The Corner

Sequester Armageddon? Not So Much

As we are getting closer to March 1, the date on which the sequester cuts will start happening, the apocalyptic warnings from White House, various federal bureaucracies, and the various Washington lobbies (especially defense) are intensifying. I have said it before, but it bears repeating: Even if sequestration goes through, the Congressional Budget Office predicts that spending will continue to go up over the next ten years, from $3.538 trillion in FY 2012 to $5.939 trillion in FY 2023. Even given inflation and population growth, it’s hard to see these projections as reflective of devastating spending cuts. Also, in FY2023 will be back to running $1 trillion deficit. And that’s before our real fiscal troubles start.  

Also, as American Action Forum’s Doug Holtz-Eakin recently noted, the sequester’s $85 billion cuts are clearly small compared to a $3.6 trillion budget and a $16 trillion economy. “That’s a small cut in a huge pie,” he says. He also adds:

The economy is growing at about $630 billion per year. For the sequester to wipe out economic growth — as liberals are now implying — it would have to create roughly 7 times its size in economic impact . . . By the same logic, the stimulus would’ve added an additional 5.6 trillion in GDP. Perhaps if that had been true we would not be having this debate today.

Unfortunately, liberals aren’t the only ones making a Keynesian case against these cuts and their devastating impact on the economy. It has been pretty strange to hear so many Republicans make a John Maynard–style case against defense cuts, while they are happy to ridicule Democrats for suggesting government spending is a way to stimulate the economy. Apart from the hypocrisy of the tactic, the validity of the argument should be taken with a grain of salt.  

#more#For one thing, it assumes a large fiscal multiplier for spending. It also assumes that cuts in military spending have large costs that are not balanced out by any benefits — ever. In other words, it’s assuming no resources are freed up by defense cuts, engineers working for defense contractors in weapons programs don’t find new jobs working for the private sector, and capital doesn’t get reallocated in the longer run.

There are several problems with this view. First, there is no consensus among economists about the size and direction of the defense multiplier. If anything, the evidence suggests that, even in the short run, reductions in defense spending may actually grow the private sector at least slightly (even if the overall GDP may shrink). Moreover, even if the cuts have a negative impact on the economy, it will likely be mild and short-lived, as the effect of the cuts will be offset by increased output in other sectors as resources shift over the longer run.

Further, arguing that defense spending can and should be cut doesn’t mean one is demeaning the value of national security or denying the legitimacy of the federal government’s legitimate role in providing defense. Recognizing the value and legitimacy of defense doesn’t imply either that every dollar spent on defense increases actually increases security, nor that every cut in defense spending imperils our security. In fact, there is plenty of evidence that defense spending is often misallocated, and therefore inefficient. The many stories written over the years about cost overruns in the Pentagon’s weapon programs or other defense programs suggest to me that there is a lot of money that could be cut without jeopardizing America’s security, and, further, also casts some doubt on the assumption that cutting defense spending would have detrimental effects on the economy. 

Finally, we shouldn’t forget that defense spending has been cut dramatically in the past without any of the dire consequences with which we are threatened today. Take the 1990s: Both Bush and Clinton cut defense spending from $299.3 billion in 1990 to $265 billion in 1996 (and yet under sequester, defense spending will actually continue to grow). During that time, defense spending as a share of GDP fell from 5.2 percent to 3 percent. To be sure, part of this drop in the military’s share of GDP was due to the economic boom in the 1990s, which increased the denominator. But during that time, many hundreds of thousands of jobs, military and civilian, were lost in the defense industry and related businesses, and yet the overall economy grew. 

Some might call that example into question by noting that economy was doing great in the 1990s. So, then, what about the defense cuts that took place after World War II? A few years ago, David Henderson over at EconLog provided a great reminder of what Keynesian economists were saying about the economic effects of post-war reduced defense spending, demobilization of military forces, and transition of 10 million service men into the labor force. The famous economist Paul Samuelson, for instance, wrote in 1943:

When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs will be great. Nor will the technical necessity for reconversion necessarily generate much investment outlays in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the war is inescapable—were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties—then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

Samuelson goes on to suggest that this could be avoided if the government maintained wartime price controls, implemented “income maintenance in the form of dismissal pay for soldiers, unemployment compensation, direct work relied expenditure,” and started large-scale public works.

Yet Samuelson’s dire economic predictions never came to pass. As David Henderson explains, there was no dismissal pay for soldiers, direct price controls were actually removed relatively quickly, and as war production plunged, no massive public-works program was implemented. (While the G.I. Bill did help some soldiers transition off the unemployment rolls, at its peak only 800,000 veterans were college; most remained in the labor force.) Henderson writes:

Between FY1945 and FY1947, federal government was cut by 61 percent. This was a 27-percentage point drop from 41.9 percent of GDP to 14.7 percent of GDP. Yet the unemployment rate over that same time rose from 1.9 percent to only 3.6 percent. The postwar bust that so many Keynesians expected to happen never did.

Henderson has much more on the issue of WWII cuts here

Sequestration isn’t an ideal way to cut spending in general and defense spending in particular, but it beats the alternative of doing nothing at all. Better yet, there is plenty of evidence that the cuts are unlikely to have the devastating economic consequences that some fear they will have. 

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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