U.S. Austerity Won't Be Pleasant

The U.S. will derive no short-term benefit from immediate spending cuts. Investors are not calling for cuts in the near-term; indeed, the demand for Treasuries remains very high and yields are very low. As a result, short-term austerity won't help the U.S.'s financial situation. The money that is used to pay down debt will merely be extracted from the U.S. economy, whether through spending cuts or tax hikes. In either case, we'll have less economic activity, fewer jobs created, and weaker growth.

That matters a lot more now than it would if unemployment was 6% and GDP growth exceeded 4%. Currently, growth and hiring are both trending down. The potential cost for austerity right now is extremely high, and the benefit is nil. The best solution would be a long-term deficit plan, where austerity measures -- including spending cuts -- are put in place but not executed for a few years, when the U.S. economy is in better shape to withstand their impact.

Calling for Delayed Austerity Doesn't Mean You Like Big Government

Did you read that last sentence? Spending cuts can, and arguably should, still occur -- just not now. This point is a practical one: as the U.S. economy struggles to recover from a very deep recession, ideological views need to be tempered with practical realities. No matter how much you or I might desire smaller government, now simply isn't the time for it.

Let's say we eliminate 100,000 government workers. What happens? Most of them will go on unemployment for an extended period. Some of them will find jobs in the near- to medium-term, which means that some of the other millions of Americans who can't find work won't get those jobs. Ultimately, you've got more Americans out-of-work and more collecting unemployment.



How is this better than if we maintained current levels of spending temporarily to ensure that these jobs stuck around for a couple of more years? If there are too many teachers, cops, firefighters, bureaucrats, etc. then by all means cut jobs -- but there's little harm in waiting a few years to do so, while there could be significant harm in laying off these workers immediately.

Consequences of a New Normal for Unemployment and Growth

If austerity begins too aggressively too soon, then the U.S. will face what looks like a new normal for unemployment and economic growth. Government job cuts could create a significant headwind for net hiring. For example, if the private sector hires 250,000 workers and the government eliminates 125,000 in a given month, then the unemployment rate will likely remain unchanged (about 125,000 are needed just to keep up with workforce growth). The headwind created by public sector job cuts would significantly delay the time it takes for the labor market to recover.

On the growth side, you'll see something similar. As federal, state, and local spending falls in the name of austerity, you won't see a proportional increase in private sector growth. If that slices off, say, 1.2% per quarter from growth, then we could go from a moderate 3.1% growth rate to an anemic 1.9%. This is precisely what we saw in the first quarter.