Ah, somebody finally spelling out the trade-offs if the world’s developed economies move now to cut government spending or to raise taxes.
This isn’t another one of those exercises that says healthcare spending and welfare payments will get cut if governments adopt austerity budgets. Really? No kidding. If governments cut spending, governments will spend less?
No, what the World Bank has done is to look at what the effects of different timing for cuts in government spending would do to growth in different parts of the world.
The bank ran two scenarios: one assumed that the world’s developed economies cut budgets quickly—that is in 2010 to 2014—and the other assumed that cuts would be more gradual—from 2010 to 2020. Both scenarios assumed that the goal was to reduce the debt to GDP ratio in developed economies from current levels of 80% to 120% (and higher in a few cases) to 60%.
Not surprisingly, the faster cuts scenario results in less economic growth in developed economies.
Compared to slower cutting, the fast cuts scenario results in a 2014 GDP that’s 1.8% smaller in the United Kingdom, 1.6% smaller in Japan, and 0.9% smaller in the United States.
But because faster budget cuts would reduce the need for government borrowing, interest rates paid by developing economies would be up to three percentage points lower. As a result, the fast cut scenario that would be so painful to economies in the developed world would by 2014 produce economies 3.4% larger on average for the developing world than if the cuts were phased in more slowly. China’s economy would be 2.9% bigger and India’s 2.3% bigger, for example.
Wonder if German Chancellor Angela Merkel has explained this trade off to angry German voters. (For more on Germany’s proposed budget cuts and its effect on global economics, se my post https://jubakpicks.com/2010/06/07/is-the-global-economic-recovery-about-to-go-into-reverse-watch-germanys-proposed-spending-cuts-to-see/ )
java12jack,
Spinning off the swap desks doesn’t make them go away. They’ll just be under separate companies.
Why is the Rich so keen about tax cuts? It is because the tax cuts IS for the Rich. The poor is not paying taxes any way. There is nothing to cut. The middle of the road is paying something like 12% effective. If you cut that, the government stops functioning. So it must be the Rich. The Rich also likes the flat tax rates because this also transfers tax burden from the Rich to other citizens.
On the other hand, cutting spending always means cutting Medicare, Medicaid, etc. that benefits the non-Rich and especially the Poor. If you look closely, they never support cutting budget items that directly or indirectly benefit the Rich. So, corporate welfare is good, the welfare for the masses is bad.
In conclusion, let’s stop fooling ourselves. Tax cuts is good for the Rich, spending cuts is bad for the non-Rich. This is what has been done for the last 30 years to bring us to the point where we currently are and this is what has to be reversed.
Christopher:
What you are trying is to micromanage the economy. You will be surprised how much does it to do so. When I am requesting 10% cut across all the Departments, I am already assuming that it will be unfair. Some will manage those cuts better than the others, some will be forced to make bold decisions, but the reality is, because of a continuous political correctness, these cuts will never happen.
> A good start is by googling “shortage of scientists [or engineers]“–you’ll see it’s a myth and the opposite is true.
I guess what we are taling about is a handful of scientist and engineers (who needs these people in the US anymore anyway?) and the rest is high school drop outs, cashiers at Wal-Mart and burger flippers at McDonalds (if they manage to graduate).
I goggled “drop out rates” and this is what I found:
New national dropout rates: 25 percent of all students; nearly 40 percent of black and Hispanic kids fail to graduate on time
http://blogs.ajc.com/get-schooled-blog/2010/06/02/new-national-dropout-rates-25-percent-of-all-students-nearly-40-percent-of-black-and-hispanic-kids-fail-to-graduate-on-time/
Brokers
Jim or Ed,
With it looking like congress is going to make US banks spin off their swap desk who do you think will benefit? Swiss banks? STD? Brazilian banks?
Why can’t we just pull sales forward forever?
@Christopher–Obama & McCain had this scalpel vs. axe argument. I hate to be so generic, but, the scalpel promise will never be kept no matter which side makes it.
@Robert1234 and others–I disagree with the poor education notion. This has been repeated so many times that it has become truth to most. I encourage everyone to read the other side to this argument. A good start is by googling “shortage of scientists [or engineers]”–you’ll see it’s a myth and the opposite is true.
@Southof8–Good point on growth. It’s amusing watching liberals say the same thing, but they never seem capable of putting their money where their mouth is whenever the economy forces what they want. And conservatives scream any time anyone suggests we can go without a growth based economy as that means lower or stagnant standard of living. Demographics will eventually force this to change, but politicians (voters) will futilely try their hardest to stop it.
@USDAportfolio–Great idea! The problem is the stone agers hate it when productivity gains take away jobs. Shouldn’t we all be subsistence farmers? I don’t see America embracing the signs of a rich economy–one that has become SERVICE based–any time soon.
This recent article on cnbc.com quantifies the trend of increasing dividends and stock buybacks I have discussed in recent posts.
http://ori.cnbc.com/id/37602225
viwi,
“If there is a 10% mandatory budget cut across all the Departments, I am pretty much sure that after the tidal wave of cries and complains, all the Departments will be able to survive without any loss of performance.”
You are assuming a lot there. First off you are assuming that a bureaucracy like our government will cut the 10% in an efficient manner. I seriously doubt that, what will be cut is the part that have the less power not the waste. Second the problem of cutting 10% across the board is the same one that was propose during the health care bill. If you take a fantastic hospital like John Hopkins, and a terribly inefficient one say XXX, and tell them both to cut 10%. At John Hopkins you cut off good people doing good work. And at XXX you may get your cut of 10%, but you probably will not change their procedures or cost ratios so that you now have a John Hopkins.
I am not sure where to start … I guess with taxes. Taxes and growth are related, and it is impossible to change taxes without affecting the current and future growth. I am personally in favor of the minimum personal tax, but I would encourage a tax on luxury spending, which includes second home, extra car, luxury items, and even liquor.
As far as for spending cuts, I am not into “cutting”, as much as I am into “stopping the waste”. We are wasting tons of money without noticing it. If there is a 10% mandatory budget cut across all the Departments, I am pretty much sure that after the tidal wave of cries and complains, all the Departments will be able to survive without any loss of performance. I did it couple times for myself, and I was amazed how much money I was able to save each time. What is the difference? I have found only one: I can me politically incorrect to myself.
US needs to reshape its focus from war and conquest to more research and innovation. That will save a lot of money from huge war and military spending. That will also bring in more money from export.
We really need a revolution in the energy sector, like the IT revolution of the last century.
Jim,
Cutting spending or raising taxes aren’t the only options. I don’t anticipate that cutting expenses will ever be an option, especially in a world with higher inflation. Expenses will always grow over time. (None of my bills are lower now than 4 years ago.)
To lower a high debt-to-income ratio, the important thing is that income grows faster than debt expenses. For the government, “income” equates to “tax revenues”. Keep in mind that there are three ways to increase tax revenues: 1) raise taxes, 2) grow the economy (with the same tax rates), and 3) do both.
The only sustainable solution is to grow the economy. (The economy can grow with no theoretical upper bound, whereas taxes are bound at 100% of the economy.)
But what does that mean?
To me, it means that corporations are in the driver’s seat, not the government. Each and every one of us, including readers of this blog, need to take ownership of our role in making our companies more profitable in the future. We can not simply go to work 9-to-5 doing what we always do, and expect “somebody else” to grow the economy. The economy only grows through the hard work and effort of each of us. We need to be constantly thinking of new and better ways to grow our businesses. We need to start educating ourselves about how our efforts at work can really affect our corporation’s bottom line. Are there better ways of doing business than you’re doing now? You bet there are. Are there opportunities out there to grow our companies? For sure! If we don’t figure them out and implement them, then we’re forcing our elected officials to do the only option we’ve left them: increase taxes.
I usually avoid these kinds of posts, because people tend to be blinded by politics and resort to the easy political choices sold to us – “we need to increase taxes” or “we need to cut spending”. These choices are comforting because they absolve us from our own responsibility. Truth is, once we realize that the only sustainable solution is to grow the economy, we realize it is our own efforts at our jobs which will decide our ultimate success.
By the way, the same companies that “figure it out” are the ones I want to be invested in. Not only will it give me the pride to say “my company is really helping my country”, but it will also make me more money.
That’s certainly a helluva good reason to invest in developing countries. Maybe a really good reason to move to one as well. I can only imagine how austere the austerity has to be in the 2015-2020 years, after another few trillion has been stacked on the national debt. Like that’ll happen.
Jim, just curious, but does the World Bank study project the national budget deficits to be for the given countries with “gradual cuts” during the 2010-2020 timeframe? 2009’s deficit in USA was in the neighborhood of a trillion bucks; 2010’s will be higher than that. I don’t see tax receipts picking up meaningfully, particularly without an increase in marginal rates, until 2012 at the earliest, and increasing marginal rates is obviously counter-productive to the goal. So it’s safe to assume we’re looking at trillion dollar annual deficits for the next three to four years, minimum.
How far out does the world bank project the USA will have annual trillion dollar deficits?
Should we conclude we’ll have trillion dollar deficits for the next ten years, bringing the national debt to approximately $23 trillion in 2020?
Is that an improvement over whatever fallout results from austerity sooner rather than later?
The economy generates approximately $14 trillion in GDP. If it grew at 3.6% a year for the next ten years (a reasonable expectation if the growth is fueled by trillion dollar annual deficits; see, e.g., 2009), then by 2020 the GDP would be, what, approximately $21 billion?
We’ll still have debt to GDP of greater than 100%. To get down to 60% debt to GDP, it seems to me there would have to be surpluses in the 2015-2020 time frame. Big ones.
Adding five years of annual trillion dollar deficits to the current deficit gets you to $18 trillion in five years. Even assuming a balanced budget in 2015-2020 does not get a 60% debt to gdp ratio without annual GDP growth of 7% a year for the next ten years.
This idea that we can grow the economy out of debt has been a complete disaster for decades becasue the growth is financed by debt. What idiot came up with this idea? That Wimpey dude who was always begging a hamburger for which he’d gladly pay Tuesday? Did the moron who invented debt fueled growth win the Nobel Prize?
I’m no economist but looking back over the last thirty years, it seems inescable that financing growth with debt leaves simply lots more debt. Who at the World Bank is pushing this kind of crack?
At 4% (wishful thinking, I know- the actual rate by then will be more like 14%), what’s the annual interest payment on a $23 trillion dollar obligation? I try that computation on my calculator and it reads error.
But let’s be optimistic and say it’s $1 trillion. We’re going to pay $1 trillion in annual interest and have a balanced budget, at at time when Social Security Trust Fund will be insolvent and the numbers of workers funding Medicare will be reduced by that many more retirees?
The World Bank guys must have all come from Lehman and Bear Stearns.
@ robert1234. I concur. I think the problem is that the financial sector and their allies effectively have control of the economic/financial side of the government (politicians & regulators). The “problem” is more political than financial.
Ilargi, over at The Automatic Earth blog says it well: “Goldman Sachs or BP, the politicians’ reaction remains the same. Screw whoever’s not in your circle, and use (your power over) their money to pay off who is. Corporations rule this planet, not the people that live on it.”
I believe many people would support addressing the issue in a way such as this: (a) money being directed to create and maintain a true safety net, (b) a huge reduction in the defense budget, (c) elimination of and pork programs, (d) a reduction in the bureaucratic managerial ranks, (e) across the board cuts in Federal spending, including salaries, of say 20% – with NO exceptions except safety net programs.
Of course this is not going to happen. Obama is a just a front man for the Kleptocracy. The average Joes will be bled dry by the sociopathic pillagers occupying the board rooms, supported by their perception managers.
We live in a faux world. The phantom economy must take precedence over the real economy.
We’ve been running massive deficits for thirty years during relatively good times. I remember when Bush I struck a deal with congress to cut spending (austerity anyone?) and raise taxes minimally to cut a then unthinkable projected $400 billion annual deficit…. and got voted out of office for his courage.
And we’re to believe Americans want austerity now, in the worst economy in pretty much any living person’s life time? Boy, that’s rich.
The boomers are addicted to spending their children’s money to buy the wars, the vacations, the healthcare, the lux cars, the cheap oil, the you-name-it they couldn’t otherwise afford without deficit spending.
Hate to be a broken record, but they don’t call it the Me generation for nothing.
The people in USA would probably accept budget cuts, simply because they dont really see any gain from our taxes. We pay as much in taxes as any nation on the planet, what we get for it is debt payments, war, a huge military, and little else. What we do not get is national health care, pencions, roads, bridges, little help for the weak, little help for the unemployed, poor social support for the infirm.. expencive universities, poor education , etc… If budgets were cut in the proper places,,, at least in the USA budget I’d bet the people here would jump om it !
To be fair to the politicians, Christopher is right; the voters won’t tolerate extended pain. It takes some real leadership to sell austerity, and keep getting reelected long enough for it to take effect.
Its too bad that these scenarios, which are great for the long run, never materialize. Politicians will never be able to look past their own self interests.
The real problem with a trade off like this for a politician is the time frame. Politicians are generally on a much shorter time frame before the people get fed up with them and seek someone else that will give what they want now.