Suppose you were already somewhat seriously in debt. A banker comes a-calling, and offers to lend you money at an extraordinarily low rate. Surprised, you read the fine print of the loan, looking for terms that could come back and bite you later – resets, balloon payments, etc. Nothing. It looks like a clean loan. You’re not 100% sure why you’re being offered such good terms, but the terms sure are good. Should you take this opportunity to increase your debt loan?
That’s the position the American consumer was in early in the last decade. Wages were not rising fast enough, and many consumers were making up the difference with increases in debt, particularly debt backed by their homes. The increased indebtedness financed an increase in consumption that helped pull the economy out of the recession caused by the bursting of the dot-com bubble, which was basically Alan Greenspan’s plan. As time went on, those “good terms” got less and less good, but the need to finance consumption with increased indebtedness didn’t go away, and consumer debt levels rose to unsustainable levels. We know how that story ended.
But that’s also the position the American Federal government is in right now. The fiscal trajectory we’re on is unsustainable largely because of two factors: entitlement spending, particularly Medicare spending, is projected to balloon as the Baby Boomers age, and the Bush tax cuts have opened a permanent gap between the percentage of the economy that the government appropriates and the percentage that it spends. (If you wanted to add a third factor, consider the increase in defense spending in the last decade.) You would think that this situation would lead to higher interest rates, either due to fears of ultimate default (unlikely) or fears of future inflation (much more likely). Short-term rates might be low because of prevailing recessionary conditions, but long rates should be high, and rising. That was the situation in the recession of the early 1990s. But it’s not the situation right now. Instead, we have very low interest rates – we can borrow for cheap, for term, and we don’t even have to put up collateral.
So: should the Feds borrow to the hilt, and spend it on stimulus to keep the economy running? In other words, should the Feds do in this decade basically what the American consumer did in the 2000s?
Put that way, the answer looks obvious – no. But it isn’t – and it wasn’t for the consumer either. The low interest rates we have now are a real opportunity. But they are also a potential trap.
The opportunity is to borrow in ways that increase our capacity to repay. That works for individuals and it works for entire economies. If we borrow to spend on things that increase our aggregate national wealth, then we’ll wind up ahead. If we borrow to spend on things that depreciate without generating an increase in productive activity, and wind up net-losers apart from the transient experience associated with the consumption, then we wind up behind.
There are, broadly speaking, three ways we can increase our aggregate national wealth: increase the total number of productive citizens (through natural increase, immigration, and/or bringing currently unemployed populations into the workforce); increase the raw materials inputs into our economy (historically by conquering territory, now by exploration and extraction); and increase the productivity of the economy as a whole (through technological innovation, application of proven technology to more of the economy, reduction of activities that amount to “dead loss,” etc.). Borrowing has little to do with the first way; though it may be possible to spend money effectively to either increase the fertility rate or bring currently unemployed populations into the workforce, the numbers involved are not going to be huge in budgetary terms. The second is primarily the preserve of private industry, and I rather think that extractive industries already have enough of an incentive to do their job. The third, therefore, is the really important thing to focus on when we talk about budget priorities.
Right now, we are borrowing overwhelmingly to subsidize consumption. Entitlement spending is the biggest component – that’s operating account spending, not capital account. Then comes defense – again, not productive spending. (There are, of course, productive spinoffs to defense spending, but spending on defense to get these spinoffs is a wildly inefficient way to get them.) And then our discretionary spending (direct and through the tax code) is bloated with subsidies for housing, for agribusiness, for the UAW. None of this has anything to do with making the economy more productive.
And the stimulus bill didn’t materially change this picture. The two biggest parts of the 2009 stimulus were: aid to the states to keep their budgets more in balance, and thereby forestall layoffs that would have reduced consumption and, therefore, economic activity, worsening the recession; and tax cuts designed to increase consumption, and thereby offset the expected reduction in consumption that would otherwise worsen the recession. That’s all well and good as a temporary measure, to smooth out the business cycle and all that. But unemployment is still very high, and interest rates are still very low. The political incentives to continue to borrow simply to finance consumption are huge.
The opposition, though, is usually described in terms of austerity, that we should be trying to cut the debt and have government tighten its belt just as private citizens have had to tighten theirs. And austerity makes absolutely no sense in the current economic environment. Precisely because interest rates are low, this is a good time to borrow. But the question is: borrow for what? Every dollar we borrow today has to be repaid or refinanced – and we should assume that refinancing will be at substantially higher interest rates than today.
The argument we need to be having is about how to increase national productivity. That means reducing or eliminating subsidies for uneconomic activity – whether the mortgage interest deduction or agricultural subsidies. That means shifting the tax burden away from income – and especially away from wages – and towards consumption. That means shifting discretionary spending priorities away from defense and towards a sustainable infrastructure. That means shifting spending away from retirees and towards youth – and that, in turn, means getting more value per dollar out of both health-care and education spending (two areas where, I suspect, productivity growth properly measured has actually been negative).
There’s a vital role for Republicans to play in this argument that I don’t really hear them playing. The great temptation when money is cheap is to say we can have more of everything – but “more of everything” in practice means capture of most of the available money by entrenched interests that generate a negative return to the public. And so there’s a place in the conversation for libertarians who argue that this capture is inevitable, and therefore we should have “less of everything” from the government. But “less of everything” as an argument by itself is most likely to succeed only as a brake on innovation, because entrenched interests are going to be the hardest to dislodge from the trough. (See, for example, the health care debate, where Republicans became rear-guard defenders of the untouchability of Medicare.) We also need to hear from Hamiltonians who actually want to make government work for the people, who are willing to go to the mat with arguments that we do need more of “this” – and therefore less of “that.”