Monday, February 7, 2011

Republican Spending Cap Would Have Caused Depression if it Were Law in 2009

by Robert Creamer
The Huffington Post

Republicans have proposed legislation that would cap federal spending at 20.6% of the country's Gross Domestic Product (GDP) -- just below the average of the last forty years. Sounds reasonable, right?

Only if you like the idea of another Great Depression.

Over the last forty years federal spending has averaged about 20.7% of Gross Domestic Product (GDP), so Senator Bob Corker (R-TN) has proposed the "altogether reasonable" idea that Federal spending should be capped at 20.6%. To exceed this cap, a two-thirds majority of the House and Senate would be necessary. Unfortunately, this proposal has been endorsed by several Senate Democrats.

But -- as the events of the last two years should have made clear to everyone -- this reasonable- sounding proposal is actually a prescription for economic suicide. Had it been in effect when the recklessness of the Wall Street banks collapsed the economy in 2008, the Great Recession would have nose dived into another Great Depression.

As most economists will confirm, the major factor that saved us from another depression was the very fact that Federal spending as a percentage of GDP substantially increased in 2009 and 2010 -- to about 24.7% of GDP.

When the bottom fell out of the economy, the GDP shrunk. The level of spending by consumers and businesses -- and demand for American exports -- also declined. As a result, millions of people lost their jobs and had less money to spend, so there was even less demand and more people were laid off. That downward economic cycle can only be broken when some actor has the ability to increase economic demand and break the downward spiral.

The only actor that can take that kind of action is the Federal Government, and in 2009 when Barack Obama took office, that's exactly what the Federal Government did. Of course, even without affirmative action by Congress or the President, Federal spending as a percentage of GDP would have gone up because most Federal spending on things like Social Security, Medicare, Medicaid, Defense, etc. continued at the same level as the overall economy shrunk. Other areas of Federal spending also automatically increased -- like spending on unemployment insurance. But President Obama and the Democratic Congress also passed an $870 billion economic stimulus bill that further supplemented economic demand -- and further increased Federal Spending as a percent of GDP.

If the Federal Government had been required to cap its spending at 20.6% of GDP in 2009 and 2010 there is little question what would have happened. Federal spending on things like unemployment, Social Security, Medicare, money for state governments, etc. would have been slashed. That would have meant that Millions of additional Americans would have lost their jobs, the economy would have continued in its downward spiral, and the financial system could easily have experienced complete meltdown.

Of course Corker would argue that he provides an escape hatch to his cap with the two-thirds vote of each house. But the economic stimulus bill that was so critical to preventing complete economic disaster did not even get two-thirds vote of the Senate.

What's necessary in the face of an economic emergency is fast action. Why would you make it harder for Congress to take the actions that are necessary to prevent economic Armageddon. You might as well put a device on a car that makes it harder to turn the steering wheel when you see an oncoming vehicle.

And that's not the only reason why Corker's cap proposal is such a disaster. As everyone knows the demographic make up of America is changing. We have more and more retired Americans who have paid into Social Security their entire working lives. That will mean that the percentage of GDP spent by the Federal Government will naturally rise as the number of Social Security and Medicare recipients increases.

If Corker's cap were to be in effect in the future it would require across the board cuts to every category of Federal spending -- including Social Security and Medicare. So in fact, his proposal is a stealth attack on Social Security benefits.

The Corker proposal is just another example of right wing economic proposals that sound reasonable rhetorically, but are catastrophic in practice.

Republicans often go on about how, when times are tough, your family has to tighten its belt and the same should be true with the Federal Government. This sounds reasonable too -- right? But it is 180% degrees wrong.

When times are tough for your family, you have fewer goods and services available to your household, so you have to tighten your belt -- that's true. But when the economy of the United States collapses it's not because we have access to fewer goods and services. In fact, economic downturns happen because we produce more goods and services than there are people with money to buy. Recessions and depressions don't generally happen because there are too few goods and services available, but because there is a demand deficit -- there is too little economic demand.

Real wealth is the sum total of goods and services in our economy. Money and the flow of money is not real wealth. It represents goods and services -- it enables the exchange of goods and services so that we can meet our needs in a highly-differentiated economy of millions of people.

Most recessions do not involve the collapse of productive capacity at all. They involve the collapse of the system of exchange we use to trade the goods and services created by that productive capacity.

When the Federal Government increases its demand for goods and services, that stops the downward economic spiral that develops when that system of exchange is disrupted by something like the Wall Street meltdown. If the Federal Government behaved like a typical family and tightened its belt, the breakdown in the system of exchange would continue and we would lose more and more wealth because fewer and fewer people would be employed producing goods and services.

Sometimes it is amazing how quickly people can forget the lessons of the very recent past. It was just a little over two years ago that the economic philosophy espoused by Senator Corker and others Republicans caused the worst economic collapse in nearly eighty years. Time for the rest of us to take a stand against economic amnesia.

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