What If the Economy Doesn’t Recover?

by Reihan Salam

Ezra Klein asks an important question about Bowles-Simpson:

Simpson and Bowles start their cuts in 2012, as they assume the economy will have recovered by then. But what if it hasn’t? A better approach would’ve been using an economic indicator as a trigger. For instance, we could’ve held stimulative measures like unemployment insurance and a payroll-tax cut until the unemployment rate dipped to 6.5 percent and then, when that milestone was hit, moved to austerity. As it is, there’s no real guarantee we’ll be recovered by 2012, and if we’re not, then we shouldn’t start cutting.

I raised a similar issue with regards to PPACA a few weeks ago:

 

As I understand it, the CBO used the economic forecast and technical assumptions in its March 2009 baseline to model the impact of PPACA on the federal budget. And the CBO is assuming that the U.S. economy will reach full employment relatively quickly, as you can see in Table 2-1. The assumption is that unemployment will average 9% this year, 7.7% next year, and 5.6% over the years 2012 to 2015 and 4.8% between 2016 and 2019.

But what if unemployment is in fact higher, as Shierholz fears? Tight labor markets as projected by the CBO would presumably contain the cost of the new health entitlement set to kick off in 2014. If labor markets are not tight — if unemployment above 6% or even above 7% persists for a longer period of time — the cost of PPACA will rapidly spiral, and the revenue projections under the CBO’s model will presumably prove overly optimistic. By how much I can’t say, but surely this is something we need to know. 

Remember that if the cost of PPACA does spiral, the federal government will need to raise taxes, and not just on the rich, to meet this new obligation. 

One could make the case that this is immaterial: while higher unemployment would mean that PPACA would prove far more expensive than the CBO projected during the health reform debate, we’d nevertheless be doing a good and important thing by expanding insurance coverage regardless of cost. Yet it’s not clear to me that the public would have backed legislation with a far higher price tag if we assume, as is not unreasonable, a challenging economic climate. Indeed, a better sense of PPACA’s cost under less-than-rosy assumptions might have yielded pressure for a more cost-effective approach to expanding coverage, whether from the left or from the right. 

But one could also that imposing spending discipline on the public sector has a wide range of benefits. If the U.S. public sector were as cost-effective as that of Singapore or Switzerland or Canada, we’d be much better off without increasing the U.S. spending burden:

According to the World Economic Forum’s GCR, the U.S. is ranked 68th in the world in terms of wastefulness of public spending. That is, 67 of the 139 countries in the index are doing a better job of channeling public dollars into productive activities, including Singapore, Rwanda, and Qatar at the top of the list and Australia, New Zealand, and Canada among our large English-speaking peers. Not surprisingly, to those of us who follow work on the quality and cost-effectiveness of public spending across countries, the northern European market democracies perform well, with Sweden at 12, Finland at 14, Denmark at 16, and Norway at 20. Switzerland is at 9, Holland is at 17, Germany is at 33.

Many argue that the “federal pay freeze” — it is a temporary freeze on cost of living adjustments, but of course federal employees will continue to receive step increases according to seniority and promotions. As Andrew Biggs and Jason Richwine observed in September, promotions happen at a faster clip in the federal workforce than in the private sector:

 

Each year a bureaucratic entity called the President’s Pay Agent compares public and private sector wages in various occupations and at different levels of responsibility. The answer is that, on average, federal positions pay 22 percent less.

But this does not mean federal employees earn less than they could in the private sector. The reason is that the federal government promotes employees to higher positions than they would hold in the private sector.

For instance, a senior accountant in government might qualify only as a junior accountant in the private sector. This senior accountant would be “underpaid” compared to private sector employees only because he is under-qualified by private sector standards.

All that said, I certainly think it is very sensible for advocates on the left to insist that the federal pay freeze is a draconian measure, as it makes other structural reforms more politically difficult to achieve.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.