Federal deficits by president

After the war is over ...

(Sung to the time of 'After the ball is over', and I mean the war against the coronavirus)

Most governments in developed countries are running deficits relative to  GDP which they haven't done since the WWII.   And the question is, what will they do after we have contained the coronavirus or even found a vaccine and a cure?  One alternative is to try to cut spending and raise taxes to pay back the outstanding debt.  This is the conventional wisdom today.  The trouble is, because government spending is such a large chunk of total spending, if the government slashes spending, it will cause economic activity to decline.  

After  WWII, guided by the insights of John Maynard  Keynes, most western countries didn't do this.  Instead, they relied on economic growth to reduce their debt-to-GDP ratios.  They continued to borrow money to fund infrastructure investments.  Despite this, their debt ratios declined.  

When interest rates and bond yields are zero or even negative, it's a sign that inflation and growth expectations are so low that private investment spending isn't and won't be enough to get growth going again.   The best way to increase growth when this happens is for the government to build infrastructure funded with debt.  This way, not only is overall demand in the economy increased, but it also adds to supply.  By building freeways, urban/light rail, high-speed long distance rail, schools, wind farms, the grid, etc., the productive capacity of the economy is increased.  Cutting interest rates doesn't necessarily add to demand when interest rates are already low.  Debt-funded infrastructure spending does.

As long as the budget deficit's percentage of GDP is below the nominal rate of GDP growth, the total outstanding debt as a percentage of GDP will continue to decline.  And as long as the borrowings are used to fund projects which add to productive capacity, they are sound.

Doug Cameron, a former NSW Labor senator, made this tweet:

Public debt to GDP was huge after WW2. Didn’t stop massive public investment in jobs, public housing, education and health. Debt diminished as economic growth kicked in.

We must ignore right wing fear campaigns on debt and rebuild a better more caring and productive society.

I think he's right.  Countries which try to pay down debt using austerity, will grow more slowly than those which try to stimulate growth using deficit spending to fund infrastructure.

How Portugal ended austerity & got growth

It is a truism in economics that everybody's expenditure is somebody else's income.  If a single individual practises austerity, and cuts their income, then that won't have any effect on overall GDP, because one person's spending is small in relation to the totality.  On the other hand, if a major participant in the economy cuts its expenditure, then it's highly likely overall income will fall.  For example, if government spending makes up 30% of GDP, and the government cuts its spending (or raises taxes) by just 3%, GDP would fall by at least 1%, probably more, because all those whose incomes have fallen will themselves spend less, creating a multiplier effect rippling through the whole economy. 

Since personal income tax and corporation tax is leveraged to GDP growth, i.e., it rises faster than GDP in an upturn and fall faster in a downturn, then any attempt to balance the budget by raising taxes and cutting spending will often fail.  Neo-liberalism prescribes austerity to reduce deficits, even in the teeth of the the evidence that this doesn't work.  Portugal is a good example of this.

From Scoop.me

Considering the booming economy, dropping unemployment numbers and the return of many once-emigrated young Portuguese citizens, it seems Portugal is on the rise. Facing the policies of socialist Prime Minister António Costa, which include properly supporting the welfare state and investing in the public sector instead of austerity measures, right wing populists don’t stand a chance.

Not too long ago, Portugal stood on the brink of catastrophe: harsh austerity policies and the erosion of labour rights pushed by the conservative government lead to significant rises in poverty and unemployment. The economy dwindled due to the lack of peoples’ spending power.

Today, everything has changed:

“Nowadays, Portugal is considered a prime example among European countries: the economy is booming, unemployment is dropping and investments are rising.” 

What are the reasons for this turnaround? What makes Portugal special when compared to other countries?

The first major change occurred during the general election in 2015. At the time, the right wing conservative government was dismantling the social welfare state piece by piece, which resulted in a furious population voicing their dissatisfaction in the voting booth – the conservatives lost 11 percent of their previous electoral votes.

Lisbon’s former mayor António Costa, a socialist, won by a landslide and brought in 32 percent for the Partido Socialista after being elected frontrunner a year prior and uniting the entire city of Lisbon during his time as mayor.

Costa succeeded in uniting the severely split left wing in Portugal, who came together to support his minority government. At first, observers were pessimistic about the potential of this coalition, predicting a collapse after a few months. Moreover, both the EU and German minister of finances saw a grave mistake in the departure from austerity. Angela Merkel described the prospect of a radical anti-austerity coalition in Portugal as “very negative”. The president of Portugal went further, calling non-conservative economic policies a “danger to national security” and attempting to keep the old government in power.

It’s been more than four years since the socialist party assumed the reins of government. The scepticism of the early days has virtually vanished. The entirety of Europe seems impressed by the success story of António Costa:

The Portuguese economy has been booming for 4 years, and 2017 marked the largest national economic growth of the century.

The Portuguese are not only showing the feasibility of socially conscious policies, but demonstrating the significant potential for success.

“The budget deficit has dropped to its lowest ever since the change to a democratic system in 1974 – simply because the government re-established and strengthened the social welfare state, leading to the Portuguese people having more money to spend.”

The socialists raised the once slashed wages and pensions, reintroduced paid vacations and retracted many tax raises, all while raising wealth taxes which affected only the rich constituents of the population. The government also introduced a property and real estate tax designed not to target the homes of average citizens. Crucially, Costa’s socialists put an end to the catastrophic privatisations that were once mandated by the EU and resulted in selling state assets at absurdly low prices.

“The assumption that one could save the economy by aggressively cutting wages and excessively attacking welfare programs was clearly a misconception”, Costa said about his predecessors.

Portugal’s swift rise from a nation in shambles to prime example is remarkable. Costa gave hope and pride back to the people after the country was shaken to its foundation by the EU’s austerity programs and the failed previous government.

The newfound optimism also influenced the outcome of the 2019 parliamentary elections

Costa’s Socialists (PS) won the parliamentary elections in Portugal with 37 percent – well ahead of the conservative Social Democrats (PSD). They finished second with 28 percent of the vote, Costa won [gained] over 4 percent and came first. The number of socialist MPs rose from 86 to 108, with the socialists winning 15 out of 20 constituencies – 8 more than in the 2015 general election.

In the current political climate, which is full of optimism, the Right cannot get a foothold.

“If young Europeans are radicalized in city districts that were economically left behind, we have to answer with social policy measures”, Costa summarized his agenda in an interview with the German newspaper Der Spiegel.

The remarkable economic growth of the past years is only the beginning. Under socialist rule, the economy grew so significantly that the money made is now set to be invested and returned to the general population. Portugal’s government plans to use the rising public sector revenue to transform the nation into a more just and modern one, after the destabilized infrastructure under the conservatives.

Costa presented a nation-wide investment proposal and surprised many once again: 20 billion Euros is considered an incredible amount of money for a country the size of Portugal. 60 percent of the funds is to go towards public transportation; the remaining money will be invested in the energy sector and environmental projects. 

The much-used railway line connecting Lisbon and Porto is to be modernized, urban subway networks will be expanded and further investment will go into public transportation in rural areas. This will generate new jobs, revitalize the economy and lift public transportation onto a state-of-the-art level. Furthermore, Portugal will become more eco-sensitive in the process. And Portugal did all this with a solid budget – in 2019 it even achieved budget surpluses.

[In case of new republication, please cite Kontrast.at/Matthias Punz as the Source/Author. The rights to the content remain with the original publisher.]

In 2019, Portugal's GDP growth was 2% (real), vs Europe's 1.4%.

Deficits matter again

By Tom Toles

The mixed economy

Dallas Freeway, early 1950s

After the war, in the UK, western Europe, Australia, Canada, and even in the USA (though less so) there was a political and economic consensus that a mixed economy was the way forward.  This meant an economy where some of the means of production (for example, natural monopolies such as the electrical grid or railways) was owned by the government, but the rest remained in private hands.  It also meant government intervention in the labour market and in industry.  It was recognised that free markets work well only where there is substantial competition.  In fiscal policy, it was the universal consensus that governments should increase spending and raise their deficits to keep economic growth going when there was a recession.  (They were also supposed to reduce deficits and spending when growth picked up again, but they often didn't.)  This fiscal philosophy was called Keynesian economics after the economist who advocated it, John Maynard Keynes, who studied the Great Depression in depth to see what could be done to avoid future depressions. Keynes demonstrated that slashing government spending to repay loans only worsened the deficit because it caused the economy to contract, which in turn reduced tax revenue.

At the end of previous wars, economic growth would collapse, as war spending stopped and government debts were repaid.  After the second world war, it was widely expected that this would happen again, especially as economies had only recovered from the Great Depression because of government spending on defence.  The allies came out of the war with government debt to GDP ratios of +-200%. But, with the understanding derived from Keynes's analysis, instead of trying to repay these debts by spending cuts and tax increases, they instead aimed to improve that ratio by increasing GDP. World growth boomed. Governments expanded the electricity grid, using borrowed money. They built social housing and schools and motorways. All with borrowed money. Despite all this borrowing, the ratios of debt to GDP fell steadily. Unemployment remained low, living standards rose, inequality diminished. Hundreds of millions of poor people shared in the prosperity that sustained growth brought, and growth was higher because they shared.  The Keynesian mixed economy worked.

At the end of this era there were problems, especially with rising inflation, and the philosophy of neo-liberalism gained popularity. And in the beginning it seemed to be a solution. But as governments shrank, privatisation expanded, and controls over the private sector (especially the finance sector) were eliminated, not only did inequality start to soar but the system itself became more unstable. Recessions became deeper, and recoveries from those recessions slower, culminating in the GFC (global financial crisis), from which the world has only just started to recover, 9 years later.  Since the GFC, trend growth in developed countries has been lower than before the GFC.  Unemployment has fallen only slowly.  Inequality has become stratospheric.

I think the public dimly senses that neo-liberalism isn't working, but doesn't know why. They vote for Trump/Brexit/AfD/One Neuron because the pollies promise that they "will do something". But politicians have no idea what to do either.

What can we do? For a start, we can start funding infrastructure using borrowed money.  Remember that it was a Republican president, Eisenhower, who built the US interstate highway network with borrowed money funded by a tax on petrol.  It added at least 1% per annum to the growth rate of GDP.  What could we do now?  High-speed rail, urban rail and trams; housing for the poorest; replace coal power stations with wind and solar; new schools and hospitals; a fibre optic broadband network; .... As Eisenhower's interstate highways showed, infrastructure spending adds to demand and employment at the same time as it raises the growth capacity of the economy.

We should start a move towards a UBI (universal basic income, or social wage) to increase the incentive to work and to make it possible for the unemployed to get some work, even part-time work, without impoverishing them.  We could make sure companies and the very wealthy pay their share of tax to fund the things that a civilised society needs, things which can't fairly be funded by private enterprise: hospitals, roads, police, schools and universities.

The Right describe this as "far left" and "radical". It seems to me it's centrist and not very different to what we enjoyed for 30 years after the war, when unemployment was low, inequality was low, and growth was high. And I think ordinary people will enthusiastically embrace these changes.

See also:

Neo-liberalism
What would Keynes do?
The basic income

The perils of ill-advised austerity

Europe's real GDP, i.e., after adjusting for price rises, is still below the pre-GFC peak.  An astonishing achievement.  This assumes a small rise in QII (data not yet available), which may not happen given the state of PMIs across Europe.  IP (industrial production) across core Europe is slowing, GDP will surely follow.  7 years of blunder and failure.  A triumph.  Provisional PMI for July out tomorrow.  We'll see what that shows.