Opinion pieces and speeches by EPI staff and associates.

[THIS WRITTEN TRANSCRIPT IS FROM BEYOND BALANCED BUDGET MANIA, AN AGENDA FOR SHARED PROSPERITY EVENT HELD ON APRIL 12, 2007.]

Getting Beyond Balanced Budget Mania and Addressing the Nation’s Needs

by Joseph Stiglitz

Well, it’s a pleasure to be here and to talk on this very important subject. Budget debates are a useful way of trying to focus attention on fundamental issues on what the country’s priorities are. But they also reflect views of the economy, of economic behavior. I think it’s understandable that there should be a lot of focus on the deficit at the current time given the absolute mismanagement of the budget macroeconomic policies over the last six years. The magnitude of the increase in the deficit in the last six years has been very large.

But as one recognizes that we’ve had six years of badly managed budgets and badly managed macroeconomics, we have to look at what the realities of our economy are today. And that includes addressing some of the important social and economic priorities.

As we talk about deficits, we have to ask the following question about economic structure. If deficits lead to decreased growth, then a dollar spent on some activity has a cost that is in some sense greater than a dollar. Because we spend a dollar. We don’t change taxes. The economy doesn’t grow as well. On the other hand, if deficits lead to a stronger economy, then that means the net cost is less than a dollar. And to ascertain that, one has to make a judgment about where the economy is today.

There are four propositions I want to put forward this afternoon. The first is that we should never actually focus just on deficits, but on broader economic concepts. The deficit is only one of several accounting frameworks. And it’s probably not the best way of assessing either the fiscal position of the economy or its economic position. I’ll come back to each of these four propositions in a minute.

The second is deficits may or may not matter depending how the money is spent, how they arise and the state of the economy. The third is that the country has a large number of priorities, real priorities. I’ll only talk about three of them, the challenge of globalization, the growing inequality, the health care crisis. But there are others such as our problems of energy and climate change. Meeting these, some of these, will require spending money that might create the larger deficit. And I’m going to try to argue that in fact if this money is spent well; it does make sense to do that, even if it led to a greater deficit.

And the fourth proposition is that the current state of the economy is such that deficit reduction, done the wrong way, could have a large macroeconomic cost. So that if you put it another way, if we spend money the right way, it could have two benefits, the direct benefit as well as the benefits that come from macroeconomic stimulation.

Maybe I should begin by giving what I think are two further points that are illustrative of these four points that I hope represent a consensus, not of everybody in Washington, but I think of all the right thinking people in Washington.

The first is that we as a nation and world would be better off if we ended the war in Iraq and reduced defense expenditure. That not only the expenditures in Iraq, but Star Wars weapons, represent weapons that don’t work against enemies that don’t exist. And if you waste money, that’s a bad thing. Keynes talked about digging holes and pump priming and argued that even that could be a benefit. But I think given the list of priorities that the country has, we have a lot better ways of spending money than this particular form of pump priming. And in fact, this particular form of pump priming doesn’t prime the pump very much. Because, as I argued in my paper on the Iraq war costs, the feedbacks of the re-expenditures don’t come back to American as strongly as other forms of expenditure.

The second proposition, illustrative of this general view, is that there are ways of changing our tax structure, raising taxes on upper-income individuals, lowering taxes on lower-income individuals, packages that could reduce the deficit and strengthen the macro economy. So, a redesign of our tax structure could accomplish several of the objectives that I have talked about earlier.

Now, behind what I’m saying right now is a view that the economy is potentially going through a difficult time. I think most people see the economy right now as being weak. The consensus forecasts are that growth in the United States will be slower this year than it was last year. And even conservative economists see a significant probability of a serious slowdown of the economy. Some people even see a recession. The mistakes in tax and monetary policy that we have made over the last six years are coming home to roost.

The mistaken tax policy, the tax cuts of 2001 and 2003, forced the burden of macroeconomic adjustment on monetary policy that led to low interest rates. Low interest rates did not lead to high levels of investments. The nation’s balance sheet in a sense was such that people took on more debt. But they didn’t spend that debt in productive real investments. In traditional monetary policy, lower interest rates lead to more investments.

So that while there’s more public debt, there’s also an increase on the asset side. In this particular case, what happened was that people refinanced their mortgages, took out larger mortgages. And it was the real estate sector, both directly and indirectly through refinancing of housing that provided a major stimulus to the economy that helped us to get out of the recession of 2001. But that has left a legacy of indebtedness. And it’s important in this not to look at average numbers, but the whole distribution.

And that we are now seeing real problems in the subprime sector. And it’s now reflecting in some other sectors that are also risky sectors of the mortgage market. Forecasts continue to be that private housing prices will decline. It will be difficult to sustain the economy. In other words, in the last couple of years, consumption has been sustained by people taking money out of their houses. With house prices going down, that’s going to be very difficult to continue, and let alone to increase in a way that would facilitate growth.

And that is one of the reasons that many people are pessimistic about the economy today. The problem is with that kind of weak economy, fiscal contraction – particularly poorly designed fiscal contraction – would exacerbate the problem and therefore risk the economy having a more significant slowdown than it otherwise would have had.

Now, that means we have to focus a great deal on managing aggregate demand and the difficult problem of rectifying the balances that we accumulated over the last six years. And there are ways of doing it. The example that I talked about before of redesigning our tax structure. We can redefine our tax structure in a way that would address the problem of the growing inequality in our society, stimulate the economy and reduce the deficit. But that will require careful modeling, careful analysis.

In 1993 at the beginning of the Clinton administration, we faced a problem of a very large deficit, much larger than today, and a weak economy. And we designed a package that had the effect of stimulating the economy. But we were very careful in designing the tax policies. We postponed the tax increases, most of the tax increases, until after the economy had recovered. And we focused what tax increases there were on upper income individuals so the impact would be minimal.

As another example, I think stronger expenditures on social programs – strengthened safety
nets, more provisions for unemployment insurance – could again enhance growth and stability and help the economy face the challenges of globalization.

Before talking about these challenges of globalization, I wanted to go back to the first point. I wanted to emphasize a little bit more on what deficits mean and why we shouldn’t focus on deficits themselves. What really matters is the country’s balance sheet, its assets and its liabilities. Consider a company. You would never say, oh, this company is borrowing a lot and therefore, it is a bad company. You would always say what is it borrowing for? Is it for investment? You want to look at both its assets and its liabilities. You want to look at its balance sheet.

And you might also want to look at some of these cash accounts. But you would certainly want to look at its balance sheet. Well, when we talk about the deficit, we’re talking about only one part of that balance sheet. We’re talking about what’s happening to the liabilities, what it owes, but not to what it’s spending the money on.

And if you are borrowing money, which the United States has done, to finance a war in Iraq or to finance a tax cut for upper-income Americans, then the country is being left worse off. The balance sheet does look worse. You have a liability, but you don’t have any asset on the other side. But if you are borrowing money to invest in education, technology, or, say, the safety net, then you may have a stronger economy. And this is particularly true when you’re facing the kind of problem that our economy is facing today.

Yesterday, I was talking to the former Finance Minister of Sweden. And Sweden has been one of the countries that has been most successful in facing the challenges of globalization. It’s a small economy, very open, with a significant manufacturing sector. In terms of some of the rhetoric that you hear in Washington and elsewhere, it should have been a disaster case. They have one of the highest tax rates. And it’s not only true in Sweden: Finland and all the other Scandinavian also have very high tax rates. If you only looked at tax rates, you would say these countries would be a disaster. And we had a discussion in which the view was that their success was in spite of. No, it’s not only in spite of, it was because of the high tax rates.

Why is that? It sounds counterintuitive. Well, the answer is it’s how the money is spent. Again, looking at both sides of the balance sheet. It was spent in ways that led to a stronger economy, enabling the economy to face some of the challenges of globalization. The net result of this is that, for instance, Sweden and the other Scandinavian countries do much better than the United States on broader measures of success like human development indicators that look at not just GDP per capita, but also look at health and longevity in terms of labor force participation. They’re doing very well. And they have a sense of social solidarity.

In a whole variety of indicators, they are doing not only well, but better than the United States. The United States has been, as I say, facing the big challenges of globalization and of inequality. Most of you know the data better than I do. That while US GDP has been growing, median income in the United States has been stagnating, actually going down in the most recent years. And people at the bottom, salaries have also been stagnating, not just recently but for a number of years.

Globalization necessitates people responding to change or moving from job-to-job. And in the Swedish model, they responded by providing for active labor policies and systems of social insurance that facilitate people moving from job-to-job and provide them with security. One of the aspects of success in a modern economy is willingness to undertake risk. And they would argue that because they have greater security, people are more willing to take risk. They’ve managed their macro economy to have full employment. But not only full employment at low, but full employment at high wages.

And so they have addressed a lot of the problems of insecurity, not perfectly but far better I think than the United States. And the result is, at least in many of the countries of Scandinavia, a much greater willingness to embrace change, the kinds of change that one needs in a dynamic economy.

All of this takes money. It doesn’t come free. How you finance that, whether you do it out of taxes or deficits, may be of second order importance. In the long run, obviously, things have to be paid for. Resources have to be paid for. But as Keynes said, in the long run we’re all dead. In the short run, we face a situation where we have the risk of a weak economy. And that short run context involves, a combination, I think, of a restructuring of our tax structure that would stimulate the economy more and provide greater equality to deal with the growing inequality that has faced the country over the last thirty years.

This would allow individuals to take more risk, invest more in education and technology, assisting active labor market policies that allow people to move from job-to-job. These kinds of comprehensive investment programs I think can provide the basis of a more dynamic economy that will in fact lead to, not only greater economic growth, but a more cohesive society.

Finally, let met just say a few words about a couple of the other issues that I think are areas that we need to spend more. And Henry’s going to talk to you more about health care. And I agree with everything he says. So I don’t want to repeat what he’s going to say. But let me just for matters of emphasis bring out a couple of points.

The first is that there has been a lot of misrepresentation of the nature of the problems that we face with an aging population. There was an attempt by President Bush to scare us about the problems of Social Security. The numbers did not reflect, I think the real nature of the risk. Obviously, there’s uncertainty. There’s uncertainty about all the parameters, about growth rates of the economy, growth rates of productivity, migration, all the numbers that go into forecasting a program that’s going to be going on for years in the future. And those inherently are difficult and uncertain numbers.

But two observations are worth making. The first is that the kinds of numbers that have been used to sell the tax cuts, optimistic rosy scenarios, are markedly different than some of the more pessimistic scenarios that are being used to say that we face a major problem of Social Security. For instance, some of my colleagues told me that if you just adjust the numbers on my migration and make the numbers of migration more realistic, the problems of the deficit and Social Security essentially go away.

The second thing is to put the numbers into perspective. Some of you may know the paper that I did on the cost of the Iraq war where we conservatively estimated the cost of the Iraq war between one and two trillion dollars. And that provides I think a new measure, a new metric, that I use for defining the magnitude of a problem. We could put Social Security on sound financial basis for the next 75 years for approximately somewhere between one-quarter to one-half of an Iraq war.

So if we can afford the Iraq war, what are we talking about a serious problem of financing, Social Security? It is a significantly smaller challenge. The health care most people think of is a more serious problem. But it’s a problem with our health care system as a whole, both public and private. And there are a couple of things within our health care system that we can do that would potentially address again a very significant fraction of the problem.

For instance, we are facing skyrocketing drug costs. And a few reforms, like allowing the government to bargain for prices and creating a pharmacology list of drugs that are more effective like Australia does, would do wonders in using drugs more effectively. So what we need here is social science innovation – not even innovation, to compare
with our innovation in our medical sciences – to figure out how to deliver the medicines in a way that is more efficient.

In general, the innovation system that we have for testing and making drugs is a very inefficient system based on monopoly and conflicts of interest, a variety of distortions, which lead to higher prices and I think less performance certainly per dollar spent.

A second observation is that practices, standard practices, on a large number of areas differ in various parts of the country. And in ways that are not really systematically related to outcome. And that at least suggests that if you switched from the most expensive to the least expensive practices that are consistent with equally good outcomes, there would be very large savings in costs that would help put the health care system on sound footing.

Now, the final challenge I wanted to just mention very briefly is climate change. I think the evidence that has come out this year has made it even more compelling than it was in the past. I was on the governmental panel of climate change in the 1995 review. And the evidence was overwhelming then. But we made a mistake. We did not expect, I think, it to play out as fast as it has. One of the aspects in which it’s come out much faster is, for instance, we didn’t anticipate the melting of the Arctic as rapidly.

I should tell a little story that I was in Davos where all the muckity mucks get together. And at a meeting session, oil executives were talking about climate change. And some of them were saying, you know, you guys are really looking at things in a very pessimistic way. You should look at the bright side of things. And what was that? And they said, well, because the Arctic ice cap is melting so fast, we will be able to get the oil underneath the Arctic sea at a much lower cost than previously we had calculated.

So there is a silver lining perhaps in every cloud. But the notion that it is clear that the accumulation of greenhouse gases in the atmosphere represent a significant risk. If we had many planets, we’d conduct an experiment on this planet and if it comes out the way that almost all the scientists are agreed will happen, we go onto the next one and say, well, we made a mistake. Too bad. That would be one thing. But the fact is we can’t go onto another planet. And if we make a mistake here, we have no alternative. And the consequences could be very severe.

It reminds me of a little joke that I heard about two planets actually going around and not bumping into each other, but coming close. And one of them was sighing, saying, you know, things are really terrible with all these humans, you know, the problems. And the other one that doesn’t have any problems said, don’t worry. It only lasts for a little while. And that sort of encapsulated the problem of global warming.

Some of the things we can do to deal with global warming will actually save us money. Getting rid of the energy subsidies that we have, including the depletion allowances that we have for oil, would save us money. The ethanol subsidies are outrageous. It almost costs as much in oil to get a gallon of ethanol, so the net output of that system is almost negative. We have a 50 cent tax on sugar-based ethanol, for instance, from Brazil. And we give a 50 cent subsidy to American corn-based ethanol. So we have an enormously distorted system. And getting rid of some of these distortions in energy would actually save us money.

But there are other things we will need to spend money on. We will need to spend money on a whole variety of technological innovations to address the challenges proposed by global warming. Research expenditures in this area have actually gone down in the last twenty years. So these are examples of things where we will need to spend money.

In short, what I wanted to say is just repeating what I said before: don’t just ever focus on the deficit. Look at the broader set of issues. Among the broader set of issues are where the economy is today? And the economy today, I think, has a certain degree of precariousness where unthoughtful deficit reduction could have adverse effects. I think there are ways of restructuring our tax structures that could stimulate the economy, address some of the most problems of growing and equality and reduce the deficit.

But more generally, there is a wide agenda facing our society, important priorities that need to be addressed that will require expenditures. And the value of spending has to be weighed against the cost of any deficit. I think there are lots of ways that we can cut expenditures, most importantly in the defense area. But if we fail to do that, it is still almost surely worthwhile spending money in these other areas even if it has some effect on the deficit.

Joseph Stiglitz is a Professor of Finance and Economics at Columbia University and was awarded the Nobel Prize in Economics in 2001.

[THIS WRITTEN TRANSCRIPT IS FROM BEYOND BALANCED BUDGET MANIA, AN AGENDA FOR SHARED PROSPERITY EVENT HELD ON APRIL 12, 2007.]

[POSTED TO VIEWPOINTS ON MAY 21, 2007.]