Most of the world's industrialized nations are experiencing ballooning public debt in the wake of the 2008 financial crash. The massive cost of propping up financial institutions was added to what was already a growing pile of debt. There are now calls from many quarters to reduce this debt by making drastic cuts in government expenditures. Not only would such cuts reduce social benefit programs, but the approach runs counter the the Keynesian notion that in a time of high unemployment the solution is more deficit spending to prime the pump of economic growth.
I am going to focus this diary on the US situation and its economic history. That is the primary interest for most of us on Daily Kos. I think that much of the economic principles involved are generally applicable to the situations in Europe and Japan.
When the Great Depression struck in 1929 the US had been following a decade of very conservative economic policy. The actual gross dollar value of the public debt had been reduced from what it was at the end of WWI. Hoover was unwilling to respond to the depression by doing anything that would add to that debt.
The response of FDR and the new deal was to engage in what was really a fairly modest level of deficit spending. By 1936 that had produced a stabilized situation, but not anything that could be characterized as a robust recovery. FDR decided to respond to Republican critics and cut back on spending. This resulted in a new recession in 1937. We can't know how long it would have taken to get the US economy out of the doldrums if WWII had not come along, but it did. The US government responded to the war by cranking its economy and industrial capacity up to maximum sustainable strength. This war was funded by massive deficit spending as immortalized in the celebrity war bond rallies.
I am getting historical data on debt and GDP from this source.
US Public Debt
In 1950 the US had public debt of $257B which was 94% of GDP. This was and was to remain for the next half century an historic high point. Tax rates were also at an all time high.
An important point to be grasped is that in practical terms we never really paid off this debt. Certainly Myrtle Jones who bought a 10 year $100 war bond in 1942 got interest payments for 10 years and her $100 of principal was returned in 1952. However the amount of debt on the books continued to grow. By 1960 the amount was $290B. Even when adjusted for inflation, this represents an increase in debt. But, what was happening was that during the 50s, despite a couple of mild recessions, the US economy continued a pattern of overall growth, Thus this $290B of debt represented only 56% of GDP.
The same overall pattern continued to 1980 and the beginning of the Regan years, when debt was $909B at 33% of GDP. We weren't paying off the debt. We were outgrowing it. One could make a pretty plausible argument that we were not spending beyond our means.
Ronnie Reagan's version of It's Morning In America brought us a new brand of conservatism. It favored tax cuts for the wealthy and loose regulations for industry, but unlike earlier conservatives they really didn't object to deficit spending. That made it possible for them to maintain government services and increase military spending while cutting taxes.
At this point the debt as a percentage of GDP begins to rise again. In 1990 $3.2T represented 56% of GDP. And so it went on through the years of Bush II. The US economy was generally following its pattern of post war growth, but public debt was growing faster than the economy. By 2007 we had a debt of almost $9T that was 66% of GDP.
The Obama administration took office faced with the worst economic recession since the Great Depression. However, unlike FDR and his new dealers they also faced a mountain of accumulated debt. Keynes developed his theories in a world that had long been under the control of traditionally conservative economists where there were low levels of public debt. He did not have to deal with the likes of Ronnie and GW.
In order to keep the Great Recession from turning into another Great Depression, the US and other governments have drastically increased the amount of public debt on the books. Much of this money went to bailout banks and other financial institutions. Current estimates are that at the end of 2010 US public debt will be $14.5T representing 98% of GDP. In short we are back where we were at the end of WWII.
The financial rescue has left us with an anemic and fragile economy. Claims of recovery are based on technical economic criteria rather than anything that is being experienced by average Americans. Unemployment remains seriously high and consumer spending which has always been the primary economic engine has yet to pick up.
This gives us a battle between the deficit hawks who are calling for spending cuts to reduce the debt and economic liberals who say that we need to prime the pump to get the economy growing again.
Paul Krugman is a neo-Keynesian liberal economist with whom I often agree. He has pointed to the post war pattern of out growing the debt rather than actually retiring it, and proposes such an approach for the future. That raises the important question of what can we expect in terms of growth for the US economy over the next 20, 30, 40, 50 years. Will it be like the last 50 years?
Nobody has a crystal ball. However, I think there are at least two reasons to question the assumption of indefinite future economic growth.
The first reason applies to all industrial economies. Economic growth has always entailed an increased consumption of natural resources. Demographic expansions are always an important component of growth. More people use more resources. The great post war growth of the US has been driven by the baby boom generation and their production and consumption. They are now reaching the age where the production is coming to an end.
The earth has its limits. It can hold a finite number of people. It has finite resources of energy, water and food production. The present oil crisis in the Gulf of Mexico offers dramatic illustration of the economic and environmental quandaries that we are facing. It certainly seems plausible that the increased economic and environmental costs of energy production are going to impose constraints on economic growth.
The second reason applies more specifically to the US. At the end of WWII we were in an historically unique position. We were the world's only fully functional industrial power. The war had shattered the infrastructure of all the others. That gave us a strong competitive advantage for about the next 25 years. That advantage has been gradually declining and the phenomenon of globalization has greatly altered out economic position in the world. Whatever happens in the midterm future, it seems very unlikely that we will return to the position of being king of the economic hill.
Thus in 2010 we are at a major fork in the economic road. Personally I place high value on concepts of economic justice and environmental sanity. A part of me calls for us to return to the values and vision of the new deal. Much was accomplished then of which we have a right to be proud. However, we face a very different world than FDR did in 1933. It is a lot more complicated than just a black and white tug of war between two opposing factions.