A scary graph from Goldman Sachs
Posted by Ezra Klein
on February 5, 2013 at 11:18 am
“On Friday,” writes Alec Phillips, an economist at Goldman Sachs, “we lowered our outlook for federal spending, to take into account the increased likelihood that cuts under sequestration take effect.”
With that built into their baseline, the cuts to federal consumption and investment look deep in the coming years. Here’s their graph, which adds a bit of historical perspective:
“Sequestration, spending caps, and reduced war spending will together reduce real federal consumption and gross investment by 11% over the next two years,” writes Phillips. Ouch. That’s a very big drop in a very weak economy.
“This is a large decline in historical context, but it is not without precedent,” Phillips continues. “This would mark the third decline in the last 50 years; the first occurred around 1970, after Vietnam War spending had peaked, followed by another around 1990 as military spending declined following the end of the Cold War and multiple rounds of spending caps were enacted.”
Even if there’s precedent for this kind of a drop, there are at least three reasons to be particularly concerned about it happening now. First, the previous periods of austerity that Phillips mentions were primarily driven by the end of major wars. That meant that a lot of that spending was not directly raising living standards in the United States, and so its absence didn’t have the kinds of consequences of, say, the sequester. Second, this graph misses the significant tax-side austerity we’re engaged in, with the expiration of the payroll tax cut and the high-income tax increases from the fiscal cliff deal serving as an additional drag on growth. And third, the economy remains unusually weak by historical standards, and this kind of fiscal drag is going to make it that much harder to recover.
Something to remember about the sequester is that part of the reason it was never supposed to happen is that it’s not backloaded. That is to say, where most deficit-reduction proposals have been structured to deliver their heavier cuts in years five-10, when the economy is further along in its recovery, the sequester’s cuts in year one are of the same magnitude as the cuts in year 10. That is to say, from the perspective of the recovery, it’s a particularly nasty and dumb approach to cutting spending.