To Create Jobs, the U.S. Must Spend

The deficit has arguably gained the distinction of being the single most widely misunderstood public policy issue in America. Just 6 percent (6!) of respondents in a recent poll correctly stated that it had been shrinking, which has in fact been the case for several years, while 10 times more, 62 percent, wrongly believed that it’s been getting bigger.

Despite prevailing notions in the capital and throughout the nation, those of us at the Levy Economics Institute — along with many other analysts and economists — have concluded that the deficit should be increased.

Why add to the deficit right now? Jobs. Our economic models clearly show that without increased government outlays we’ll be unable to generate enough GDP growth to seriously attack unemployment. If we tried to balance the budget through tax hikes, our still-recovering economy would be hurt. That leaves a temporarily bigger deficit as an important option.

A mutation in the link between growth and jobs makes the issue urgent. While we are seeing some economic growth, the unemployment rate is not responding as strongly to the gains as it did in the past.

This slow job growth — today’s “jobless recovery” — isn’t an outlier. It’s a phenomenon that has been increasing over the last three decades, with jobs coming back more and more slowly after a downturn, even when GDP is increasing. The weak employment response has been an almost straight-line trend for more than 30 years.

Our institute’s newest econometric models show that each 1 percent boost in the GDP today will create, roughly, only a third as much improvement to the unemployment rate as the same 1 percent rise did in the late 1970s.

Traditionally, we’ve assumed that GDP growth would be followed by an employment surge. The break in that link is now very clear. It’s especially worrisome this year, with only a small GDP rise universally anticipated.

The Federal Reserve, for one, just reduced its growth outlook to 2.8 percent at most for 2013. The shallow recovery we’re seeing may indeed continue through 2014 and beyond. Since employment now consistently lags well behind GDP, we’ll have a long slog before we reach pre-crisis unemployment levels (below 4.6 percent). Some Federal Reserve officials believe it might take three years just to get from today’s 7.6 percent down to 6.5 percent. Full employment would still be nowhere in sight.

The quantitative data are telling us that without a stimulus, we can’t expect a strong employment lift. But instead of stimulus, we’re devising federal budgets that cut spending and lay off workers. The sequester is expected to depress GDP growth by perhaps half a percentage point — when we know that more growth than ever will be needed to raise employment — and cost anywhere from 700,000 to more than 1 million jobs.

Slower government spending is one reason that post-recession growth has been below par compared with other recoveries, Fed Vice Chair Janet Yellen has argued. As government outlays and employment have shrunk, the contribution of public funds to national growth has also fallen. By our estimates, that contribution now stands at about zero. That’s another data point indicating that federal deficits need to be increased.

To better understand the changing relationship between growth and jobs, the Levy Institute recently looked at three scenarios through 2016: what the results might be of a small, medium or large stimulus. A strong stimulus was clearly the most effective option, since it had a powerful, positive influence on employment growth and, in the long term, on deficit reduction. Of course, that route is completely unfeasible in the current political climate. But we saw that even a small amount of deficit spending could help put the recovery on track if it were combined with a mix of private investment, increased exports and good policy alternatives.

That points toward a way forward. Increasing the deficit while our economy is fragile is not “pro deficit,” any more than a family with a 30-year home mortgage is “pro debt.” To reclaim a phrase that deficit hawks have tried to make their own, it is “sensible and serious.” The federal government can run a deficit, as it almost always has, to help the nation return to prosperity.

With our new understanding of the fraying tie between GDP growth and jobs, we know that millions of Americans are on course for an agonizingly slow march out of joblessness unless we make a move. The nature of slumps and recoveries has changed, and the policies to manage them need to change too.

This article appeared in print on page 12 of the April 9th, 2013 edition of Hamodia.