The economics of budget sequestration

Here is my latest New York Times column, on how we should deal with sequestration.  One theme is that, economically speaking, we really can get away with cutting our defense budget:

 In the short run, lower military spending would lower gross domestic product, because the workers and resources in those areas wouldn’t be immediately re-employed. Still, that wouldn’t mean lower living standards for ordinary Americans, because most military spending does not provide us with direct private consumption.

To be sure, lower military spending might bring future problems, like an erosion of the nation’s long-term global influence. But then we are back to standard foreign policy questions about how much to spend on the military — and the Keynesian argument is effectively off the table.

On a practical note, the military cuts would have to be defined relative to a baseline, which already specifies spending increases. So the “cuts” in the sequestration would still lead to higher nominal military spending and roughly flat inflation-adjusted spending across the next 10 years. That is hardly unilateral disarmament, given that the United States accounts for about half of global military spending. And in a time when some belt-tightening will undoubtedly be required, that seems a manageable degree of restraint.

When you hear talk of Keynesian arguments as applied to sequestration, don’t be so quick to aggregate the “G.”  The Keynesian argument, as well as some supply-side arguments, does apply however to infrastructure and also to the funding of basic scientific research.  The domestic half of the sequester should be redone to focus more tightly on farm subsidies and Medicare reimbursement rates:

 THE Keynesian argument suggests that spending cuts do the least harm in economic sectors where demand is high relative to supply. Thus, the obvious candidate for the domestic economy is health care, and the sequestration would cut many Medicare reimbursement rates by 2 percent. We could go ahead with those cuts or even deepen them, because America has had significant health care cost inflation for decades.

We already have huge demand in our health care system, along with a corresponding shortage of doctors. And the coverage extension in the Affordable Care Act will add to the strain. In this setting, cutting Medicare reimbursement rates wouldn’t result in fewer health care services over all. Yes, doctors might be less keen to serve Medicare patients but might be more available for others, including the poor and the young. In the long run, the improved access for those groups would yield much return on investment, and would move the health care system closer to many of the European models.

Of course that is unlikely to happen.  Here are some related points by Veronique de Rugy, which I found helpful for doing the piece.

I would view the sequestration as a kind of referendum on whether we are ever capable of cutting or restraining spending and I fear not.   When it comes to the defense budget, “gdp fetishism” suddenly makes a comeback.  Or sometimes I read or hear the argument: “let’s not do this, it is only a small nick in the budget deficit.”  That attitude is exactly the problem.  The point remains that the laws of opportunity cost still apply.  As David Brooks has noted, I am willing to live with the price of my house going down.


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