Why We Cannot Afford to Cut Domestic Spending in 2011

On the first day of 2011, Princeton economist Paul Krugman ran an eye-opening chart in his New York Times column, illustrating the relationship between economic growth and unemployment.

Krugman chart
The horizontal axis shows annual growth rates of real GDP [after adjusting for inflation]; the vertical axis shows the year-to-year change in the unemployment rate. “Two things are clear,” Krugman writes. “First, the economy has to grow around 2 1/2 percent per year just to keep unemployment from rising. [See the cluster of blue squares in the center of the chart where the change in unemployment ranges from 0 to -1% while GDP rises by at least 2.5%] Second, growth above that level leads to a less than one-for-one fall in unemployment, (because hours per worker rise, more people enter the work force, etc.). [People who have jobs are given more hours, and those who had given up looking for work, as well as recent graduates, join the work force.] Roughly, it takes two point-years of extra growth to reduce the unemployment rate by one point.”

When financial pundits talk about a “recovery” most mean that GDP growth will accelerate. But as Krugman points out, this does not translate into a commensurate fall in unemployment. He explains: “Suppose that US growth picks up. Even so, it will take years of high growth to get us back to anything resembling full employment. Put it this way: suppose that from here on out we average 4.5 percent growth, which is way above any forecast I’ve seen. Even at that rate, unemployment would be close to 8 percent at the end of 2012, and wouldn’t get below 6 percent until midway through Sarah Palin’s first term.” [No comment–MM]

Even If You Have A Job . . .

In 2011, even those who are employed cannot expect pay hikes that keep up with inflation. When the supply of workers exceeds demand, employers don’t feel any pressure to hand out raises. Yet, in the year ahead, many Americans will need a higher income just to run in place. The USDA predicts higher food prices in 2011, and the price of oil is already headed for $100 a barrel. (Joe Petrowski, chief executive of Gulf Oil and the Cumberland Gulf Group gives oil a 1 in 4 chance of reaching $147 a barrel by Memorial Day.) As the cost of food, utilities and transportation climb, middle-income and low-income families will feel the squeeze.

Meanwhile, health care inflation won’t begin to level off until health care reform has a chance to kick in, penalizing waste, while rewarding more efficient, higher quality care. Next year, insurers will be required to justify premium increases, but as long as the volume of unnecessary tests and surgeries grows, year after year, premiums will continue to soar, in tandem with medical bills. (See my post on overuse of stents here, and Naomi’s post on spinal surgery here.) It is also worth noting that, in California, the cost of a hospital stay has been rising by 10% a year.

If regulators put pressure on insurers, they may, in turn, question unnecessary procedures. And as Medicare changes how it pays for care, insisting on better outcomes, pointless surgeries will become less profitable. But this will take time.

Finally, thanks to the tax cut compromise that I wrote about earlier this month, the deficit will balloon in the years ahead. This, in turn, will weaken the dollar, lifting the cost of imports. The bottom line: wages will remain more or less flat, and the purchasing power of most paychecks will fall.

If you read the mainstream press, no doubt you have heard that next year, the economy will be perking up. But to most financial pundits, “recovery” means that the economy is growing, and that Wall Street investors are reaping profits. (Next year, financial gurus expect that commodities and stocks will climb, though Treasury prices are likely to fall—bad news for seniors who depend on fixed-income investments.)

But on Main Street the recession will continue. The official jobless rate may slip a bit, but real unemployment will remain high as the number of workers who have given up looking for work and no longer qualify for unemployment benefits swells. Both middle-class families and seniors living on a fixed income will need all of the help that the government can provide. If Washington fails them by trimming spending on domestic programs, unemployment benefits and so-called “entitlements” (Medicare, Medicaid, SCHIP or Social Security), more and more Americans will find themselves losing their footing on a slippery economic ladder. This is a pattern that we have seen unfold over the past 20 years: While some in the upper-middle-class slip into the middle-class, families in the middle-class become working-class, the working class become poor, and the poor become homeless. This is how the number of children living in poverty has grown, while the middle-class shrinks, and the upper-middle-class becomes increasingly insecure. What economists who came of age on Wall Street don’t seem to understand is that, over time, a recession on Main Street will catch up with Wall Street—and Washington. I’m afraid that Paul Krugman is only half-kidding when he refers to “Sarah Palin’s first term.”

15 thoughts on “Why We Cannot Afford to Cut Domestic Spending in 2011

  1. Yep, I agree Maggie. This is what a depression feels like at the start. One thing you don’t take into account is that we may encounter some unexpected calamity, natural or man made, and then things really drop off the cliff.
    I am very concerned, as it seems so are you.

  2. The charade of overwhelming debt, which the repubs are purposely inflating to kill government safety and security programs, must be exposed and become the new mantra for progressives if they want to prevent this social clamity.

  3. I don’t think that any of the republocrats are that smart or evil. I have been devotely non (or is it anti) partisan for as long as I can remember, There is enough blame to go around to both political parties and the rest of us too.
    I think for far too many years far too many of our elected officials have just been doing whatever it seems individually best for each one to get elected and reelected to walk down marbled floors on red carpets into guilded ballrooms and boardrooms.
    Power corrupts and the elite have entrenched themselves. As sad as it may be, it could be a collapse is the only way to get to a place where problems can be solved.
    I certainly hope that isn’t the case.
    I have the luxury of having a number of older folks as mentors and friends (the 70 to 90 year old set). I have been asking them the same question over the last month, “Are things worse than they have been in the past?” To a person, they say no its not worse, its really all the same as it has been.
    So perhaps that is a hopeful sign that a real collapse is not right around the corner.

  4. A bit off topic, but have you any reaction to the Scott-Wyden proposal?
    http://www.washingtonpost.com/wp-dyn/content/article/2010/12/28/AR2010122804150.html
    “In short, the legislation would allow states to opt out of the federal health law in 2014 instead of 2017, provided they meet minimum coverage benchmarks. The argument, Wyden said, is that the bill would give both conservatives and liberals a chance to prove their theories on how best to run health care. Conservative-leaning states antagonistic to the bill’s individual mandate provisions can try more market-based models. And the more liberal states that considered the overhaul insufficiently bold can give the public option a shot.”

  5. Ng, John, Joe Says . . .
    ng–I totally agree.
    Progressives must get the message out, explaining how conservatives who insisted on extending tax cuts for the very, very wealthy (both income tax cuts and additional cuts in inheritance taxes) have caused the deficit to balloon.
    Now, they want to cut corporate taxes.
    They pretend that they care about the deficit but the fact is that they are willing to drive the economy to the very edge of the cliff in hopes that this will help them achieve what they have declared is their primary goal: to make sure that Obama is not re-elected.
    John–
    The idea of letting states decide whether or not they want to enforce the individual mandate is an unworkable idea.
    In states that have no mandate insurers could not be required to cover people
    suffering from pre-existing conditions without charging them exorbitant rates. (If there is no mandate, but insurers are required to cover sick people without charging them more, many people would wait until they become sick before buying insurance. This means that a disproportionate share of people in the insurance pool woudld be very sick (while wealthy,healthy people stayed outside of the pool, secure in the knowledge that if they become sick, they will be able to get insurance at a reasonable rate.).
    This would mean that in states that had no mandate, premiums will be much, much higher.
    If your child had cancer, you knew you had to have insurance and lived in such a state, what would you do? Logically, you would move to a state where there is a mandate, where premiums are lower (because everyone, young and healthy as well as sick and poor are in the same pool) and where insurers are required to cover your child at the same rate as other people”s children, even though she is suffering from cancer.
    Assuming Texas decided not to have a mandate, sick people would move to New Mexico–driving up rates in New Mexico.
    The mandate is something that has to be applied nationwide, or it won’t work.
    Thanks for the link to the Washington Post story. It makes it pretty clear that Wyden is backing this idea purely for pragmatic political reasons– he needs Republican (bipartisan) suppport.
    The good news is that I am convinced that the mandate will not be overturned. I guess I should write a post about this–I’ve written about it in comments.
    The media has inflated the importance of the Virginia ruling–igoring the many courts (12, if memory serves) that have refused to even hear the case. The constitutional argument is very, very weak.
    But for the media this is a story like “Tornado Heads for Manattan.” If you have any sense, you know that the chances that it will happen are slim to none. But the media will get as much mileage out of it as they can –until it doesn’t happen.
    Finally, one of hte biggest problems with our health care system is that it is so fragmented. The last thing we need is 50 different systems in 50 states. As for “state’s rights” that was always the argument used to support segregation and opposition to civil rights legislation.
    The very same states would like to avoid the mandate . .
    Joe Says–
    The opinion of a half dozen or even a dozen people doesn’t override the facts (no matter how old they are). You’ll find the facts in the numbers: the history of median salaries, the growing gap between the rich, the middle-class and the poor, the eye–popping rise in the percentage of wealth owned by the top 1%, the sharp climb in the percentage of U.S. children who live in poverty . . . .
    I could go on.
    Things have changed–greatly. Just read history and look at the numbers.

  6. What caught my eye was “more liberal states that considered the overhaul insufficiently bold can give the public option a shot” and “opt out of the federal health law in 2014 instead of 2017, provided they meet minimum coverage benchmarks.”
    I’m confused.
    Does PPACA allow states to ‘opt out’ after 2017?
    And does it still contain provisions for ‘public options’ at the state level?
    Does this mean that a state-level public option would amount to a single-payer system for states?
    (And how does MA puzzle into all this? They have something called Commonwealth Care which I presume is a euphemism for Medicare.)
    And thanks for patiently responding to comments. So few writers do.

  7. Many people maintain that the very spending that you advocate is directly causing the inflationary pressure that you bemoan.
    It is also worth pointing out that high(er) inflation is almost always accompanied with high(er) interest rates. This discourages investment and makes it more expensive for businesses to expand.
    Conclusion: reducing domestic spending will keep inflation down, preserve the purchasing power of the dollar, speed the recovery, and lower unemployment.

  8. John, Pipster . .
    John–
    First, you’re very welcome. You ask thoughtful questions, so while responding to you, I feel I’m also expanding the information in the post for others.
    Yes, the legislation does let states opt out after 2017. (I forget the exact details.) But there are so many things in the Affordable Care Act that people will like (the subsidies, no co-pays for preventive care, insurers cannot deny people with pre-existing conditoins or cap either annual or lifetime payouts, closing the donut hole for seniors, the fact that 20-somethings will be able to be covered on their parents’ insurance)
    that if a state tried to opt out in 2017, it would probably face real opposition from the majority of the public.
    The is why the legislation says that states can opt out– legislators who understood and supported the bill were pretty confident that after experiencing 3 years of full health care reform, (2014-2017) people will not want to give it up.
    I don’t think there is any provision for individual states creating a public option.
    If they did, it would probably be somewhat less expensive–which might mean that some people would move from a state that didn’t have a public option to one that did. (At one point, the Commonwealth Fund suggested that while a family plan under private insurers would cost roughly $13,000, a public option plan might cost $1,000 to $1,500 less. )
    Things are going to get messy if different states have very different versions of health reform . . (The system is already fragmented).
    But as I have said in the past, I think we’ll wind up with a public option nationwide–probably before 2014.
    Under reform, insurers are going to be regulated to a degree that many will feel they can’t make the profits their shareholders expect. So they’ll get out of the health insurance business.
    (Wall Street is expecting this. Moody’s has already downgraded the entire health insurance sector.)
    We’ll wind up with many fewer insurers.
    Meanwhile, under the reform legislation, consumers are supposed to be able to choose between 2 or more insurers in each state. There may not be 2 private sector insurers operating in every state (particularly poorer states with more sick people.–Alabama, etc.)
    Thus, I think the public option will be revived. Obama is already talking about it. This would be an excellent talking point for liberals in the 2012 elections, and could help them get elected. If they were elected, I’m quite sure that they would bring the public option back.
    pipster–
    If you read Bloomberg and other financial news sources, you will find that the consensus is that the Fed’s actions (printing money) will lead to higher rates.
    As we print more and more dollars, their value falls.
    If we want foreign investors to continue buying our Treasuries (denominated in dollars), at some point we’re going to have to hike the interest rates that we pay on those Treasuries.
    The notion that government spending leads to inflation is an old one that goes back to Republican/Democratic debates in the 1960s and 1970s.
    The Republicans always worried about inflation. The Democrats worried about unemployment–and supported the idea of the government creating jobs that would provide needed services.
    The 1990s proved that you can have BOTH low inflation and low unemployment simultaneously. We don’t have to resign ourselves to 17% unemployment (the real unemployment rate at this time.)
    We can’t afford to have government wasting money (overpaying private contractors providing services in Iraq) but we will all benefit if govt creates jobs by investing in smaller class sizes in our schools, repairing bridges and roads that desperately need repair,
    the environment, etc.

  9. It’s interesting that you think Republicans want to run us off a cliff just so Obama doesn’t get reelected. So does that mean you were rooting for a continued housing and banking meltdown before the election in 08, so Obama would have a better chance of being elected. That or rooting like Harry Reid for increased American military deaths due to the surge to help them politically in the 06 elections. I’d be wary of determining motivations of people you oppose, they can do the same back at you.

  10. Jagna–
    Of course I wasn’t “rtoing for” an economcie meltdown, or more military deaths.
    My son-in-law is an Army officer and going to the Middle Est next year. I love him very much.
    I would be very interested in seeing your evidence that Harry Reid said that he was hoping for more military deaths.

  11. I’m not a fan of the healthcare legislation (at least on the financing side) because it doesn’t go far enough. However, the fact is that in the November election, about 95% of the members of the House Progressive Caucus were reelected (most of them voted for the bill after opposing it), while very few of the Blue Dog Democrats, all of whom voted against it, were reelected.

  12. Then why do you think republicans want to “run us off a cliff” on purpose? When you question someone’s motivation, they can question yours.
    My brother was running around Camp Anaconda in 2007, when Reid muttered the infamous “the War is lost” line. To a man every person in his unit was disgusted. It said to them he doesnt give a crap about the job they were doing and their lives were nothing but politics to him.

  13. Jenga, ACarroll
    My son-in-law (who has been in the military for a long time) could have told you that the war was lost before it began.
    The “West Pointers” who are his friends agreed. When the war began, they were not at all enthusiastic. They all have read history–including the history of Vietnam.
    They blame Cheney and Rumsfeld, who they say, viewed Iraq as a “board game”–and they were the pawns.
    This is not an internatinoal affairs blog–and I don’t plan to comment further on the war. But I also don’t want anyone to be left with the impression that Harry Reid wished for military deaths.
    When you realize that a war is lost, you get out–as safely as possible. You dont’ keep sending young men and women into the futile war for another 4 years.
    Btw, I’d love to see a list of Republican Congresspeople who sent their own children into Iraq (not just into the military–but specifically into Iraq.)
    ACarroll–
    Interesting point about the re-election of the progressives.
    I think it’s clear to most people that the Democrats lost in the fall because:
    1) this is what usually happens in the midterm election during a president’s first term (his party loses because people blame the president for not having fixed all of the problems that he said he would fix in the first two years.)
    2) with unemployment close to record highs, voters were bound to vote against the party that controls both Congress and the White House. (Most people just don’t realize how long it takes to turn unemployment around. See Paul Krugman’s chart in my recent post.)
    3) the president and his economic advisers failed to recognize just how serious our economic problems are. They have consistently over-estimated how quickly recovery would come–and how strong it would be.
    That undermines trust.
    This is what voters where thinking about when they went to the polls in the fall– the economy and jobs.
    The election was not a referendum on health care reform, which is why House progressives who voted for reform were not punished, and blue dogs who voted against it were not rewarded.
    Finally, I agree that the financing of health care reform doesn’t go far enough. But if you read the legislation carefully, you see that it opens a great many doors for cutting spending. There are all of those sentences in the legislation which begin “The Secretary of Health and Human Services may . . .”
    I’ll be writing more abbout this as I complete my three-part post on “How the Afford Care Act Pays for Itself, Reduces the Deficit, etc. . .
    The progressives who supported reform legislation had two choices: try to win on every important point –and fail to pass any legislation– or win as much as they could on as many points as possible–with the goal of passing legislation which represents “a good beginning.”
    As I keep saying, major reform is a process, not an event.
    Given the fact that this is an extremely conservative/centrist Congress with only a sprinkling of truly left-of-center reformers, I’m impressed that the legislation is as good as it is.
    And the opposition was so extreme. I’ve never seen such a conservative Republican party–though I’m too young to remember the McCarthy period. . .
    Prediction: if the Democrats manage to hold onto the White House and the Senate in 2012, we will have a public option by 2014, if not earlier.
    (Many private sector insurers will have gotten out of the business, leaving a void that will need to be filled.)
    By 2015, I also predict that Medicare will be negotiating for better prices on drugs and devices–and that Medicare will refusing to pay full price for drugs and devices that are not more effective (for patients who fit a particular profile) than rival treatments.
    I also expect a real crack-down on drug-makers and device-makers that pay kickbacks to physicians (see my next post) and I expect that brand-name hospitals will find it much harder to overcharge
    for basic services
    This is the only way that we can really “break the curve” of health care inflation, and, over time, perhaps bring the cost of care down to a lower percentage of GDP.

  14. Maggie writes: You’ll find the facts in the numbers: the history of median salaries, the growing gap between the rich, the middle-class and the poor, the eye–popping rise in the percentage of wealth owned by the top 1%, the sharp climb in the percentage of U.S. children who live in poverty . . . .
    Joe Says: I’m not sure that monetary comparisons are what I was thinking or that they are generally all that important to most of the folks I talk to. They care more about happiness, which can often relate in an opposite fashion as wealth at some point.

  15. I’m sure you guys didnt want to decrease domestic spending either when the economy was on fire in the late 1990s. I’m sure you all spouted a bunch of sob stories about how there are still people “left behind” who need govt support.
    The bottom line is that if you are predisposed to looking for a reason for the fed govt to spend money on domestic issues, you are ALWAYS going to find one.
    Even if our GDP grows at double digit rates and our unemployment rate falls to 0.1%; the instant that anybody proposes cutting back on spending will bring a wail of anger about how there are poor children out there who need help, poor elderly widowers who cant get buy without a govt check, etc
    You are all disingenuous — in your eyes there is NEVER a “good” time to cut back on spending.