Why Slashing Government Spending Now Would Result In A Depression

The U.S. Government Should Resolve Economic Crisis By Spending More Wisely – Not By Spending Less!

As the United States debates its economic future in light of large government budget deficits, it is important that the public [understands that] before we can reach the point where the government can spend less, the country must go through a period where the government spends much more wisely. To simply slash government spending now would result in a depression in the United States and around the world. [Let me explain.] Words: 1251

So says Richard Duncan (www.richardduncaneconomics.com) in an article* reformatted and edited […] below by Lorimer Wilson, editor of www.munKNEE.com, for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article reposting to avoid copyright infringement. Duncan goes on to say:

How Is The Economy Measured?

Economies are measured in terms of their Gross Domestic Product (GDP). GDP is made up of personal consumption expenditure, private investment, net trade (i.e. exports minus imports) and government spending at both the federal level and the state and local level. If the size of each of these components is known, it is only necessary to add them together to find the size of the whole economy.

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In 2009, the United States GDP was $14.1 trillion, according to the Bureau of Economic Analysis (BEA) [of which:]

a) personal consumption accounted for 71%,

b) government spending 21% and

c) private investment 11%  with

d) 3% deducted  from GDP because exports from the U.S. were 3% less than imports into the U.S..

What Is The Outlook For The U.S. Economy?

a) The outlook for personal consumption is bad because the household sector is heavily indebted. Household debt increased from 64% of GDP in 1998 to 97% of GDP in 2008 at which point, millions of Americans became unable to repay their debt, defaulted, were cut off from additional credit and were forced to spend less. The drop in private spending threw the world into economic crisis and caused U.S. unemployment to soar to 10%. Prospects remain discouraging because home prices have fallen by more than 30% on average, meaning that even the Americans with good credit ratings have much less collateral to borrow against. With limited access to credit, household spending will remain depressed.

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b) The outlook for private investment is also bad. Capacity utilization, which measures the extent to which factories are operating relative to their capacity, is roughly 75% which  is one of the lowest levels since records began in the 1960s. Businesses will not invest more at a time when they cannot utilize the capacity they have already put in place.

c) The outlook for net trade continues to look negative. Because the United States imports so much more than it exports net trade has been deducted from U.S. GDP every year since 1975 and there is no reason to expect this to change given current government policies.

d) The outlook for government spending remains negative. The amount reported for the federal government in the GDP data provided by the BEA underestimates the true impact of government spending on the economy because it represents only the federal government’s direct purchases of goods and services. It excludes normal transfer payments such as unemployment benefits, Social Security payments, Medicare, and assistance to state and local governments, as well as emergency assistance to the financial sector. In other words, federal government transfers provide significant support to other sectors of the economy, particularly personal consumption expenditure and state and local government… At a time when government spending is under fierce attack in the United States, every American needs to understand how much of the economy depends on that spending.

Why The Government Should NOT Try To Balance Its Budget

This year the U.S. budget deficit will be approximately $1.4 trillion. If the federal government were to attempt to balance its budget by spending US$1.4 trillion less in 2011:  

a) Personal consumption would decline because less government spending would cause unemployment to rise sharply.

b) Private investment would decline because there would be much lower demand for goods and, consequently, much lower levels of capacity utilization than exist now. 

c) Tax revenues would also decline as consumption and investment declined, making it necessary for the government to cut its spending even further to balance its budget.                                                                                                                                                                         

d) Interest rates would not go lower. In the past, it was understood that if the government spent less and borrowed less then interest rates would fall since there would be less demand for loans. Lower interest rates would then boost the economy by allowing businesses and consumers to borrow at cheaper rates and to spend more. That is not the case now, however. Short-term interest rates in the United States are very near 0%.

Conclusion: The economy would contract by more than the amount that the government reduced its expenditure – and, perhaps, much more.

What Must The Government Do Then To Avoid Eventual Economic Ruin?

[Needless to say,] the U.S. government cannot continue to run trillion dollar budget deficits forever. Therefore, we must:

a) shift the national debate away from slashing government spending regardless of the consequences and instead

b) discuss how the government could spend that money in a way that generates a high return on investment

c) [that is to say], shift the government spending away from areas that support consumption to areas that boost investment. [Such] an investment strategy would allow the United States to develop new, high-tech industries that would boost U.S. exports, reduce U.S. imports, create U.S. jobs and generate significantly higher tax revenues.

[The US News and World Report has reported the following and it begs to be debated as to whether such proposals are sufficiently wise recommendations to avoid eventual economic ruin or are short-sighted to the degree that they will propel the U.S. headlong into a worldwide depression: 

Conclusion

The United States is in crisis. Before we can reach the point where the government can spend less, the country must go through a period where the government spends much more wisely. To simply slash government spending now would result in a depression in the United States and around the world. Just do the math.

*http://www.richardduncaneconomics.com/2011/01/19/what-every-american-needs-to-understand-about-the-economy/

Editor’s Note: