Clinton was right to put the US back in the black
Diane Coyle on the battle to cut spending
Thursday 18 December 1997
The recovery from George Bush's pre-election blow-out, which took the deficit to 4.4 per cent of GDP, a whopping $330bn, in 1992, has been remarkable. While the two most recent Republican presidents, Ronald Reagan and George Bush, turned out to be about the most financially profligate in modern American history, Bill Clinton has certainly been the most responsible.
He has been helped by the remarkable US economic performance in the longest recovery since the war. Tax receipts have grown steadily with the economy, while demands for cyclical payments like unemployment benefit have fallen back. There has been extra help from special factors. For example, the government's healthcare bill has at last started to grow more slowly as increased competitive pressures with the spread of "managed care" has capped the expansion in Medicare and Medicaid outlays.
Even if the economy slows in 1998, as it almost certainly will, the budget deal struck between the President and Congress will keep the government's finances on an improving trend. The non-partisan Congressional Budget Office and Office of Management and Budget are likely to predict a small deficit next year, making cautious assumptions. But most Wall Street analysts expect a small surplus. Chase Securities, for example, predicts it will be $25bn in the black.
Some critics have despaired of President Clinton's adherence to financial orthodoxy, much as many Labour supporters criticise Gordon Brown for outdoing the Tories on tough public spending controls. For example, Robert Reich, the former US Labor Secretary, recalls his battles against budget cuts in his memoir of the first Clinton term. He could not see the virtues of reducing borrowing when there was a crying need for spending on the poor, on education, on public infrastructure. "Going into debt in order to help our people become better educated and more productive is entirely reasonable," he wrote in Locked in the Cabinet. "No sane business executive would fail to borrow money in order to make a profitable investment like this."
Mr Reich blamed Alan Greenspan, the Federal Reserve chairman, for persuading the President that a vote of confidence from the bond market, in the form of reduced long-term interest rates, would prove a reward that made it worth cutting spending on traditional Democrat programmes.
A famous remark from Mr Clinton's campaign director early in 1993, as the new administration got to grips with the economic realities after the inauguration, confirmed the Wall Street influence. James Carville said: "I used to think that if there was reincarnation I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody."
Was Mr Greenspan right? The move from huge deficit into budget surplus in the space of five years is one of those rare real-life experiments that will test the economic theory. According to the theory that has become orthodoxy around the world, the elimination of the deficit will have two beneficial results. One is that long-term interest rates should stay low, keeping the cost of borrowing for companies, consumers and home-buyers low too. This should help keep investment and consumer spending strong.
The other is that the reduction in the amount of private savings the government has to absorb by selling Treasury bonds in order to finance the deficit will release those savings for more productive investment.
There is another element in this equation, in the amount by which American spending on imports exceeds American incomes. This gap - the balance of payments deficit - is big and growing. It is eating into US national saving, with foreign capital plugging the gap. But even so, a lower government budget deficit should help improve both domestic saving and investment.
The government's reduced need to sell Treasury bonds should also have a supplementary consequence. For some time there has been concern that the Asian financial crisis will reduce foreigners' appetite to buy US government securities, triggering a fall in the bond market which could in turn undermine share prices.
A combination of higher long-term rates and a fall on Wall Street undermining the value of the now very common stock option schemes used to pay managers and professionals could make a serious dent in US growth. But if the government is actually repaying some debts next year, the bond market looks much less vulnerable.
Some economists are predicting that this is exactly what will happen. The yield on the benchmark long bond is near 6 per cent. Optimistic forecasts predict it will fall towards 5 per cent over the next year - and would be even lower but for the fear of an upturn in inflation.
But the Old Democrats, like Old Labour, would argue that this is not enough to justify the failure to spend adequately on social priorities like education and welfare reform. Mr Reich said precisely this on a recent visit to London, criticising the Fed for being over-zealous. US interest rates could be even lower without any risk of triggering inflation, he argued.
This overlooks two things. One is the market response to any perceived laxness on the Fed's part. If Mr Greenspan took short-term interest rates, which he can control, too low, long-term rates, which he cannot control, would rise. These have a much bigger influence on the demand for credit and the economy's growth.
There is also a subtler argument in favour of the orthodoxy. The American economy is in many ways returning to a performance last seen in the mid- 1960s. Low inflation, low unemployment, rapid job creation, a government budget more or less in balance. Economists see the 1960s as a golden age to which the industrialised nations have been unable to return. The fiscal and financial solidity of the economy, and the prosperity this generated, was what allowed the US to launch the Great Society and civil rights programmes.
Implementing political and social ideals does not come cheap and is never uncontroversial. It certainly cannot be done when a big deficit is forcing the government to penny-pinch. Critics of Gordon Brown's Iron Chancellorship like to compare him to the stern Stafford Cripps, forever associated - somewhat unfairly - with austerity and tough measures. It is more revealing to compare the strategy with Bill Clinton's, which will leave his successor as President the platform from which he can launch a more idealistic politics. Mr Brown just hopes to speed up the process and get to the launching pad in time for a second Labour term of office.
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