WASHINGTON — Republicans like to say that federal spending is “crowding out” investment by the private sector. That’s scary sounding, but it isn’t actually happening.
The notion that rising federal spending is hurting the private sector is a key part of the Republican argument in the current clash over the federal budget deficit. Republicans want to cut spending, not raise taxes, and argue that the spending by itself is dangerous.
House Speaker John Boehner, R-Ohio, argued in 2011 that government spending was “crowding out private investment and threatening the availability of capital” in the U.S. economy.
“If you allow these debts to continue to grow, they’d crowd out the private sector,” Rep. Kevin McCarthy, a California Republican who’s a member of his party’s leadership team in the House, said this week on NBC’s “Meet the Press.” “They’d crowd out the opportunity for small businesses to grow. That’s why the economy continues to linger.”
Yet while it’s true that federal deficits pose risks to the economy if left unattended and growing, there’s no sign that they’ve put a drag on the current economy. Most mainstream economists blame the impaired housing market and consumers paying off debt and building savings as factors that have dampened demand for goods and services in the economy.
“You would expect that if there were ‘crowding out,’ that the government borrowing is somehow competing with private-sector borrowing, you’d expect that to show up in interest rates, and it is not. They’re at rock bottom,” said Nariman Behravesh, chief economist for forecaster IHS Global Insight. “Is ‘crowding out’ a potential problem sometime in the future? Yes. Is it a problem right now? No, it is not.”
That view is shared by Scott Anderson, chief economist for Bank of the West in San Francisco.
“Deficits as a share of the U.S. economy have risen sharply at times with little to no discernible impact on the level of U.S. interest rates. In fact, just a cursory look at periods when the U.S. ran large deficits as a share of (the total economy) – 1983, 1991-92, 2008-2012 – we actually saw declines in nominal long-term (lending) rates,” said Anderson.
He noted that the yield, or return on investment for bondholders, has not and did not rise sharply. “So the link between high levels of government spending and borrowing does not appear to raise the cost of money during these periods and therefore would not crowd out private consumption and investment,” Anderson said.
When does “crowding out” occur? Economists think it happens when there are large deficits at a time of full employment and strong growth. That’s when the excessive government borrowing can discourage private investment and raise the cost of borrowing for consumers and businesses.
A real-world example of this would be China, where the economy is booming, yet lending rates are very high relative to the United States. In China, inefficient state-owned companies borrow heavily from state-owned banks.
“Small private companies are ‘crowded out’ from the Chinese credit market,” Behravesh said, suggesting that innovation and entrepreneurship associated with small business, both important ingredients for growth, are being held back.
Meanwhile, the United States has subpar growth and a 7.7 unemployment rate that hardly qualifies as full employment. Interest rates hover around historical lows while more than 12 million Americans were unemployed and another 8 million underemployed last month.
In a paper published by the National Bureau of Economic Research in April 2005, Columbia University economist R. Glenn Hubbard and Federal Reserve economist Eric Engen declared as “inconclusive” the link between government debt and interest rates. Hubbard headed George W. Bush’s White House Council of Economic Advisers from 2001 to 2003.
“While analysis of the effects of government debt on interest rates has been ongoing for more than two decades, there is little empirical consensus about the magnitude of the effect, and the difference in views held on this issue can be quite stark,” they wrote.
It’s not to say that deficits and debt couldn’t lead to a potential “crowding out” of private investment.
Economists who subscribe to the theories of David Ricardo, a classical economist from the late 1700s, think that large deficits don’t encourage private spending in the economy because consumers anticipate future tax hikes to pay for deficit reduction, and they save. Conversely, they also think that tax cuts amid high deficits would be at least partially saved instead of spent for the same reason.
“Is that (saving) happening? Maybe. I don’t see a lot of people saying that in various surveys,” said Behravesh. “There are certainly issues around the deficit and people worrying about will they have Social Security, will their benefits get cut, will their taxes be raised. That could be causing them to hold back.”
The latest data from the Employee Benefit Research Institute, released this week, found that 57 percent of workers surveyed reported $25,000 or less in retirement savings excluding their homes. Only 2 percent of active workers and 4 percent of retirees surveyed identified the need to save as their most pressing need.
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