Why the Budget is the Wrong Thing to Fight About

The country is consumed right now with the fight over the Federal budget, specifically the plan of Rep. Ryan (R-WI) to balance it by (mostly) radically cutting spending on medical programs, especially Medicare. The recent Republican loss in New York’s 26th district’s special election—which had more to do with my friend Jack Davis running on a third-party ticket—has been interpreted as a referendum against the Ryan plan. And the states are, of course, tied up in budget battles of their own, most visibly the aggressive push to cut the cost of public employees by curtailing their unions.

Unfortunately, while all these fights are, of course, important, they are still, fundamentally, the wrong economic issue for America to be fighting over right now. Because despite Rep. Ryan titling his plan “The Path to Prosperity,” none of these controversies touch upon the true fundamentals that determine that prosperity.

All these controversies are, at bottom, about one thing: rebalancing public-sector spending. And it is fantasy to imagine that this is the key to putting our economy back on track.

To hear some Republicans talk, you’d think that if only we squeeze hard enough, and go whole hog for their eat-your-spinach skinflint economics, prosperity will return. This is the elevation of deferral of gratification to the master key (if not the sole!) economic virtue, from which all else will follow. If only we’re tough enough on ourselves right now.

Unfortunately for Republicans, that kind of tightwad economics rightly died in the Keynesian revolution over 70 years ago.

It’s not so good for Dems either.

To hear some of them talk, you’d think that if only we pump up government spending enough, perhaps financed by higher taxes on the rich, we can pump-prime our way back to prosperity. This is the elevation of counter-cyclical Keynesianism (spend your way out of a cyclical downturn) into non-stop stimulation of the economy, whether its problems are cyclical or structural.

The fundamental economic problem we face right now isn’t recession—in which case we could just sit back and wait for it to end, with a little help from the standard playbook. It is the structural underperformance of the U.S. economy, for reasons that weren’t caused by the recession and won’t go away when it ends.

As a result, Republicans and Democrats are arguing about how to divide the pie, when the real question is how to bake more pie in the first place.

So . . . what is the solution? What do we have to fix?

The number one thing is trade. Free trade collapsed a very long time ago. What we have today is not free trade at all, it’s ruthlessly manipulated trade—manipulated by America’s big trading partners, starting with China but including many others. And we’re doing nothing to stop them.

America’s titanic ($497 billion last year) trade deficit is ripping the guts out of industry after industry, but we have no answer. And you can’t gut industry after industry and expect not to reduce your GDP.

If we didn’t have this horrendous trade deficit, we simply wouldn’t be fighting many of these budget battles. Why? because we’d have a larger GDP, so tax revenues would be higher. Spending on public benefits would be lower, and painlessly so, because fewer people would be poor and middle-class people would have more money to take care of themselves.

How much GDP have we already lost?

The Economic Strategy Institute estimated in 2001 that the trade deficit was shaving at least one percent per year off our economic growth. (Source, p.93) This may not sound like much, but because GDP growth is cumulative, it compounds over time. Thus economist William Bahr has thus estimated that America’s trade deficits since 1991 alone (they stretch back unbroken to 1976) have caused our economy to be 13 percent smaller than it otherwise would be.

That’s an economic hole larger than the entire Canadian economy.

Size of GDP is, ultimately, more important than size of government. We can have legitimate liberal vs. conservative arguments over the latter, but even from a conservative point of view, it’s far more important to have a government that conduces to a GDP large enough to provide all the things we want than to have a small government per se.

Growing the economy may, in fact, call for increased spending in some areas. Even a precocious third-grader can see why even fiscal tightwads should make an exception for spending that ultimately brings in more money than it costs.

What kind of spending are we talking about? One kind is government programs to fill in the gaps in the private sector’s innovation capabilities. Such programs fund, for example, technology research to bridge the gap between pure science and corporate research and development (R&D). This is the so-called “Valley of Death” in the innovation system: the private sector can’t make money doing such research, but it can’t ultimately keep generating new products unless somebody does it. So it’s appropriate for the Federal government to step in.

America’s hidden history of doing this stretches from the Internet back to founding father Alexander Hamilton. We still have such programs today, but on a tiny scale compared to what we need—and tiny compared to what our rivals do.

Thus the giant stimulus package it passed in 2009 included money for every Congressional pork barrel under the sun, but nothing for one of the industrial-policy programs with the best track record of saving and creating jobs: the Manufacturing Extension Partnership, despite a campaign promise to double the program’s funding. This program maintains a network of centers in every state designed to help American manufacturers adopt innovative technologies. One evaluation found that it generated $1.3 billion a year in cost savings for manufacturers and $6.25 billion in increased or retained sales, all for an annual federal outlay of only $89 million.

Another good but underfunded program is the Technology Innovation Program. Free market ideologues have repeatedly tarred this program as corporate welfare despite the fact that an audit by the respected National Academy of Sciences vindicated its claim to generate economic benefits far exceeding its cost. One single $5.5 million grant, for example, seeded development of the small disk drive industry, which enabled creation of the iPod, the iPhone, TiVo and the Xbox.

This is how you make an economy grow—not by squeezing the economy you already have, or borrowing yet more money to “stimulate” it.

As a result of America’s neglect of such programs, there is a starvation of basic and applied research in areas such as biocomputing, computer architecture, software, optoelectronics, aeronautics, advanced materials, factory automation, sensors, energy conversion and storage, nanomanufacturing, robotics, and green energy.

We are in danger of having our economy fail to grow because we were so busy arguing over the harvest that we neglected to plant the seeds.

Ian Fletcher is Senior Economist of the Coalition for a Prosperous America, a nationwide grass-roots organization dedicated to fixing America’s trade policies and comprising representatives from business, agriculture, and labor. He was previously Research Fellow at the U.S. Business and Industry Council, a Washington think tank founded in 1933 and before that, an economist in private practice serving mainly hedge funds and private equity firms. Educated at Columbia University and the University of Chicago, he lives in San Francisco. He is the author of Free Trade Doesn’t Work: What Should Replace It and Why.

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