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The Economy is Falling Further and Further Behind

by DEAN BAKER

Proponents of austerity both in the United States and Europe are eager to claim to success for their policies. In spite of economies that look awful by normal standards, austerity advocates are able to claim success for their policies by creating a new meaning for the word.

In Europe we have the bizarre story of both George Osborne, the UK’s chancellor of the exchequer, and Olli Rehn, the European Union’s commissioner for economic and monetary affairs, claiming success for their austerity policies based on one quarter of growth. Apparently, they are arguing that because their policies did not lead to a never-ending recession, they are a success. Remarkably, they seem very proud of this fact.

In the United States we were treated to the Wall Street Journal boasting of the success of the 2011 debt ceiling agreement on the eve of another standoff on the budget and the debt ceiling. The measure of success in this case appears to be that the sequester budget cuts put in place by the agreement are still in place and that the economy has not collapsed as a result. By this standard the WSJ has a case, but as with the austerity crew in Europe, this is a rather pathetic bar.

First, it is worth noting that many of the disaster warnings about the sequester from President Obama and the Democrats were grossly exaggerated. There was no plausible story in which cutting 5 percent of the discretionary portion of the federal budget would lead to imminent disaster. Most departments have some amount of reserves in various forms that they can tap into in order to minimize the impact of these cuts over a relatively short period. This meant nothing horrible happened when the sequester first began to bite on March 1.

However this doesn’t mean that the sequester is harmless. Suppose the 5 percent cutback rule was applied to any major corporation, even a highly profitable one such as Verizon or Apple. Surely these companies could find ways to reduce their operating expenses by 5 percent. They could put off hiring workers to fill vacancies. They may delay renovating office space. Perhaps they would freeze or cut some workers’ pay.

In the short-run there would probably be little change in the company’s ability to operate. After all, much of what they do is already baked into the cake. Verizon is going to be a huge and highly profitable wireless and phone company in 2013 and 2014 even if they cut back their marketing and don’t do proper maintenance and care for their network for six months or a year. In time of course the cutbacks will take a toll and likely lead to serious loss of market share and profits.

In the case of the federal government, we will see departments that are less able to do their jobs over time. This has been highlighted most clearly at the National Institutes of Health, where many promising lines of research were abandoned because of the sequester. But there will be similar stories in other departments.

Also, while kicking federal employees is apparently great sport for many, over time these people will look for other jobs and those who will replace them will likely be less qualified. Most people don’t want to work at a job where their pay and hours can be cut at any time for reasons that have nothing to do with their performance.

Employers in the private sector understand this fact even if it too complicated for members of Congress. This means that we can expect future government employees, like air traffic controllers, meat inspectors, and FBI agents, to be less qualified and committed than the current crew. The Wall Street Journal might think it some great victory that this deterioration has not been evident six months after the sequester, but people with more knowledge of the business world might be less impressed.

But the deterioration of government services might be the less important damage done by the sequester. The more visible and certain damage is the slower growth of the economy and higher unemployment.

Businesses hire people and undertake investment when they see demand for their product and/or have a new innovative idea. Outside of Wall Street Journal editorial page land, no business increases employment or undertakes investment because the government has laid off workers and cut back spending. This means that the government cutbacks directly reduce employment and curtail growth.

In the last two years, the government sector has shed 200,000 jobs. In a comparable period in the last recovery (August 2003 to August 2005) it added more than 300,000 jobs. This difference of 500,000 jobs would have a substantial impact on the labor market, especially when we consider that spending by these workers can be expected to increase the employment impact by at least 50 percent, bringing the total gain to 750,000 workers.

We can tell a similar story about growth, which has averaged just 2.2 percent over the last two years. This pace is less than most estimates of the economy’s potential growth rate, which means that rather than making up ground lost in the recession, we have been falling further behind the economy’s potential level of output. According to the Congressional Budget Office we are losing roughly $1 trillion in output a year because of the lack of demand in the economy.

So we know the sequester will give us deteriorating government services, higher unemployment, and slower economic growth. That’s the track record which prompts the Wall Street Journal’s boasts and advocacy of more austerity.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This essay originally ran in the Guardian.

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Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

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