Fiscal Austerity Is Undermining Long-Term U.S. Economic Prospects
SOURCE: AP/Mike Groll
Since the 2010 midterm elections, a new wave of politicians in Washington has steered the fiscal side of economic policymaking in the wrong direction. They moved away from policies such as the 2009 American Recovery and Reinvestment Act and countless smaller policies that stopped the Great Recession and that began paving a path toward a jobs- and investment-led recovery.
Instead, for the past two and a half years, we’ve been steered toward a path of spending cuts and fiscal contraction. That path is costing America billions of dollars and millions of jobs that have great economic potential.
A lot has changed in the time since 2010, as the Center for American Progress’s Michael Linden explains in his report, “It’s Time to Hit the Reset Button on the Fiscal Debate.” First, the U.S. fiscal deficits are disappearing, even though such deficits are considered textbook policymaking, supplementing demand through public investment to fight a recession. In May the Congressional Budget Office updated its projected deficit to 2.1 percent of U.S. gross domestic product in 2015, down from its forecast of 10 percent in 2009. Today’s fiscal situation is simply not as pressing a matter as it used to be—even for those who rang the debt and deficit alarms. Economist Douglas Holtz-Eakin, for example, recently said, “A lot of the energy and appetite for a substantial [deficit] fix is gone.” Though higher than we might like, the overall U.S. debt situation is entirely tenable and, as the CBO projections show, has stabilized over the long-term outlook.
Second, we’ve seen what effects such austerity policies have had in the United States and elsewhere, as countries have tried to cut their way to economic prosperity; they simply have not worked. Growth is slowing and unemployment stagnating in countries around the world, according to the most recent IMF World Economic Outlook. Adding insult to injury, the world also recently learned that the economic analysis upon which politicians justified austerity measures turned out to be riddled with errors; economists Carmen Reinhart and Kenneth Rogoff had, in fact, gotten the causality backwards.
Data watchers are aware of the trajectory of the U.S. economy since we embarked on this austerity path in 2011. Bureau of Economic Analysis data show that economic growth has slowed to an average of 1.5 percent over the past two quarters, down from 2.5 percent in the recovery through 2010. At the same time, Bureau of Labor Statistics data show private-sector employment-growth rates, which typically lag behind GDP growth accelerations and have been flatlining since early 2011.
Each month, the Federal Reserve estimates the capacity-utilization rate for the U.S. industrial sector—manufacturing, mining, and energy utilities. The rate measures actual current production by the U.S. industrial sectors relative to the share of potential output, given the existing quantity of productive capital available. Output in the industrial sector, according to the Federal Reserve, is a main driver of economic volatility over the business cycle and thus provides a key indicator of the U.S. economy’s overall health.
The graphs presented below illustrate the costs of austerity from a different angle: the long-term costs of allowing so many productive people and assets to lay idle. By allowing the continuation of the widespread unemployment of workers and potentially productive assets—also known as capacity utilization (see sidebar)—we are forgoing investments in new technology and in the technical skills and productivity of the U.S. workforce that drives economic growth. In other words, as a result of fiscal contraction and the acceptance of a protracted economic recovery, the potential for the U.S. economy to grow is shrinking. The analysis presented here shows that this shrinking will cost the U.S. economy $433 billion and 2 million jobs by 2019.
The effects of underemploying workers and capital
When the economy’s productive capacity—people and equipment—lays idle, there is little incentive to make further investments. If businesses expect demand in the economy to pick up, they have a lot of room to expand output without the need to install more production capacity. A slower turnover of investment capital means that businesses will be slower to incorporate new technologies into the production process, meaning on average slower rates of the productivity growth that is key to sustained increases in the standard of living.
Slower investment spills over quickly to other parts of the economy as well; first through less demand for the workers who make such investment goods and provide related services, and then to the workers and businesses that earn a living selling to these people, and so on, percolating through the economy’s web of relations. Mass unemployment of workers also significantly pulls down overall economic productivity. Workers off the job can see their skills erode even during brief spells of unemployment. In addition, the added economic insecurity that high unemployment creates for workers and their families can create a cascading effect; it can lower investments in—and produce diminished results from—both education and skills development in those who will soon enter the workforce.
Figure 1 shows the recent trends in capacity-utilization rates of U.S. industrial-capital stock, as well as the employment rate of the U.S. working-age population. The capacity-utilization rate for all U.S. industries peaked at 85 percent in late 1997, after which the Asian financial crisis undercut global demand for U.S. exports and flooded international markets with cheap industrial products following sharp currency devaluations. (Chinese policymakers, to their credit, did not follow their Asian neighbors in devaluing and helped accelerate the region’s recovery from the crisis.) The plunge continued as the dotcom bubble burst, and the United States slipped into a short recession in 2001.
Through the economic expansion in the 2000s, industrial capacity use recovered quickly but incompletely, plateauing at an average of 80 percent from January 2005 through December 2007, the start of the Great Recession. (see Figure 1) In the current recovery, after plunging with the recession, capacity utilization rose rapidly, although as of March 2013, 6.5 percent more industrial capital is laying idle in the United States than before the peak productivity years of the 1990s.
This recovery is different in that a broad return to employment did not accompany the rising capacity utilization. Figure 1 also shows how the employment ratio has trended lower over the past two business cycles: 1991–2001 and 2001–2007. The employment rate in the 2000s expansion never rivaled that of the 1990s expansion; since the end of the Great Recession, the employment rate has struggled even to hold steady at 59 percent of the working-age population, well below the robust jobs growth of the 1990s.
Shrinking U.S. economic potential
Several times per year, the Congressional Budget Office forecasts U.S. potential economic output. Potential output is a concept economists use to describe just how much an economy could produce if it were operating at full steam—that is, with low unemployment and high rates of capacity utilization. Needless to say, Figure 1 shows the U.S. economy remaining far from this point, and the spending cuts and other fiscal contraction put in place after 2010 are driving us further away.
To see how much further, we can look at how CBO forecasts have changed over time as policy has shifted more and more to fiscal contraction. The shifting forecasts capture the effects of a changing U.S. economic structure under the investment- and job-led growth policies of 2009 and 2010, relative to the conservative austerity policies that tightened spending on public investments and services thereafter. Figures 2a and 2b compare two sets of CBO estimates of potential GDP for the fourth quarter of this year and for the fourth quarter of 2019. CBO made the first set of estimates in August 2009, just as the Great Recession officially drew to an end and the U.S. economy began growing again. The second set of estimates date to CBO’s most recent “Budget and Economic Outlook” report, released in February 2013.
Figure 2a shows the profound ways that austerity and the protracted recovery are undercutting long-term U.S. economic-growth prospects. In 2009, as the growth from the Recovery Act and other stimulus measures kicked in, the longer-term outlook for the U.S. economy looked stronger than it does today, after the past two and a half years of spending cuts and other fiscal contraction. Whereas in August 2009, the CBO forecasted a U.S. GDP of $17.2 trillion by the end of 2013, in its most recent projection from February, the CBO sees the 2013 economy nearly $300 billion smaller.
We can similarly compare the CBO’s August 2009 and February 2013 forecasts for U.S. potential output in 2019—the longest comparable forecast window. By the end of 2019, U.S. potential GDP will be $433 billion lower than where the CBO expected it to be when more pro-growth policies were in place in 2009. In today’s terms, future GDP will be nearly 3 percent lower, in large part as a result of the policy shift to spending cuts and increasingly fractious congressional budgetary policymaking.
The change in the jobs-market outlook for the United States is similarly stark. (see Figure 2b) The CBO’s estimates also provide a benchmark for full employment in the U.S. economy. In August 2009 the CBO projected that a full-steam-ahead U.S. economy would be employing 153 million workers by the end of the year; but the CBO’s February 2013 estimate of U.S. potential full employment in 2013 fell by 2.5 million jobs. In the long-term forecast through 2019, shrinking economic potential doesn’t seem to diminish as badly: By 2019 the shrinkage of U.S. jobs potential—from the period before the shift to austerity policies, relative to after this shift—will be only 2 million jobs. These data points in Figure 2b should not be interpreted to mean that the employment growth situation will improve in the long term, but rather that the results from slowing overall productivity growth and a slowing growth of the labor force in the United States is due to demographic trends.
There are a number of reasons why employment has failed to recover from the Great Recession at a satisfactory pace. This recession was a much deeper contraction than any experienced in recent history, and it carried with it the hangover of an $8 trillion real-estate investment bubble. Construction—a highly labor-intensive industry also tending to generate broad employment gains through the rest of the economy—boosted employment rates through the 2000s. But in retrospect, this employment growth papered over what otherwise was an impotent underlying jobs recovery from the much more mild 2001 recession: The U.S. jobs engine was fundamentally weaker than it seemed even before the Great Recession hit.
These reasons can help explain the historical economic situation of a structurally shifting U.S. economy. But they cannot explain the choices made by congressional leaders today to cut deeper to the bone, rather than making investments and creating jobs to build a more prosperous and productive U.S. economic future.
Adam S. Hersh is an Economist at the Center for American Progress.
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