The Fiscal Debate Is Missing Half the Picture – An Economic Perspective

By / 5.20.2011

The following is an anonymous piece by an economist at an international financial institution. The views expressed here are solely those of the author.

Despite what politicians across the political spectrum will scream at you, the United States’ screwed up finances haven’t yet reached the level of an existential debt crisis.

To be clear, America must get its fiscal house in order, and ongoing debates and collaboration across the legislative and executive branches are important to righting America’s budgetary ship over the next few years. But let us dispel the notion that unduly draconian debt-reduction measures–that only touch the discretionary budget no less–must be enacted yesterday. Big picture reform of entitlement spending, increasing federal revenue, and scrutinizing the Pentagon’s budget must, and will, happen. However, the shrill, mostly right-wing political calls to cast ideologically-motivated yet relatively tiny budget cuts as the solution to a spending emergency will not solve the debt crisis and could create a culture that chokes off needed investment in critical areas. As any CEO will tell you, a certain level of borrowing to fund strategic investment is a critical component to reaping higher future returns. The same is true of public borrowing to support America’s long-term economic growth.

Here are three unique reasons why the U.S. continues to be in a position to borrow:

(1) Liquid financial markets and the reserve characteristics of the U.S. dollar create a nearly inexhaustible supply of creditors for our public debt. In plain English, this means that U.S. dollar assets are the safest global investment and savings vehicle and are easily accessible, keeping the federal government’s cost of borrowing relatively low (i.e., the US can harness global, not just national savings).

(2) Confidence in our monetary system to keep a lid on inflation will preserve U.S. Treasuries as desirable assets. Fear of inflation stoked by printing money to finance deficits is a primary fear of investors and not concern for the U.S. due to an independent Federal Reserve. The Fed appears to be aware and prepared for potential inflationary risks, and its track record, through several business cycles, has been praiseworthy as inflation, measured by the consumer price index, averaged 3.1 percent between 1982 and 2011.

(3) We are saving more domestically and could replace external demand for US dollar assets. A surprisingly large percentage of U.S. Treasuries remained in the hands of U.S. residents as of December 2010, and with the household savings rate doubling since its trough in 2005, the capacity to fund our public liabilities domestically will improve.

Long-term economic growth constraints erode debt sustainability in the US

The resulting ongoing and outlandishly panicked fiscal debate ignores a critical measurement of the nation’s economic health: our long-term economic growth potential. Not only is it a source of wealth and power, it is a major component of assessing our level of sustainable debt. Nominal economic growth – a function of increases to our stock of labor and capital — reflects a nation’s capacity to repay debt. When it is faster than the growth of new net borrowing then there is no problem. In other words, if your family’s income is growing faster than the amount you are borrowing, then your indebtedness is declining – a good thing! This is the dual assessment employed by international investors and rating agencies.

Borrowing to fund investment is critical to fostering future economic growth. By ignoring crucial investments in the nation’s stock of capital and labor, our politicians are mortgaging our future. Investment in public infrastructure, education, and immigration reform foster more rapid growth as they increase our stock of capital and labor, expanding economic capacity and productivity. By failing to be cognizant of the basic investment needs to maintain and expand our growth potential, our political leaders are just making political hay.

Hence, the fiscal debate on the Hill, which ignores economic growth potential, could ironically contribute to long-term market insecurity by raising our interest costs, and possibly lead to a greater debt crisis. What’s needed is a balanced approach, one that puts our long-term fiscal policy on a sustainable path through a combination of controlled spending, entitlement reform, revenue increases and with a contribution from the Pentagon, while committing to invest in our future.

Here are three critical areas of investment where the United States is failing to maximize growth potential by under-investing in capital stock and labor:

Public infrastructure: The United States’ capital stock is suffering from decades of neglect, increasing the cost of doing business and decreasing our competitiveness. The 2009 American Society of Civil Engineers infrastructure report card gave us a grade of “D”. Compared to some of our competitors — who are investing in high-speed rail, clean energy production, and smart grids – we may appear to be standing still. For example, Europe invests 5 percent of GDP in infrastructure while the United States spends less than 2.4 percent.


Educating our future workforce: Sadly, our secondary education system compares poorly internationally and, while our universities are the envy of the world, we manifest an artificial brain-drain as we expel U.S.-educated, non-citizens to the benefit of our international competitors. Our education system is one of the most expensive but yields only average results. According to the OECD, the United States spent 7.6 percent of GDP on all levels of education in 2007, almost 2 percentage points above the OECD average, but secondary and tertiary completion rates remained below the average of other advanced countries.

Immigration: Immigration reform can and should be viewed through this economic lens – we must create a reliable system of immigration to expand our future labor pool, increase economic growth, and produce the resources we need to help finance unfunded public liabilities.

Our political class will continue to yell at one another on CNN and Fox, but keep in mind that all spending is not the same, and that there are sound economic arguments to support crucial investment in these discreet areas for the long-term economic health of the country.