A view of the budget deficit from the other side of the pond.
Analysis
February 10, 2003
Economic Agenda by Lea Paterson
Bush can't buck the market forever
IF WE in Britain are fretting about Gordon Brown’s everexpanding budget deficit, spare a thought for our comrades on the other side of the pond. It was only a year or two ago that the White House was telling anyone who would listen that the US Government would be in the black for ever and a day. But, as last week’s federal budget statement from President Bush made clear, the outlook for US finances has turned full circle.
The problem with US finances is not, as was widely argued after last week’s statement, that Mr Bush is expecting a record deficit of $300 billion-plus (£183 billion) in each of the next two years. Nor is the core of the problem that five years from now the White House is still expecting an annual deficit of $190 billion. The US budget difficulties go much deeper than Mr Bush’s headline numbers — the real problem is not in the short-to-medium term, but five-to-ten years out.
There is nothing wrong with the US economy — or indeed virtually any other economy with insipid growth — running a modest, short-term budget deficit. As the eurozone has illustrated only too well, running too tight a fiscal policy at a time when growth is weak is a recipe for economic disaster. In almost every case, a country that has seen tax revenues suffer because of weaker than expected growth ought to just ride the storm, let deficits rise and delay corrective action until the economy looks brighter.
In the short term, policymakers can go even further. Running a small structural deficit — that is, increasing the size of a budget deficit by cutting tax or raising spending — can provide a crucial boost for an economy experiencing temporary growth problems. Modest structural deficits may also be justified in the short term if they allow politicians to boost long-term economic potential with tax and spending changes. Mr Bush’s plan to abolish dividend tax, for example, may fall into this category.
The problems begin if there is a permanent shortfall in tax revenues that means an economy runs a structural deficit for many years. This certainly looks to be the case for President Bush — especially when one considers that last week’s figures did not account for US financial obligations running into tens of billions of dollars. Long-run structural deficits, especially sizeable ones, can lead to serious economic problems.
Why does the size of a country’s budget deficit matter? In part because if there is a gap between tax and spending, governments have to finance this by either printing money (which is highly inflationary) or, more typically, issuing bonds. More government bonds means lower bond prices and higher long-term interest rates. And this can hurt economic performance, especially in a country such as America where the mortgage market is highly sensitive to movements in the longer end of the yield curve.
Supporters of Mr Bush point out that, despite recent rapid increases in the budget deficit, long-term rates have not risen. But that does not mean that it is fine to run budget deficits forever. The lack of movement in long-term rates primarily reflects the fact that analysts have been worrying about short-term risks to the economy, rather than the longer-term financing gap.
As the US recovers, and analysts increasingly focus on the picture going forward, long-term interest rates will rise. A recent paper by the Washington-based Brookings Institution* estimates that for every time the US budget surplus is reduced by one percentage point of GDP, long-term interest rates will increase by between half and one percentage point. And that could significantly limit America’s capacity for growth in the coming years.
The long-run impact of the US budget deficit becomes even more worrying when one considers that the headline figures unveiled by President Bush last week are only the tip of the iceberg. To start with, they exclude hefty costs that the US is almost certain to have to incur in the months ahead if there is war in Iraq. These could easily swell the US budget deficit by 10 per cent this year, and could also have a substantial impact on the public finances in 2004.
There are other, longer-term problems with Mr Bush’s budget arithmetic. By issuing figures only until 2008, the White House left the US public with the misleading impression that after rising this year and next, the Government’s budget deficit then moves to a downward trend. But most analysts expect that, after 2008, there will be little further improvement in the US deficit. Indeed, the signs are that America’s financial position could get steadily worse.
One reason to worry about the longer-term deficit picture is that the “jobs and growth” package unveiled by Mr Bush in January is a ten-year programme. It will cost the US Government some $390 billion in the next five years, and roughly the same again in the five years after that. In anyone’s book, $390 billion is not an inconsequential sum, and Americans will be footing the bill for Mr Bush’s plans for many years to come.
More fundamentally, there is also the issue of what White House officials call “the real fiscal danger”. The obligations of the US Government under its Medicare and Social Security programmes are little short of staggering. As the programmes stand today, they have a combined unfunded deficit of $18 trillion — about five times the size of America’s total national debt. Mr Bush has made noises about reform of Medicare and the Social Security programmes, but no concrete proposals have yet to emerge.
The market is worrying about the record budget deficits expected in the US both this year and next. This gloom has been substantially overdone. But there is a far stronger case for concern about the longer-term picture — especially when one considers spiralling Medicare costs. For the time being, Mr Bush can get away with spending way beyond his means. But he cannot buck the market forever.
*The Economic Effects of Long-Term Fiscal Discipline. the Brookings Institution, December 2002
lea.paterson@thetimes.co.uk
timesonline.co.uk |
