conversableeconomist

Don\’t Know Nothing About Military Strategy

I don\’t know anything about issues like the appropriate number of soldiers in the armed forces, or which weapons systems are really needed, or where forces should be based around the world. But I do know something about federal budget numbers. As the political debate unfolds over appropriate levels of defense spending in the years ahead, here are some historical and international perspectives.

Measured as a share of GDP, U.S. defense spending is down substantially from the figures of 10% or more that often occurred in the 1950s and 1960s, and down from the 6% reached during the Reagan defense build-up of the 1980s. Although defense spending as a share of GDP has nudged up since September 11, 2001, it was 4.7% of GDP in 2011.

Defense spending also doesn\’t dominate the federal budget as it once did. Back in January 1961, in President Dwight Eisenhower\’s farewell address, he warned of the dangers of the \”military-industrial complex.\” But at that time, defense spending was still almost 10% of GDP and more than half of total federal spending. Indeed, defense spending was as much as 70% of all federal spending back in the early 1950s (and higher than that at the peak of WWII). But for the last two decades, defense spending has dropped to about 20% of all federal spending.

While U.S. defense spending at relatively low levels, historically speaking, both relative to GDP and relative to total federal spending, it remains high relative to spending by other countries. Here\’s a table showing that U.S. defense spending is more than 40% of the world total, and that U.S. defense spending comfortably exceeds the sum of defense spending by the next 10 largest spenders.

The U.S. economy is the largest in the world, and it also spends one of the greatest shares of that economy on defense. By my count, only eight countries in the world (for which SIPRI has data) spend a larger share of their GDP on defense than does the U.S.:  Saudi Arabia, 11.2%; Chad, 6.2%; Georgia, 5.6%; Iraq, 5.4%; Israel, 6.3%; Jordan, 6.1%; Oman, 9.7%; and UAE, 7.3%.

Of course, spending isn\’t the only variable that matters in national defense: strategy, diplomacy, ideology, economic ties, even personal cross-border ties can affect the likelihood and extent of instability. Defense spending can be quite good at projecting certain kinds of power, but not especially useful at blocking a biological or nuclear weapon that fits in a panel truck or even a large suitcase. That said, these sorts of numbers cut both directions in the debate over levels of defense spending. Those who favor reductions in defense spending over time might take note of the fact that we haven\’t been living in Eisenhower\’s world for some time, and U.S. defense spending has a smaller share of the economy and of federal spending than the historical norm. Those who favor higher defense spending might take note of the fact that the U.S. is far and away the largest defense spending nation now–and that many of the other largest spenders are our allies.

For both sides, I\’m always interested not just in hearing argument about \”more\” or \”less,\” but about what is enough. If you prefer cutting defense, how low would you go before you would say \”enough\”? If you prefer increasing defense, how high would you go before you would say \”enough\”? If someone can\’t explain their answer to that question, I suspect that underneath their show of confident certainty, they don\’t really know any more about weighing the costs and benefits of military spending than I do.

Thanks for Danlu Hu for putting together the U.S. defense spending figures over time from the Historical Tables of the President\’s Budget for 2013.

conversableeconomist

Searching for Plausible Budget Projections

The official federal budget projections are dishonest. They make future budget deficits look smaller by enacting spending cuts and tax increases that won\’t kick in for some years–but then then Congress and the President postpone or eliminate those changes before they actually take place. As a result, the nonpartisan Congressional Budget Office has for some years offered two sets of budget projections: the \”extended baseline scenario\” is based on what current law says will happen in the next 10 years; the \”alternative fiscal scenario\” assumes that certain changes aren\’t going to be made, and thus probably presents a more realistic picture. The CBO\’s 2011 Long-Term Budget Outlook shows the difference.

Start with the basic projection of how much debt the U.S. economy will accumulate in the next 25 years. The \”extended baseline scenario\” says that the rise in the debt/GDP ratio has pretty much topped out at this point, and will rise to a little over 80% of GDP by 2035. The \”alternative fiscal scenario\” is much more grim, suggesting that the debt/GDP ratio would approach 200% of GDP by 2035. Just to be clear, this forecast doesn\’t mean that the U.S. government would actually be able to borrow this much–only that we are on a debt accumulation path that looks unsustainable.

What are the different underlying assumptions here? Take a look at the different paths of taxes and spending in the two scenarios.

On the tax side, the \”extended baseline\” scenario has a bunch of tax increases arising in future years: for example, the expiration of the Bush tax cuts of the early 2000s, a gradual rise in the revenues collected by the alternative minimum tax, and others. As a result, it is based on federal taxes collecting 23% of GDP by 2035–far above the level seen in recent decades. In contrast, the \”alternative fiscal scenario\” is that federal taxes in the long-term will be more-or-less at their historical average for the last few decades of 18% of GDP.

On the spending side, both scenarios show that in the future, when you are asked for a short description of what the federal government actually does, the appropriate answer will be \”retirement and health care spending.\” The two scenarios don\’t differ in projected Security spending. In Medicare spending, the \”extended baseline scenario\” incorporates cuts to physician pay in the future; the \”alternative fiscal scenario\” says that physician pay will remain at 2011 levels. Also, in the \”extended baseline scenario,\” CBO explains that \”government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.\” In the alternative scenario, these other areas of government spending remain at the current levels as a share of GDP.The other big spending difference is that the \”primary spending\” lines shown here leave out interest payments on past borrowing, which grow MUCH larger with the larger deficits in the the \”alternative fiscal scenario.\”

Of course, one can quibble with the details of what is assumed in the \”alternative fiscal scenario.\” But from where I sit, the official budget predictions in the \”extended baseline scenario\” look intentionally misleading, and the CBO is performing a public service by offering more plausible projections. 

conversableeconomist

How much are automatic stabilizers affecting current deficits?

When the economy hits a recession, tax revenues drop automatically, without any change in legislation. Spending on certain programs to help those in need rises automatically, as more people draw on those programs, without any change in legislation. How much of the current budget deficits are due to discretionary changes in tax or spending policy, and how much to these kinds of automatic changes?

The Congressional Budget Office addresses this question in an April 2011 report. The dark blue line shows the actual budget deficits and surpluses. The light blue line shows what the budget deficits or surpluses would have been if the automatic stabilizers had not occurred. Thus, the gap between the two lines is the measure of the effect of the automatic stabilizers.

 The effect of the automatic stabilizers is large in recent years. The CBO writes: \”In 2010,
CBO estimates, automatic stabilizers added the equivalent of 2.4 percent of potential GDP to the deficit, an
amount somewhat greater than the 2.1 percent added in 2009.3 According to CBO’s baseline projections, the contribution of automatic stabilizers to the budget deficit will decrease as a share of potential GDP—to 2.1 percent in 2011, 1.7 percent in 2012, and 1.5 percent in 2013 … . That contribution will then continue to fall—to 1.0 percent in 2014, 0.5 percent in 2015, and 0.1 percent in 2016—consistent with CBO’s
projection for output to come back up near potential output by 2016.\”

It\’s also interesting to note that the budget surpluses of the late 1990s were made larger because of automatic stabilizers: that is, the unsustainably booming economy of that time brought in extra tax revenue and held down the need for supportive social spending in those years. 

conversableeconomist

Setting up a discussion of the Obama stimulus package

Last week I gave a talk to an alumni group here at Macalester College about budget deficits in the short run and in the long run. For the short-run portion of this talk, I set up my discussion with two figures. I reproduce them here, in part for those who would like to cut-and-paste a copy for their own presentations.

The first figure shows three paths for the unemployment rate. The middle line shows the path for the unemployment rate presented by Christina Romer, head of President Obama\’s Council of Economic Advisers, in January 2009–more specifically, it\’s actual data up though 2008, and then a forecast after that date. The bottom line shows Romer\’s prediction that the unemployment rate would be lower if the \”stimulus package\” legislation — the American Recovery and Reinvestment Act of 2009– was enacted. The top line shows the actual path of the unemployment rate. This version of the figure appears in \”Did the Stimulus Stimulate? Real Time Estimates of the Effects of the American Recovery and Reinvestment Act,\” by James Feyrer and Bruce Sacerdote, NBER Working Paper 16759, February 2011.   

Of course, this figure is often used to argue that the stimulus didn\’t work. But of course, it is equally possible that the January 2009 forecast was too optimistic, and that the stimulus made the unemployment rate lower than it would otherwise have been. 
The Congressional Budget Office publishes regular estimates of the effects of the ARRA legislation. The May 2011 report, for example, states that the legislation: 

— Lowered the unemployment rate by between 0.6 percentage points and 1.8 percentage points,
— Increased the number of people employed by between 1.2 million and 3.3 million, and
— Increased the number of full-time-equivalent jobs by 1.6 million to 4.6 million compared with what would have occurred otherwise …

Here\’s a useful CBO figure for illustrating their case that the stimulus improved matters.
With these two figures to set up the discussion, one can then talk about what makes a stimulus package more or less effective in a variety of contexts. Is it timely, temporary and targeted? What about factors like the pre-existing level of debt, the extent to which the economy is open to international trade, the response of monetary authorities, and other factors?

In their NBER paper, Fehrer and Sacerdote summarize some of the conflicting evidence about the effects of the stimulus. Their own findings, as summarized in the abstracts are: \”A cross state analysis suggests that one additional job was created by each $170,000 in stimulus spending. Time series analysis at the state level suggests a smaller response with a per job cost of about $400,000. These results imply Keynesian multipliers between 0.5 and 1.0, somewhat lower than those assumed by the administration. However, the overall results mask considerable variation for different types of spending. Grants to states for education do not appear to have created any additional jobs. Support programs for low income households and infrastructure spending are found to be highly expansionary. Estimates excluding education spending suggest fiscal policy multipliers of about 2.0 with per job cost of under $100,000.\”