‘What Good Are Economists Anyway?’ asked Business Week’s cover story for 16 April 2009, noting that though the world is ‘simply too complicated’ for ‘exactitude’ in prediction, it is distressing that ‘seven decades after the Depression, economists still haven’t reached consensus on its lessons’. An even harsher rebuke came from within the profession when Paul Krugman asked, in the pages of the New York Times Magazine, ‘How Did Economists Get It So Wrong?’ (here). Despite his title, Krugman did not have all economists in mind, but only those who followed recent neoclassical fashion (he left undiscussed the reasons why Keynesian theory fell into disrepute in the 1970s). * * * Krugman dismissed the approaches dominating academic economics over the last 30 years as fundamentally misguided and called for a return to Keynesian theory as part of a recognition of the fundamental ‘messiness’ of the economy.
Writing in the Financial Times (August 5, 2009), Robert Skidelsky (best known for his authoritative biography of Keynes) similarly noted that the efficient-market hypothesis’s collision with the iceberg of economic reality had ‘led to the discrediting of mainstream macroeconomics’ and given the lie to economists’ claim to practice a predictive science. Such shock at the predictive failure of economics is surprising, given the dismal record of professional forecasting. — Paul Mattick, Business as Usual: The Economic Crisis and the Failure of Capitalism, Reaktion Books. Kindle Edition, 2011 (pp. 19-20).
In his second-most recent Op-ed (“The Fiscal Fizzle: An Imaginary Budget and Debt Crisis,” The New York Times, July 20, 2014, here), Paul Krugman argued that the “fiscal panic has fizzled,” citing the most recent Congressional Budget Office “Long-term Budget Outlook,” July, 2014, (here):
I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled — and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office — which are distinctly non-alarming — as somehow a confirmation of their earlier scare tactics.
The “deficit scolds” Krugman refers to are right-wing economists and politicians who argue that deficit reductions are needed to avoid the serious crisis that will eventually develop with the continuing federal deficits and exponential growth of the national debt. There are two ways to cut the deficit: reducing federal spending or increasing federal revenues. Krugman has been consistently critical of Alan Simpson, Erskin Bowles and the National Commission on Fiscal Responsibility and Reform (here), a conservative group that includes the premier Congressional budget slasher, Congressman Paul Ryan (here). The Republican Party and the economic right generally want lower taxes, and favor the budget slashing approach to reducing the deficit. Indeed, the Washington Post editorial cited by Krugman (here) simply presumes that raising more government revenues by increased taxation of the rich and corporations is out of the question.
The economic right has little incentive to actually help relieve the Budget and Debt crisis. Ideologically, they express a broad aversion to government, and many powerful “conservatives” today simply want, as Grover Norquist puts, it to “shrink” the federal government “down to the size where we can drown it in the bathtub.” Politically, their agenda is to blame the Obama Administration for our economic woes, and perfect their control of the national government so they can finish this job.
Krugman has repeatedly campaigned against “austerity” budgeting, correctly arguing that cutting taxes and government spending has disastrous consequences for recovery and growth, both at home and abroad. In his most recent Op-ed (“Left Coast Rising,” The New York Times, July 24, 2014, here), Krugman points to the latest confirmations of Keynesian theory from the states of Kansas (whose tax cuts resulted in fiscal crisis and less growth) and California (which has increased taxes without such negative impacts). The lessons are clear: austerity cannot work, and the “trickle-down” fantasy is a hoax. The key to improving the economy, therefore, will be to remove the budget slashers and tax reducers from their positions of control.
To tackle the deficit problem, increasing tax revenues from the wealthy and corporations is a must, but it also appears to be a political impossibility right now. It appears that Krugman, in these circumstances, has opted to argue that there is no need to worry about the deficits right now, in an attempt to disarm the deficit scolds. Although the “fiscal fizzle” argument is a logical approach to pursuing that political objective, analysis of the CBO forecast shows there actually is a serious budget crisis, and we are running out of time to correct the problem. In my view, facing the truth is preferable to continuing to play a political game. Billionaires like Nick Hanauer (see my last post) deserve to know the urgency of the danger for them in the current situation: We cannot rely on politics, so Hanauer’s initiative remains the best hope for America’s future. So far, however, too few politicians and economists recognize (a) the proven failure of mainstream, neoclassical forecasting, and (b) the brutal consequences of the accelerating inequality of income and wealth.
The CBO Forecast
Paul Krugman, referring to CBO’s July report, makes this argument:
The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009. It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow — but the economy is growing too, so the budget office expects the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.
The July report extends through 2039 its presentation in February of 2014 of “The Budget and Economic Outlook: 2014 to 2024” (here). My analysis here is based entirely on the February report, for two reasons: (1) The February report contained a detailed budget budget forecast but the July report does not, and there is crucial information in the details that are omitted from the July report; (2) I need more time to review the July report for its consistency with the 2024 forecast, and to study the extended projection through 2039. (I will present a follow-up post as soon as I have completed that review.)
Here, from the February report (p. 2) is the Summary Table of CBO’s baseline projections, in which both deficit and debt estimates are presented in actual dollars and as a percent of GDP:
Note that the real (inflation-adjusted) deficit is projected to grow from -$514 billion in 2014 to -$1,074 billion in 2024. The national debt is projected to grow from $12.7 trillion in 2014 to $21.3 trillion in 2024. This enormous growth in the debt, however, only results in a projected increase in the debt/GDP ratio from 73.6% to 79.2%. This reflects, of course, a similarly substantial increase in projected GDP.
GDP (income) is projected to grow at a little over 3.1% on average through 2017, and to increase at an average rate of 2.2% in the 2018-2024 period (Summary Table 2, p.6). The data in Table 1 produce rounded GDP figures of $17,278 trillion in 2014 (12,717/.736), and $26,843 trillion in 2024 (21,260/.792). (CBO’s actual estimates are shown on Table 3-1, p. 50, as shown below.)
Notably, this amounts to a 55% increase in total income through 2024. It is also noteworthy that the U.S. Census Bureau (here) projects the U.S. population to increase at a much slower rate, from 318.9 million in 2014 to 343.9 million in 2024, an increase of 7.9%. The CBO forecast therefore implicitly reflects substantial projected increases in per capita income and in productivity through 2024.
Our first observation must be that the CBO forecast takes no account of future impacts of the ongoing growth of income inequality, and concentration of wealth. CBO acknowledges the substantial decline in GDP (income) growth that has taken place since the late 1970s, reporting (p. 41) the following average annual growth rates: 4.0% (1950-1973); 3.3% (1974-1981) and; 2.2% (2002-2013). The projected average from 2014-2024 is 2.1%. The CBO offers no explanation for this steady decline. As detailed in this blog, that decline in income growth is associated both logically and statistically with increased income inequality.
Its forecast of growing productivity and per capita income through 2024 simply ignores the 10% decline of median income that has taken place since the Crash of 2008 (while top 1% incomes have grown dramatically); CBO offers a “supply-side” forecast, in fact, that does not account at all for consumer demand. Although the past impacts of inequality growth are reflected in its low income growth expectations, it makes no adjustment for the continuing massive transfers of wealth to the top 1% or the continuing decline in bottom 99% income. I’ll return to this later.
Again, Krugman emphasized this point: “The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009.” CBO presented (p. 4) the following graph of revenues and outlays since 1974, as a percentage of GDP:
This graph displays the record high (since 1974) ratio of the federal deficit to GDP of 9.8% in 2009, but this huge, unprecedented deficit clearly reflected the Crash of 2008 and the consequent loss of government revenues, as well as the huge outlays expended to bail out investment banks and other financial institutions. That the ratio has fallen again does not indicate that we are out of trouble; indeed, the situation is considerably worse because the debt and interest on the debt is much higher than before the Crash. It is more noteworthy that, while CBO projects rising government revenues, the increase in real outlays projected through 2024 is considerable, and larger. In general terms, the explanation for this rising deficit (p. 74) is clear, as revealed by the following table:
- Total mandatory outlays are projected to increase from $2,1 trillion in 2014 to $3.7 trillion in 2024, a 77% increase;
- Total discretionary outlays are projected to increase from $1.2 trillion in 2014 to $1.4 trillion in 2024, a 16% increase;
- The defense budget portion of discretionary outlays is projected to increase from $604 billion in 2014 to $719 billion in 2024, a 19% increase;
- Interest on the national debt is projected to increase from $233 billion in 2014 to $880 billion in 2024, a 378% increase.
The interest on existing debt is increasing exponentially, because no debt is being retired and all debt holders own a “perpetual annuity” on their bonds. While the interest on existing debt is compounding, moreover, the government is continuing to borrow to cover each year’s new deficit, adding to the balance of debt. Notably, under these projections, sometime in 2020 the interest on the debt surpasses the entire defense budget.
The increase in debt interest is the most certain of these projections, and because as discussed below the forecast is extremely optimistic, this represents a best case scenario for debt interest: These projections do not include any allowance for additional income and wealth concentrations over the next few years: Monopoly-driven excess profits are providing well over $500 billion per year in additional net worth for the wealthiest Americans and their corporations. As mentioned above, the CBO’s projected increase in income obscures the related decline of the median income of the bottom 99%, and fails to recognize that more than 95% of all new income, as reported by Emmanuel Saez, has gone to the top 1% since 2010.
In these circumstances, we are confronted with the very real likelihood that the national debt and the deficits will be be substantially higher in 2024 than projected by CBO, and that the debt interest will surpass the defense budget before 2020.
CBO’s Forecasting Uncertainty
CBO acknowledges the tenuous nature of this situation:
Over the next decade, debt held by the public will be significantly greater relative to GDP than at any time since just after World War II. With debt so large, federal spending on interest payments will increase substantially as interest rates rise to more typical levels (see Chapter 2 for a discussion of the economic outlook). Moreover, because federal borrowing generally reduces national saving, the capital stock and wages will be smaller than if debt was lower. (p. 7)
Regarding economic growth, its statements maintain guarded optimism. For example: “The CBO projects that … economic activity will expand at a solid pace in 2014 and the next few years,” and that “federal fiscal policy will restrain the growth of the economy by much less than it has recently.” CBO, nevertheless:
. . . estimates that the economy will continue to have considerable unused labor and capital resources— or “slack”— for the next few years. According to the agency’s projections, the unemployment rate will decline gradually but remain above 6.0 percent until late 2016. The labor force participation rate (the percentage of people in the civilian non-institutionalized population age 16 or older who are either working or are available for and actively seeking work), which has been pushed down by an unusually large number of people deciding not to look for work because of a lack of job opportunities, will move only slowly back toward the level it would be without the cyclical weakness in the economy. (p. 27)
CBO’s actual projection, however, reflects the standard neoclassical presumption that an economy will always rebound to full employment “equilibrium,” reflecting the “full potential” of the capital stock:
By the second half of 2017, CBO projects, real GDP will return to its average historical relationship with potential (or maximum sustainable) GDP, which implies that GDP will be slightly below its potential. (p. 27)
The basis of its projection of the rate of income growth through 2024 is said to reflect “long-term trends”:
Over the next decade, potential output is projected to grow by 2.1 percent per year, on average, which is much lower than the average rate since 1950. That difference primarily reflects long-term trends, particularly slower growth of the labor force caused by the aging of the baby-boom generation. (Id.)
This CBO forecast hedges, though, as have all other mainstream forecasts I have reviewed in the last two years: CBO implicitly concedes that it lacks confidence in its projections, reminding us of the element of uncertainty:
The economic recovery has had unusual features that have been hard to predict, and the path of the economy in coming years is also likely to be surprising in various ways. (Id.)
Economic forecasts are always uncertain, but the uncertainty surrounding CBO’s forecast for the next several years is probably greater than it was during the years following previous recessions because the current business cycle has been unusual in a variety of ways. (p. 39)
In these circumstances, CBO simply makes the most optimistic forecast of GDP growth it possibly can (p. 5), given its forecasting techniques:
CBO assumes the economy rapidly returns to what economists have been calling the “new normal” growth rate, and then continues at that rate, which is termed the “maximum sustainable output of the economy.” This, of course, is pure guesswork.
CBO discusses distribution of income, but only draws inferences from the trend in labor income (wages and salaries), without accounting at all for the concentration of income (p. 43). Thus, CBO produces this graph (p. 43) of “Labor Income”:
The flaw here is that data for”labor income” include the salaries paid to very wealthy people. Thus, CBO ignores other forms of compensation and wealth transfers, ignoring the distribution of income between wealthy and other people, and without considering how growing income inequality affects demand, consumption, and consequently income growth, taxation, and budget deficits.
I’m not picking on CBO in particular here: All of this reflects the bankrupt state of macroeconomic forecasting analysis today. CBO tries to predict the future, but cannot do it any other way than by projecting supply-side “trends” — i.e., by guesswork. Its projection of household net worth (wealth) highlights the fact that its main problem is reliance on aggregate (as opposed to distributed) data:
This graph has the familiar contours of the top 1% wealth graph, because it fully includes and mainly reflects top 1% wealth. After the Crash of 2008, as is now increasingly common knowledge, wealth lost by the top 1% (mainly stock market values) rebounded, while housing values did not. The bottom 99%, on the other hand, lost a large share of the $3.7 trillion of net worth reduced from the collapse of the housing bubble.
This forecast, therefore, is basically a projection of the growth of income and wealth of the wealthiest Americans and their corporations. When income and wealth are rapidly redistributing to the top, which has been true for three decades, aggregate net worth data and aggregate “labor income” data are all but useless. Economic science has yet to appreciate that the distribution of income and wealth, in terms of its concentration at the top, is a primary determinant of income growth. Economists have yet to implement distributional forecasting, accounting for the effects on growth of depressed demand.
With that in mind, here’s one more graph from the CBO forecast:
This is CBO’s first graph (p. 3), and it tracks the national debt as a percentage of GDP. As discussed earlier, CBO identifies that percentage as 73.6% for 2014, and 79.2% for 2024. Notice that from 2007 on out, from the last year or so of the Bush administration, debt has skyrocketed; so has unemployment. After the Crash debt has continued to grow rapidly until the last year or so, when signs of modest growth have appeared that have been eagerly interpreted as “recovery.” (It must be noted, though, there was zero growth in the Q 1 of 2014, speculatively attributed to cold weather.)
It cannot be overemphasized that economists have no good reason to suppose that the national debt will not continue its sharp upward climb after this year. So long as income and wealth continue to concentrate at the top, income will grow ever more slowly, and there is no good reason to imagine that income growth can be sufficient to counter the acknowledged, rapid increase in debt interest. In these circumstances, to mechanically project a near-immediate return to something called “maximum sustainable output” is an exercise in extremely wishful thinking. And remember: even under its own postulated conditions of “maximum sustainable output,” CBO has projected that debt interest will mushroom out of control.
Summary and Overview
Since the early years of the Reagan Administration, income and wealth inequality have grown steadily. Natural inequality growth was heightened by reduced regulation of monopoly profits and increased taking of economic rent at the top, beginning in earnest with the Reagan Administration. Also beginning in earnest with the Reagan Administration was the reduction of federal tax revenues collected from the wealthiest Americans and their corporations. The federal government was not deterred from staying in business, and much of its business turned to the enhancement of wealth. Thus, it incurred massive debt in order to finance these tax reductions.
Today, the interest on that debt is growing exponentially, forcing government to either raise more taxes or cut spending even more drastically than it already has in the last few years. The latter course is actively pursued by the right-wing economists and advocates for the wealthy, who continue to hunger for more wealth with almost no regard for the consequences. They are gradually destroying the U.S. economy and American prosperity, for all but a select few.
Extremists have justified this course of action with a pathological hatred of government, and by the objective, as Grover Norquist puts it, of shrinking the government down to a small enough size to “drown it in the bathtub.” There are less extreme “deficit scolds,” like the Washington Post editors, who expressly only want to socialize banks and too-big-to-fail corporations and financial institutions, making sure that government at least has enough revenue collected from other taxpayers to bail them out again, should there be another crisis like the Crash of 2009.
Paul Krugman has been opposing these hideous, antisocial agendas for some time. In current circumstances, however, in which the full extent of the peril posed by the growing debt interest burden and by the continuing growth of income and wealth concentration are not well understood, he has opted to promote the idea that we have nothing to worry about from the national debt and the growing budget deficits. That strategy, unfortunately, relies on the bankrupt mainstream, neoclassical mindset which has continuously produced unreliable forecasts and which he himself has forcefully challenged.
The CBO forecast reveals the flaws in that mindset, and demonstrates that the danger from our growing debt and budget deficits is real, and growing exponentially. The possibility of not making it to 2024 without a fatal catastrophe is real. In the next post I’ll review a CBO inference which seems absurd on its face: that we might somehow make it to 2039.
In current circumstances, where threats to the sustainability of our planet’s ecosystem, and the frightfully escalating warfare among nations, can make economic matters seem trivial by comparison, we should ask ourselves how our country, and the rest of the world for that matter, would cope with any of those other problems with a collapse into another great depression. We really need to save the American economy and the federal government.
JMH — 7/25/2014 (ed. 7/26)