Let’s challenge our elected officials to figure this out.
Increasing public investment is an increasingly popular policy recommendation. In commenting on the Liberal Party win in Canada’s recent elections, Larry Summers argued that issuing debt at historically low interest rates to increase public spending on infrastructure is both good economics and good politics. In a recent interview in The Atlantic, Bill Gates argued that the U.S. needed to dramatically increase clean energy R&D spending in order to combat climate change, noting that even if coupled with his recommended carbon tax, such spending should create high-paying jobs and contribute to economic growth.
Growing our economy, improving our infrastructure, and tackling climate change are worthy goals. But are Messrs. Summers and Gates right? Is increased public spending in these areas both good economics and good politics? The answer is: “It’s complicated.” So let’s challenge our policy makers to figure this out.
There is strong evidence that certain types of public investment, particularly infrastructure investment, promote economic growth. And as Mr. Gates noted, R&D spending has traditionally spurred innovation, created jobs, and contributed to growth.
No brainer? Not quite.
Before we race to increase public investment on economic grounds, we should answer two questions:
First, how do we increase public investment while driving our debt-to-GDP ratio down to healthier levels? There is ample evidence that high debt-to-GDP ratios actually drag down growth. Our debt-to-GDP ratio is already dangerously high. How do we avoid the drag from additional debt offsetting the growth from additional infrastructure and R&D spending?
Mr. Gates has an answer for this: He proposes a carbon tax to cover the additional R&D spending he proposes. Mr. Summers has a different proposal: Worry about growth now and debt later. With pro-growth public spending policies, Mr. Summers believes there is a good chance that our debt-to-GDP ratio will return to healthy levels (i.e., GDP will grow substantially faster than debt, thereby returning the ratio to healthy levels). This may be likely, but it is not guaranteed. And relying on Congress to really cut spending in the future if we must is risky business.
And the question of risk underlies the second question: If we borrow to pay for pro-growth spending, what is our plan for addressing the cost of servicing the debt when interest rates start rising? Today, the average interest rate on federal debt is roughly 2%, well below historical norms. While we can look forward to “comfortably” spending $400 billion a year to service a $20 trillion debt in a growing economy, what happens when the annual bill rises to $1.2 trillion? We should not assume that ultra-low interest rates are the new normal. Just because Joe DiMaggio hit safely for months did not mean that he would hit safely for an entire season or the rest of his career. Regression to the mean is almost a law of nature. Interest rates will eventually go up, even if we cannot predict precisely when. Are we going to grow faster than interest rates rise? If not, what’s our plan B? I’d love to hear it.
At the risk of stating the obvious, proposing additional public spending and a carbon tax plays well with the Democratic base. Blue Dog and other fiscally-conservative Democrats may have concerns about the long-term costs, however, especially if those costs lead to tax increases that reach the middle class. This is hardly far-fetched. The U.S. could double taxes on the top 1% of tax payers (raising another $365 billion) and not even eliminate our annual deficit (which is more than $425 billion), let alone fund new programs. If we want to keep spending more, especially with entitlement costs outstripping GDP growth, eventually the middle class is going to have to pay more in taxes. This may not be good politics.
It is perhaps equally obvious that increased spending, taxes, and debt do not appeal to the Republican base, even if carefully crafted to promote economic growth. Establishment Republicans could be more open-minded, but would almost certainly be concerned about the long-term impact on the debt. They could look to fund infrastructure and clean technology R&D with corporate tax reform and increased receipts on repatriated funds, but this idea did not gain sufficient support the first time it was floated. Thus, they would almost certainly look to pay for any increased spending with additional spending cuts. With the Republican Party’s current emphasis on increasing military spending, the only place meaningful spending cuts could be achieved would be from entitlement programs. And the Republican Party has not shown any leadership on this issue.
In short, reorienting federal spending to promote economic growth without creating unacceptable levels of long-term economic risk is a complicated endeavor. But we do not elect our Representatives and Senators to solve only easy problems. And the status quo is hardly inspiring: Mediocre growth and high deficits. So, let’s challenge our politicians. Let’s add another question to our list for our elected officials: What is your plan for boosting public spending on infrastructure and clean energy R&D while ensuring that our debt-to-GDP ratio returns to healthier levels and that we can service our debt without squeezing discretionary spending when interest rates inevitably rise?