James K. Galbraith is one of the great economists of our time, and with one of the best outlooks for what can actually work. So we're just going to get out of the way.
James K. Galbraith
Keynote at the EPS Bernard Schwartz Symposium
This morning I want to address a very specific aspect of the debate, and to do so as an economist. I want to ask whether the fear of long-term deficits should legitimately be used to justify proposed cuts in Social Security and Medicare, and for that matter, whether that fear of long-term deficits stands as an effective obstacle to the entire project of a new strategic direction for economic growth and recovery. To address that question, I need to say a few words about the work of an institution that is justifiably an icon in this city, one of the very few respected, non-partisan and professional organizations we have – the Congressional Budget Office. Its work is used as the foundation for much of the debate over the future fiscal position of the United States.
The CBO has an important professional function, and everybody who has been on the Hill, as Congresswoman Kennelly and I have, understands what that is. It is to provide a fair evaluation of the budget costs of particular legislative proposals. Its fundamental job is to permit people to make proposals, and to have them come back costed in a way that is trustworthy, transparent, and consistent. In order to do that, there needs to be a common set of baseline economic projections to provide that standard of consistency. For that purpose, however, it is not necessarily important that the baseline forecast be realistic as a projection of what the economic future is going to be.
So long as it’s consistent and everything is being judged by the same yardstick, then the internal consistency of that forecast is a secondary consideration. But those forecasts are being turned and used for a much different purpose: to describe for us all the fiscal future of the United States. As those forecasts are presently constructed, that future looks to many people to be extraordinarily scary, with the public debt spiraling out of control. It is important to ask whether the forecasts are realistic. For that we have to ask, how does the CBO make that forecast?
First is to assume away our current economic difficulties over a period of time; that is to say, assume that the economy will recover from the recent crisis and recession. Generally over a five-year horizon, we return to a relatively low rate of unemployment. To get there, we have a relatively rapid rate of growth. If this were to happen, it would be great; we’d all be in favor of it. If it were to happen without any changes in policy, it would be wonderful; we would all be delighted.
Of course with economic recovery, people would resume paying income taxes and the deficits would fall, as they did in the 1990s, when we moved to full employment and the budget went into surplus. The problem with this as a projection of the actual future is the one already given at the start of this program by Tom Palley, which is the growth model that got us to full employment in the late 1990s, and that got us closer to full employment in the 1980s; a model based upon the very rapid expansion of bank credit for various purposes in the late 1990s, the drive for information technology investment, and in the 2000s, for that matter, the housing bubble. That model is broken. The institutions that underpinned that form of growth are not going to be able to do it again. The institutions themselves remain deeply impaired by the effects of the crisis, and they don’t have customers. They don’t have households with equity they can borrow against. They don’t have businesses who are out there trying to find credit for business expansion.
We are not going to return to full employment by any automatic process. However, having assumed that we are, the CBO then recreates very large deficits with a new series of assumptions that kick in after the effects of economic recovery are felt. One of them is runaway healthcare costs, and the assumption that the worst things that could happen in that sector are going to happen. I’ll leave that one aside for the most part. Another, which is very important, is that there will be a return to what are historically very high real interest rates – a nominal interest rate on short-term money of about 5% (with a 2% inflation rate, or a real interest rate on short-term money of 3%, as opposed to the present levels, which are negative 1.5%–2%), so a 4%–5% shift in the short-term real rate of interest, the rate that applies to government debt.
Another thing that happens as a consequence is an enormous run-up in the net interest payments of the federal government, running up to fantastic values, 20% and plus of GDP in 25 or 30 years, which is an expenditure item on the federal budget. These things are supposed to happen in conjunction with a very low rate of inflation – 2% – with the result that debt in comparison to nominal GDP spirals out of control. That is where the long-term budget deficit and debt projection comes from. Are there weak points from the standpoint of an economic realist in this projection? I think there are two major weak points.
One is that it is extremely unlikely that the Federal Reserve will return or would return to a high short-term real interest rate in the absence of a rise in inflation. There’s no reason why they would take that step. If they did, it would have catastrophic effects on business investment. It most likely would precipitate back into recession.
There’s very little historical precedent for such a policy. There was one stage in the postwar period when we had 3% real interest rates, 4% real interest rates with a 2% inflation rate; that was the late 1990s. It wasn’t true in the’50s and ’60s; it wasn’t true in the 2000s. The ’70s were an unstable period in which the inflation assumptions didn’t apply. Those 1990s years were very different from our present situation. There’s no logical reason for that assumption to be there, but it generates an enormous part of this deficit debt dynamic.
The second problem is that those interest payments are public spending; they have to go to somebody. We’re not wiring them to Mars; we’re sending them to people who hold US government debt. That’s going to show up as income on those people’s accounts, income that would amount to three or four times the total of present defense spending, in relation to GDP – vast sums that look like the mobilization for World War II more than like anything else, although they’re not going for anything particular except checks into people’s bank accounts. Assuming that the money would be spent – some of it would be – the inflation projection is surely out the window. If the inflation projection’s out the window, the debt to GDP ratio isn’t going to look like they project it’s going to be.
My position, my argument, is that much of the debate on this issue is based on a mirage, hidden inside technical assumptions the CBO has made. These are not terribly damaging for most of the purposes, but are completely inappropriate for a serious discussion of the actual fiscal position of the United States and its actual economic condition. That’s not to say that we aren’t likely to have large deficits going forward. We are, but those large deficits are likely to be due in the future for the same reasons that we have them today: an underperforming economy, a very high rate of unemployment, and relatively low tax take in comparison to what it would be at potential. That will be accompanied not with high but with continuing very low interest rates, with different implications for the debt.
This suggests that when you think about this problem coherently, the long-term policy problem is the same as the short-term policy problem: it is to create jobs and to place the economy back on the footing of stable prosperity. That is the desirable objective per se, and something that will require a sustained effort, a new strategic direction (as well as comprehensive reform that has not actually occurred and is not sufficiently addressed in the reform bills of the financial sector), to make it once again an effective, functioning part of the economy. That’s the correct strategy, as I said, not only for economic growth and the condition of the economy in the medium- and long-term, but also for the funding of Social Security and Medicare.
As has been argued very effectively in the earlier panels, the major problems with Social Security and Medicare’s funding is low wage growth and inadequate employment; there are not enough people paying the payroll taxes at present rates. Fix that problem. Then the other problem, to the extent that it is a problem, goes away.
Suppose it were true that even large public debts were associated in general with low economic growth in countries whose conditions were comparable to our own. That would be the case because those countries do not have an effective growth mechanism generated by the private financial sector, so that they do not have a credit system creating jobs and enabling people to pay taxes that cover the services that the public sector provides. These two problems are integrated; they cannot be separated.
The prescription cannot simply be cutting the public sector’s interventions in the economy. It has to be to repair the other side of the balance sheet. That has to be the first step in a strategic proposal for the economy – to recognize that the private sector is important, that it has taken a colossal hit in the last three years as a result of a colossal mismanagement in the previous fifteen or so, and that the reconstruction of a functioning private financial sector that serves our economic purposes is an indispensable priority.
What are the other components of the program? It seems to me that we ought to recognize right now that we have an ongoing housing crisis. The problems of home mortgage finance – and for that matter, of mortgage fraud – are being compounded by a vast new industry of practically automated foreclosures, driving hundreds of thousands of people out of their homes on the basis of incomplete and shoddy documentation. This is an emerging social crisis, and stabilizing people in their homes is an emerging and hugely important social priority for stabilizing jobs, neighborhoods, local property tax revenues, and an entire infrastructure of the American economy.
Part and parcel of that, extending from it very slightly, is the step that’s already been discussed this morning on a number of occasions: the need to stabilize the budgets of states and localities for the duration of the crisis. There is no reason why, in an economic downturn, we should tolerate the destruction of public schools, of police and fire forces, the closing of libraries, the non-maintenance of parks. These are services on which people rely, on which they fall back in hard economic times, and it’s just an artifact of the way we structured things that they’re under such pressure. There’s no economic reason why they should be. Steps should be taken to take this problem off the books. Heather Boushey made a political argument as to why Democratic Congress doesn’t want to help Republican governors. Fine, do it the other way: take Greg Anrig’s suggestion and federalize Medicaid, and there will be a flow of funds that will go to the states and localities that will help deal with that problem.
We need to think about how the national economy can be made to grow. It seems to me that the important concept here is once again encaptured by the word “strategic.” We need a strategic policy imparting a new direction to economic growth. We have had, broadly speaking, recognizable strategies in the past. In the postwar period, we created a broad middle class that was largely home-owning; institutions achieved this. In the late 1990s, we created a very large, effective and internationally successful information technology sector, in part through a drumbeat of public promotion of the importance of these technologies. I don’t think there was a day in the Clinton-Gore administration in which the President or the Vice President didn’t talk about the importance and value of those industries.
What is it going to be in the future? We have to address our energy challenges, our climate challenge, and that part of the fact that doing so involves the reconstruction of the country. That is to say, we need to give people choices about the way in which we produce and use energy. For that, we need to rebuild our infrastructure.
There are many other things we could do to rebuild our common public capital in a way that the private sector knows can be sustained. We need to have both public and private investment moving down this road. That is a reason for enacting a national infrastructure fund: to create an institution akin to the reconstruction finance corporation, and akin to institutions that have existed and still exist in many countries around the world. It would give the private sector confidence that there will be a sustained effort in this direction, that their investments, in which they are staking their own money, have a good chance of paying off.
The same can be said for jobs programs. The programs should be put in place, focused on goals and objectives that meet our immediate needs, providing hope for progress toward solving the country’s actual economic and environmental problems – not temporarily, but permanently.
Another thing is getting up to scale, and moving toward a recovery program that the public perceives as making a difference in a relatively short period of time. One element should be wholesale measures that will affect a large number of people in a short period of time, if they work. There’s been some discussion of having a payroll tax holiday for this purpose, to give a major injection of funds into working American families, which they can use to rectify their balance sheets, improve their consumption. I supported the President’s decision to take a proposal that originated in the Reagan tax cuts, a major tax break for business investment. Even though this is a vast subsidy to capital, if it works, the idea is that business investments will pick up, and there will be a reciprocal effect of firms’ investment activities stimulating the investment activities of other firms, thus beginning to move from a vicious to a virtuous cycle of economic growth.
Even if we do all of that, the crisis we have experienced has been profound beyond any of our professional experience. We have lost more jobs, and people have stayed out of work longer, than in the ’70s or the ’80s, or in the recession at the end of the millennium. We’ve lost eight million jobs. Many of those have been lost by older workers for whom work is hard, not people like me who speak from a microphone and sit in a chair, but people who stand up behind cash registers with back braces year in and year out.
We have to recognize that looking for jobs for many of those people is an exercise in futility and will be so until they are ready for Social Security, because there will always be a younger or a healthier person who’s better for that job, and who actually needs the job more in many respects because they’re starting out rather than finishing up. This is why we should consider another wholesale measure: reducing the age of eligibility for Social Security and Medicare.
I suggest that we create a window, the way universities do when they need to get rid of an ineffective professor. At the age of 62, for the next three years, people could retire with full benefits. It should allow people for whom that’s a good deal, people for whom work has been hardest, to take it up.
Someone asked earlier, “What do you do for the older workers who still want to look for jobs?” This is one thing. Other workers who still want jobs would find it easier to get them, if they weren’t competing with this enormous pool. In addition, younger people would find it easier; there would be more openings. The unemployment rate would come down, and the whole population would be on a happier, more rational footing in a very, very early stage. The same would be true if the age of eligibility for Medicare were reduced to 55. Allow people who have medical issues, but who are holding onto their jobs just because of their insurance, to move on, if they want to.
We hear the opposite proposal, for cuts in both of these programs, and I would bet it will take the form of further increases in the retirement age. We’ve talked about the consequences of raising the retirement age to 70, up to a 40% cut in the lifetime stream of benefits for those who, for one reason or another, are obliged to take early retirement. This is justified on the very shallow grounds that the average life-span of the population is lengthening – a fact which is only the case because we’ve been paying people successfully under Social Security and Medicare to live longer; a real example of successful economic incentives, if you ask me. The fact is that the increase in life expectancy doesn’t apply to the bottom half of the income distribution; it’s much less for those who actually work hard in their working lives.
That policy is a particularly invidious, dishonest, and cruel way to approach whatever is done about Social Security and Medicare. I want to stress that it has also very adverse economic effects. It would make unemployment worse by requiring people to hang onto jobs that they would otherwise happily give up in favor of other applicants and contestants for those jobs.
Without having gotten back to full employment, doing this simply congests the labor queue, creating problems which will afflict younger workers for their entire lives, as they experience long periods of job search and unemployment before they get that crucial first job. Overall, there will be less demand, less growth, and the economy will not meet the needs of its actual population. Poverty will be greater under these proposals. All of this is unnecessary and avoidable. It is certainly not justified by the argument that we face somehow a long-term, very-hard-to-specify in any concrete sense problem with the funding of the United States government.
If you could pin deficit hawks to a wall (which I would very much like to do), and get them to try and tell you what it is that they are worried about, what would such people say? I think the only thing they would say is that with the United States government soaking up capital funds, there would be less available for business. If there’s less available for business, that means the cost of funds for business must be much higher. That will show up in the interest rate.
We have to ask, do all of these people from Wall Street know what they’re talking about? Have they looked at the interest rate lately? The capital markets are in some ways the arbiter of this. Are the capital markets afraid that the United States government is going to run into difficulty paying off its debts? Are they unwilling to lend to the US government because they fear a rising rate of inflation?
The answer is: not in the next 30 years, not over the longest term of debt that the US government presently issues, where the interest rate has been falling, and is now at practically historical lows – 3.6% for 30 years the last time I looked. We have, I think, a refutation. It’s not the most conclusive bit of evidence, but it is a fairly strong refutation, that the problems (that appear on a superficial glance in the budget projections of the Congressional Budget Office) are actually taken seriously by people who have money – their own money, and other people’s money – on the line.
There’s been a good deal of talk of the sustainability of Social Security. The point has been made that very small adjustments in payroll tax formulas would cover the actuarial deficit of the Social Security trust fund over 75 years. Even if this were not the case, even if there was a substantial difference between what the payroll tax is expected to take in and what Social Security is expected to pay out, the programs would still be sustainable.
What is it that Social Security and Medicare actually do? You cannot separate the public effect from the effect on private finances. Social Security provides a benefit, a payment, to the elderly population, survivors and dependents, which in some respects replaces payment that those who have families who are prepared to support them would otherwise make. It assures that those who do not have families that would otherwise support them get a payment anyway, on the basis of their past contributions to the system. The payroll tax likewise assures that you make a contribution, whether you have parents you would otherwise support or not.
When thinking about this, assuming that we don’t want the elderly population to get out of the way by dying off, the major transfers in both halves are not from the young to the old. They’re within the elderly population, from those who would otherwise have means to those who don’t, and within the working population, from those who would otherwise not have burdens, to those who otherwise would. In economic terms, both of those transfers occur in the present. They are not matters that pass back and forth across time. They both can be sustained indefinitely. They are also fair. They are generous in the broad sense of that term; that is to say they are wise, they are just. And they give us a society which is vastly happier than it could ever otherwise be.
In Session One, Mike said that his Medicare does not benefit society. I guarantee you it benefits your children and your grandchildren. They don’t have to worry about the specific consequences of something that might happen to you, in terms of the medical cost, and otherwise would be worried greatly about it. Medicare spreads the risk over all of us, which is what we should properly be doing. Again, there is no financial impediment along those lines.
Congress will face recommendations, the first of December, from a Commission of very doubtful judgment and fairness. It seems to me very important that Congress take the message from this panel, and from all of our efforts, that it should not panic, that it should not be panicked. They’re not facing any form of an emergency that requires action in the lame duck session – action which on mature reflection, we would only come to regret.
We need to continue discussing these issues, continue the process of educating the American policy elites about what the American public already knows: that these programs are stable, they are successful. They are a vital element in the design of a successful strategy for economic growth and recovery going forward.