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Tuesday, February 16, 2010

Penny Wise and Pound Foolish: Why Obama's Symbolic Spending Freeze May Grow the Deficit

With rising anxiety about mounting federal deficits, President Obama declared a freeze on all non-defense discretionary spending in his latest budget proposal. Heavy on symbolism and light on impact, the Administration's proposal attacks all of the areas of the government least responsible for the inexorable increase in federal deficits, while potentially starving key parts of the discretionary budget critical to America's economic prosperity.

Let's be clear: ballooning deficits do pose a real long-term threat to the United States' economic security. Under current forecasts, the accumulated deficit could total $20 trillion by 2020. That could hobble Uncle Sam with interest payments on the federal debt nearly as large as the projected total for all domestic discretionary spending. Efforts clearly must be taken to avoid such an unsustainable - and risky - financial future.

That said, curbing domestic spending is the wrong route to trim the deficit. The President's spending freeze applies to only a small fraction of the federal budget, while exempting both the mounting costs of two wars and the ever-rising bill for the nation's entitlement programs - Social Security, Medicare and Medicaid.

Together, defense spending and the three big entitlement programs account for roughly 60 percent of President Obama's $3.7 trillion FY2011 budget. Defense spending has soared 70 percent since 2001, in inflation-adjusted terms, reaching the highest level in post-World War II history. The Pentagon's $708 billion 2011 budget is now 23 percent higher than the peak of Regan-era Cold War military spending. At the same time, the steady rising costs of an aging population are projected to drive the price tag for entitlement programs alone to nearly half (46%) of the U.S. budget by 2020.

There is simply no route to a balanced budget without the hard work of serious entitlement reform, including efforts to control the rising costs of health care in America. Likewise, slashing domestic spending will do little to control the deficit without efforts to rein in defense spending, beginning with the responsible disengagement from the wars in Iraq and Afghanistan.

Without a growing economy, taming the deficit will prove impossible

Despite long-term deficit concerns, slashing federal spending or raising taxes in the short-term - e.g. while economic recovery is tenuous and unemployment still hovers near ten percent - would be tantamount to economic suicide. As long as the economy remains on shaky ground, real deficit-cutting efforts will effectively stay shackled; tax revenues will remain stagnant while efforts to trim spending or raise tax rates could send the economy tumbling back into recession. Thus, without a growing economy, taming the deficit will ultimately prove impossible.

As such, getting the budget back in the black has more to do with smart investments to ignite America's engines of economic growth than symbolic spending freezes. While Clinton-era deficit reduction efforts are often credited with taming the federal deficit in the 1990's, it was robust economic growth, largely driven by the long IT boom of the mid and late '90's, that did the lion's share of the work to turn deficits into the surpluses.

Along with real entitlement reform and winding down the wars, smart government investments in broad-based economic growth must therefore be the keystone of a three-part strategy to truly balance the federal budget.

Domestic spending freeze undermines critical investments in America's prosperity

That's where the pernicious potential of the new spending freeze becomes clear: the embrace of symbolic "restraint" on domestic spending could have a real impact on the Obama Administration's efforts to make critical investments in areas like infrastructure, education, and innovation, undermining precisely the efforts necessary to get America on the path to prosperity.

The IT boom that paved the way to America's return to fiscal health in the 1990's was in fact the result of precisely the kinds of federal investments that today's budgets threaten. For four decades after World War II, the federal government made enormous investments in research universities, national laboratories, communications and micro-processing technologies, and the necessary infrastructure to support the development and commercialization of information technologies that have transformed the American workplace, created entire new industries, and made the American economy the most productive in the world.

Yet even as these government investments were paying dividends and new technologies were in the process of remaking the American economy, the U.S. government was already in the process of weakening its commitment to the very innovation system that had made the IT revolution possible. In the 1980's, federal funding for education, infrastructure, and technology R&D was already on the decline, an overall trend that only continued through the Clinton and Bush years.

Thus, even as the economic boom associated with the IT revolution was eliminating deficits that at the beginning of the decade had appeared intractable, the U.S. government became complacent about precisely the kinds of public investments that catalyzed American innovation and prosperity. With the exception of bio-medical research, which saw big increases in the late 1990's and early 2000's, federal investment in America's innovation economy has stagnated over the last three decades. And without accelerated technological innovation and progress, America's prospects for real sustained economic growth are limited.

President Obama's first budget, and the stimulus passed by Congress last winter, offered some hope for a change in course. Spending on R&D, education, technology, and infrastructure was up. And to the President's credit, the proposed 2011 budget has preserved funding increases for many of these programs despite the proposed discretionary spending freeze. But if America hopes to catch the next technological wave and ride it to fiscal stability, it will have to invest much more in its innovation economy, returning to levels not seen since before 1980.

Case in point: investment needed to secure clean energy competitiveness

Energy is a case in point, although by no means an isolated one. While investing in clean energy, or any other particular sector of the economy, will not single-handedly cure America's economic ailments, new growth sectors with multi-trillion dollar potential don't grow on trees. Making investments now to catalyze competitive clean energy technologies and industries will pay big economic dividends down the line.

American policymakers would thus be foolish to ignore the economic potential of soaring global demand for clean energy in any serious strategy to get both the U.S. economy and the federal budget back on track.

Unfortunately for a cash-strapped America, in today's increasingly competitive global environment, securing market share and leading industries in the clean tech sector won't be possible on the cheap.

In his State of the Union, President Obama lamented, "There's no reason Europe or China should have the fastest trains, or the new factories that manufacture clean energy products."

On the one hand, President Obama is right; neither China nor the EU has some inherent competitive advantage in the clean tech field.

But the President is missing the very clear reason our Asian and European competitors are out-pacing the United States in clean tech: governments in Beijing, Tokyo, Seoul, and across the eurozone are all launching (or redoubling) comprehensive national clean energy strategies backed by big, long-term public investments to support each stage of the clean tech value chain.

Take China as an example, where both the Chinese central government and numerous provincial governments are together committing tens, if not hundreds of billions of dollars annually to secure competitive clean energy industries - and the jobs, tax revenues and export opportunities that go with them.

Carving out America's market share in the growing sector will similarly require both a focused national strategy and sustained public investment to support the key components of a competitive clean energy economy: robust clean energy innovation, manufacturing leadership, and strong and consistent market demand.

"I do not accept second place for the United States of America," President Obama boldly declared in his State of the Union. Yet when it comes to the race to harness clean energy growth, the United States will continue to languish in second place - or worse - as long as clean energy investment remains restrained by the Administration's spending freeze.

Real strategy to control the deficit requires long-term focus

In the end, there are no short-term, easy fixes to a problem as intractable as the soaring federal deficit. Nor will critical public investments in education, infrastructure, innovation, and competitive American industries pay huge dividends in the next budget cycle.

Rather, a real effort to put both the federal budget and the U.S. economy back on track will require an honest commitment to take up several hard tasks over the long-haul: bringing solvency to the nation's critical entitlement programs; reining in historically-high defense spending without imperiling the nation's security; and making a series of robust, sustained public investments that can put America back on the path to long-term, shared prosperity.

Jesse Jenkins is Director of Energy and Climate Policy at the Breakthrough Institute, and co-author of "Rising Tigers, Sleeping Giant," a major report on international clean tech competitiveness. Follow him on twitter @JesseJenkins

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