How do we grow out of the budget crisis?

Source: Early Retirement

The graph shows that the government debt problem started in the Reagan-GHW Bush years and grew again with the stimulus packages required by the recent financial crisis to avert a full depression. It is not now as bad as the debt crisis after World War II, which was resolved by the long term rapid economic growth through the 59s and 60s.

Of course we need some combination of tax increases (and/or reductions in tax expenditures) and reductions in government spending to stop making the hole deeper and to start climbing out of it. I would suggest that some of the tax breaks (such as tax deductions for interest on huge mortgages) should not only be eliminated to raise money but to correct errors in public policy.

However, we need also to grow the economy to get out of this problem and to improve the lives of Americans. Economists universally agree that government needs to assure good policies and good institutions to grow the economy. Economists agree that government should assure access to international markets while avoiding protection of domestic industries against the legitimate challenges of fair competition. The antithesis of good economic policy would be to fail to increase the debt ceiling (or even to threaten to do so) threatening the good faith and credit of the United States Government. More to the point, good institutions such as the rule of law, and good economic policies that reduce the uncertainties faced by investors and business managers are required. Given the drag on our economy of $4 per gallon gasoline prices and the periodic petroleum crises, not to mention the questions of electric power availability and costs, a good energy policy is increasingly seen as required by the economy.

The public sector also must provide public goods. Thus government must assure a good transportation and communications infrastructure, and provide for the common defense. On the other hand, spending huge amounts on unnecessary foreign wars or protection against imaginary or miniscule threats wastes money that could be used productively.

It is increasingly clear that the key to long term economic growth is a high rate of innovation. Government can encourage such a high rate of innovation by:

• supporting basic research
• encouraging innovation based on imported technologies in areas of U.S. comparative advantage
• tax financing of industrial research and development
• maintaining immigration policies encouraging the immigration of technological innovators and entrepreneurs, including scientists and engineers, and training of foreign graduate students in relevant fields
• maintaining good intellectual property rights policies, keeping up with changing technology opportunities
• assuring a strong workforce by good education policies, including both secondary and tertiary education.

Republicans and Democrats agree on the need to reduce government deficits and the importance of growing the economy. I hope to see the Congress and the Obama administration work out a good plan to do both. I suspect that such a plan would best be achieved as a compromise worked out using the best conservative and progressive principles. I fear that people from the extreme wings of the political parties will block such a solution by insisting on their view of the world, views not supported by the informed opinions of economists.