may wind up being agreed to as part of a deal to lift the debt ceiling.
(Failing to reach such a deal over the debt limit by early August, by the way, would lead to economic catastrophe and further cloud the unemployment outlook.)
If an extended period of slow growth is more likely than the official projections suggest, we’re in for a much nastier mix of high unemployment in the near term and large budget gaps over the medium term. This is only more evidence that the right policy response is a combination of more aggressive action to bolster the job market now and much more deficit reduction enacted now to take effect in a few years. On both strategies, we should be as bold as we can.
(Peter Orszag is vice chairman of global banking at Citigroup and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)
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