The deficit is fa­mil­iar, but the dan­ger is dif­fer­ent

The Washington Post Sunday - - BUSINESS - Ezra Klein

Back in the 1990s, we knew why we feared deficits. They raised in­ter­est rates and “crowded out” pri­vate bor­row­ing. This wasn’t an ab­stract con­cern. In 1991, the in­ter­est rate on 10-year Trea­surys was 7.86 per­cent. That meant the in­ter­est rate for pri­vate bor­row­ing was, for the most part, much higher, chok­ing off in­vest­ment and eco­nomic growth.

En­ter Clinto­nomics. The the­ory was sim­ple: Bring down deficits and you’d bring down in­ter­est rates. Bring down in­ter­est rates and you’d make it eas­ier for the pri­vate sec­tor to in­vest and grow. Make it eas­ier for the pri­vate sec­tor to in­vest and grow and the econ­omy would boom.

The the­ory was cor­rect. By the end of Clin­ton’s term, the in­ter­est rate on 10-year Trea­surys had fallen to 5.26 per­cent, lower than it had been in 30 years. And the econ­omy was, in­deed, boom­ing. “The deficit re­duc­tion in­creased con­fi­dence, helped bring in­ter­est rates down, and that, in turn, helped gen­er­ate and sus­tain the eco­nomic re­cov­ery, which, in turn, re­duced the deficit fur­ther,” Trea­sury Sec­re­tary Robert Ru­bin said in 1998.

We fear deficits to­day, too. But we’re not sure ex­actly why. In 2012, the in­ter­est rate on a 10-year Trea­sury was a

rock-bot­tom 1.8 per­cent. What­ever is hold­ing the pri­vate sec­tor back, it’s not the cost of bor­row­ing.

In the ab­sence of high in­ter­est rates now, some deficit hawks have moved on to warn­ing that we’ll be crushed by high in­ter­est rates soon. In March 2011, Ersk­ine Bowles pre­dicted that we’d see a fis­cal cri­sis in which for­eign cred­i­tors would stop buy­ing our debt in “two years, you know, maybe a lit­tle less, maybe a lit­tle more.” Alan Simp­son said it would be less than two years.

The two years is al­most up, and the fis­cal cri­sis is nowhere to be seen. Sim­i­larly, Ja­pan has sus­tained low in­ter­est rates for more than a decade de­spite a more crush­ing debt load than ours. “Bel­low­ing about a dis­as­ter that never comes,” warned John Makin, a res­i­dent scholar at the Amer­i­can En­ter­prise In­sti­tute, “saps the mo­men­tum from sound fis­cal pol­icy.”

The prob­lem with th­ese dire warn­ings about im­mi­nent — or, worse, on­go­ing — deficit crises is that they’re ap­ply­ing the frame­work of the 1990s to the econ­omy of the 2010s, with pre­dictably poor re­sults. The rea­son to worry about the deficit to­day is not that higher in­ter­est rates will crowd out pri­vate bor­row­ing or lead to a mar­ket panic, as there’s no ev­i­dence ei­ther con­se­quence is in the off­ing any­time soon. Rather, the rea­son to worry about the deficit to­day — and the trends in government spend­ing and tax­a­tion that drive it — is that the most worth­while kinds of government spend­ing are get­ting squeezed out.

The key in­sight be­hind this the­ory is that some forms of government spend­ing rise au­to­mat­i­cally and rapidly, and po­lit­i­cally, they are very dif­fi­cult to cut, while other forms of government spend­ing need con­gres­sional ap­proval ev­ery sin­gle year and have few con­stituen­cies to pro­tect them. In the first cat­e­gory are Medi­care and Med­i­caid and So­cial Se­cu­rity, all of which are pro­jected to con­sume much more of the fed­eral bud­get in the coming years. In the sec­ond cat­e­gory are such things as ed­u­ca­tion fund­ing, re­search and devel­op­ment, stim­u­lus, in­fra­struc­ture in­vest­ment and even the mil­i­tary. And the fear is that the first cat­e­gory is squeez­ing out the sec­ond cat­e­gory.

As David Leon­hardt notes in “Here’s the Deal,” the fed­eral government has been track­ing spend­ing on “ma­jor phys­i­cal cap­i­tal, re­search and devel­op­ment, and ed­u­ca­tion and train­ing” since 1962. Over that pe­riod, it’s fallen from about 2.6 per­cent of GDP from the mid-’60s to the mid-’80s to 1.8 per­cent from the ’ 80s un­til the fi­nan­cial cri­sis. The stim­u­lus pushed it above 2 per­cent again, but that’s a tem­po­rary lift. Be­tween the cuts from the 2011 Bud­get Con­trol Act and the pos­si­ble cuts from the se­quester, this spend­ing — which is es­sen­tially the in­vest­ments we make in our fu­ture — is likely to be driven to his­toric lows. Mean­while, an Ur­ban In­sti­tute study finds that “look­ing solely at the fed­eral bud­get, an el­derly per­son re­ceives close to seven fed­eral dol­lars for ev­ery dol­lar re­ceived by a child.”

“Growth of en­ti­tle­ments is

The deficit hawks are ap­ply­ing the frame­work of the 1990s to the econ­omy of the 2010s, with pre­dictably poor re­sults.

crowd­ing out pro­grams for younger fam­i­lies and their kids and are likely to im­pair so­cial mo­bil­ity,” says Is­abelle Sawhill, co- di­rec­tor of the Cen­ter on Chil­dren and Fam­i­lies and the Bud­get­ing for Na­tional Pri­or­i­ties Project at Brook­ings.

The Obama ad­min­is­tra­tion agrees. It has spent years try­ing to reach a deal with Repub­li­cans in which en­ti­tle­ment cuts would be paired with tax in­creases — and in­vest­ments in the fu­ture would be spared. That ef­fort has largely failed, and Democrats and Repub­li­cans have set­tled into an odd and trou­bling de­tente on the deficit: Taxes will re­main low, and spend­ing on Medi­care, So­cial Se­cu­rity and Med­i­caid will re­main high. Ev­ery­thing else, how­ever, will get the ax. The se­quester, for in­stance, cuts deep into med­i­cal re­search and ed­u­ca­tion, but it doesn’t touch So­cial Se­cu­rity at all.

Just as in­ter­est rates posed a threat to the econ­omy in the 1990s, in­suf­fi­cient government spend­ing on re­search and devel­op­ment, in­fra­struc­ture and ed­u­ca­tion poses a threat go­ing for­ward. Many of the tech­nolo­gies that drive to­day’s econ­omy, from an­tibi­otics to GPS to biotech to shale gas ex­trac­tion to the In­ter­net to jet en­gines, re­lied on fed­eral fund­ing to get started. And there’s lit­tle doubt that it’ ll be dif­fi­cult to build a 21st- cen­tury econ­omy atop a 20th- cen­tury phys­i­cal — not to men­tion dig­i­tal — in­fra­struc­ture.

But the pol­i­tics are tough. “When you in­vest in your fu­ture growth, you’re of­ten in­vest­ing in a group of peo­ple who are chil­dren and, by def­i­ni­tion, lack po­lit­i­cal power,” says Gene Sper­ling, di­rec­tor of the Na­tional Eco­nomic Coun­cil. “Or you’re in­vest­ing in things that are pre­cisely what you want government to do be­cause no par­tic­u­lar per­son cap­tures the ben­e­fit but it in­stead ben­e­fits ev­ery­one.”

By con­trast, when you try to raise taxes or cut back on health or re­tire­ment spend­ing at a moment when health- care costs are ris­ing and the pop­u­la­tion is ag­ing, very spe­cific peo­ple with very pow­er­ful lob­bies feel the loss, and fight it.

In the 1990s, we man­aged to stop the fed­eral government from crowd­ing out the pri­vate sec­tor. But so far, in the 2010s, we’ve failed to stop the fed­eral government from crowd­ing out, well, it­self.

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