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Tuesday, July 27, 2004

Defending the Bush Deficits

Since President Bush took office in 2000, the economy has gone through at least three major shocks that were not of his making – a major terrorist attack that damped consumer confidence; the depression in business spending that followed the bursting of the stock market bubble; and a series of accounting scandals that afflicted some of the largest and most visible corporations in the United States.

Yet, the U.S. economy has outperformed that of every other G7 country since 2001. Today, the unemployment rate is at 5.6 percent, almost exactly where it was in 1996 when Bill Clinton was re-elected, proclaiming in his State of the Union speech that the “economy is the healthiest it has been in three decades.” In the last three quarters, since the 2003 tax cuts were enacted, the U.S. economy has been growing at a 5.4 percent annualized pace, which is the fastest clip we’ve experienced since 1984.

This remarkable record on the economy owes much to the pro-growth policies of the Bush administration. By reducing the tax code’s inherent penalties on work, savings, investment and entrepreneurship, they have kept us out of a prolonged recession. Yet, critics of President Bush’s fiscal policies have argued that today’s record federal deficit, which will reach $445 billion in 2004, will cause long term economic growth to flounder by pushing interest rates higher.

Like Chicken Little, who caviled because she mistook a tumbling acorn for a crashing sky, President Bush’s critics are unjustified when they foretell of an impending economic doom. Alarmists who worry about the historical heights to which deficits have climbed need to step back and review the historical data for context. At the end of 2001, the federal debt of the United States that was held by the public stood at 33 percent of U.S. GDP, which was the lowest it had been in 18 years. At the end of 2003, federal debt stood at 36 percent of GDP, and it is currently projected by the Congressional Budget Office to reach 40 percent of GDP by 2005 before beginning to decline again.

By historical and international standards, these levels of debt are very modest. For instance, the debt burdens of Germany and France are over 60 percent of GDP; in Japan, debt is almost 150 percent of GDP. In the United States, we have had 24 years since 1939 when the federal debt was below 36 percent of GDP. In 41 years, the debt has been higher. The President’s critics might suggest that economic growth should have been better in the low debt years than in the high debt years – in fact, real GDP growth averaged 4.44 percent in the high debt years and just 3.14 percent in the low debt years.

To some extent, this divergence in growth rates was a result of the war years, when debt piled up quickly and economic growth was relatively robust. But the story is the same over a more restricted time horizon. Indeed, we can look at only the years since 1963, which is when the debt fell to present-day levels for the first time since WWII. Since then, public debt fell to a low of 24 percent in 1974, rose to a high of 50 percent in 1993 and fell back to 33 percent in 2001. Economic growth was higher in the relatively high debt years during this period, averaging 3.47 percent versus 2.59 percent. Unemployment was also lower in the high debt years averaging 5.65 percent as opposed to 6.43 percent in the low debt years. And consumer price inflation was almost three times higher in the low debt years than in the high debt years — 7.6 percent to 3.0 percent.

Looking back at American history, it is apparent that economic prosperity can continue even if the federal government maintains a debt burden that is much higher than it is today as a percentage of GDP.

Moreover, large budget deficits have never been a cause of – or even correlated with – the high interest rates or slow economic growth that deficit hawks predict. For instance, in the late 1940s and 1950s, the Truman and Eisenhower administrations practiced fiscal restraint, keeping taxes high (the top rate was over 90 percent) and paying down the federal debt. The result: four recessions between 1948 and 1961. Contrary to the expectations set by the President’s critics, real interest rates actually rose slightly during this period of fiscal restraint; the real, inflation-adjusted 10-year government bond yield edged up from 170 bp in 1953 (when the 10-year was first issued) to 280 bp in 1961.

In the 1960s, the federal government ran modest deficits while cutting taxes. In the 1980s, the federal government ran much larger deficits, while cutting taxes sharply and increasing spending. In both periods, economic growth was robust. In the 1960s, interest rates fell slightly; throughout the 1980s, they dropped dramatically, which is exactly the opposite of what the deficit Chicken Littles would predict.

The lesson is clear: economic prosperity can continue even if the federal government never balances its budget. The greater threats to prosperity are high levels of taxation, and regulatory barriers to growth. President Bush deserves our gratitude for having steered the right fiscal course to keep the economy on track.

Aman Verjee is Director for Strategic Planning of a Silicon Valley Company and is the Editor of Thank You, President Bush, which is on sale now.

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