The economic consequences of the Covid-19 pandemic have been severe. The unemployment rate in the United States rose to 14,7% in April, the highest level in the country since the Great Depression when it peaked at over 25%. In contrast, the peak unemployment rate during the Great Recession was 10.6%. Clearly, these are pressing times for the economy.
In response to this unemployment crisis, the Federal government has taken dramatic steps to mitigate the impact of the soaring unemployment numbers. To date, there have been three bills passed by Congress and signed by the President to deal with the crisis.
The first was an $8 billion package passed in early March to directly deal with fighting the virus. It included funding for preparation to deal with the virus, to combat the spread of the virus, and funds to respond to the impact of the virus. This was followed with a $104 billion dollar package in mid-March to provide sick leave for those infected with the virus and paid family leave for workers impacted by the virus. However, the most important, broadest, and expensive of the bills passed was a $2 trillion relief package passed and signed into law at the end of March.
This bill provided $600 billion dollars in relief for individuals and families in the form of direct stimulus payments (up to $1200 per individual and $500 for each dependent child) and expanded unemployment benefits for those who lost their jobs (including independent contractors, free-lancers, and gig workers). The unemployment relief included an additional $600 payment on top of regular benefits. Corporations received $500 billion in assistance, small businesses $377 billion, State and local governments $340 billion, and public service entities like hospitals $180 billion.
The result has been a dramatic increase in the size of the Federal government deficit (the amount government spending exceeds tax receipts each year). With the addition of the stimulus spending, the government added $737 billion to the budget deficit in April alone. Prior to the crisis, it was projected the U.S. would have a $1.1 trillion deficit in 2020. As a result of the crisis (due to stimulus spending and the reduction in tax revenues due to unemployment), the deficit is now projected to be $3.8 trillion in 2020, an increase of $2.7 trillion.
Despite all this, there may well need to be additional aid provided by the Federal government to prevent a greater collapse in the economy. Most importantly, State and local governments are facing a fiscal crisis as the pandemic causes tax receipts to plummet and expenditures to rise. They are asking for Federal assistance to weather the crisis.
Republicans in Congress are increasingly arguing against additional Federal assistance. They point to the rising Federal deficit (the yearly increase in Federal government debt) and Federal debt (the total amount of money the Federal government owes) as reasons to halt further government assistance. According to Senate Majority Leader Mitch McConnell: “We can’t keep propping up the economy forever…We now have a national debt the size of our economy for the first time since World War II, and that is a matter of some concern….I think it’s also time to begin to think about the amount of debt we’re adding to our country and the future impact of that.”
Measuring the impact of deficits on the economy requires comparing the amount of the deficit relative to the size of the economy, i.e., Gross Domestic Product (GDP). A larger deficit has less impact on a bigger economy than a smaller economy. Likewise, a smaller deficit has more effect on a smaller economy than a larger economy. The table below shows the Federal Deficit as a percentage of GDP from 1900 to the present.
The peak of the deficit as a percentage of GDP was 26.9% in 1943 during the height of World War II. The previous high was during World War I when it reached nearly 17%. Since World War II, the highest it reached was 9.78% in 2009 as a result of the Great Recession. In 2019, the deficit stood at 4.49% of GDP. It is projected that as a result of the pandemic the deficit will reach 17.9% of GDP in 2020, the second highest in history. How much of a concern should this be?
The main question has to be why are we as nation borrowing all this money. During World War I and World War II, the argument was that it was worth incurring the debt to win the wars. So, is the increased deficit worth it to defeat the economic impact of the pandemic? Is it equivalent to winning a war?
According to President Trump, it certainly is. He said: “I do, I actually do, I’m looking at it that way. I look at it, I view it as, in a sense, a wartime president. I mean, that’s what we’re fighting.“ He continued: “To this day, nobody has ever seen anything like it, what they were able to do during World War II. Now it’s our time. We must sacrifice together, because we are all in this together, and we will come through together. It’s the invisible enemy. That’s always the toughest enemy, the invisible enemy.”
In this view, it is clear that Republicans in Congress would be derelict in their responsibilities to the country if they refuse to appropriate additional Federal spending to prevent economic collapse. In Trump’s view, it would be the equivalent of refusing to provide the funds to win World War I and World War II,
Also of concern is the total amount of debt (the sum of all the yearly deficits) the United States has. Again, to judge the impact of the debt on the country, we need to look at the amount of debt relative to the size of the economy. (This is analogous to looking at the amount of debt a person has relative to their income. The higher a person’s income, the more debt they can afford). The table below shows the history of the Federal debt as a percentage of GDP.
As shown in the chart, the debt has typically risen during times of war: immediately after the Revolutionary War, during the Civil War in the 1860’s, just prior to 1920 during World War I, and during World War II in the 1940’s. The one exception is the dramatic increase in debt as a result of the Reagan tax cuts in the 1980’s that began the process of re-establishing an Oligarchic Capitalist system.
As with the deficit, the peak of the Federal debt as a percentage of GDP occurred as a result of World War II, reaching 119% in 1946. It then fell during the 1950’s, 1960’s, and 1970′ throughout the period of Democratic Capitalism. With the election of Ronald Reagan in 1980 and the re-institution of a system of Oligarchic Capitalism, it began to rise, reaching 68% on the eve of the Great Recession in 2008. As a result of the Great Recession and the policies adopted to combat it, the debt as a percent of GDP reached 101% (equal to the size of the economy) in 2014. It than began to decline, but with the Trump tax cuts it reached 106% in 2019. It is projected that it will reach 110% as a result of the Covid-19 policies to save the economy. Should this be cause for concern?
As with the deficit, the question is what is the purpose of borrowing the money? Is it worth it for the country? In the case of the Trump tax cuts (which primarily benefited corporations and high-income/high-wealth individuals), the answer is probably not. In the case of spending to prevent economic collapse as a result of the pandemic, the answer is probably so.
Also, there is a question as to how well an economy can carry a debt load that is greater than the size of the economy itself. The answer lies in what the prospects are for the economy going forward. If the prospects are for further growth, then the debt can be more easily dealt with. If the prospects are for stagnation, the debt will become an increasing burden.
Below is a chart of the recent record of Japanese government debt as a percentage of GDP. It has been well over 200% (twice the size of Japanese GDP) over the last decade. While Japanese economic performance has not been outstanding, neither has it resulted in economic collapse.
The increase in the Federal government deficit and the rise in the debt will not lead to economic catastrophe. In fact, in the short-run, the increase in the deficit and the increase in the debt are necessary to prevent economic catastrophe. As discussed in my book, Capitalism, Socialism, and the Promise of Democracy, this is the fundamental lesson of Keynesian economics. In the long-run, however, both the debt and deficit need to be dealt with.
Again, Republicans in Congress would be derelict in their responsibilities to the American people if they did not approve further government spending to counter the negative economic impact of the pandemic and prevent economic collapse. However, more important questions are whether increasing the deficit is the only way to accomplish that and what needs to be done to deal with the debt and deficit in the long run. We could accomplish both the increase in government spending to prevent short-term economic collapse and also deal with the long-term objective of reducing both the deficit and debt by financing the increase in government spending, not by borrowing, but by an increase in taxes on higher-income/higher wealth households. In fact, it makes the most economic sense to do it. This will be the subject of my next post.
Do you think the Federal government should continue to increase spending to counter the economic effects of the pandemic?
