Article on US economic policy by Richard Wellings in the Yorkshire Post

THERE is talk of recovery, but little reason for optimism. Government action may have cushioned the initial impact of the recession, but the long-term economic consequences of borrow and spend policies have yet to be felt.

The problems are perhaps most severe in America. President Obama’s spending spree – in the name of economic recovery – means that this year about half the money the Federal Government spends will be borrowed.

Not satisfied with the worst debt levels since the Second World War, the President is embarking on a whole host of expensive programmes to subsidise healthcare, boost education and protect the environment.

At a cost of $787bn, his Recovery and Reinvestment Act is the largest stimulus package in history. Much of this money will be used to fund social programmes and environmental schemes that will require further outlays to keep them going.

This follows eight years of Keynesianism under George W Bush, who increased public spending, strengthened the government’s role in the economy and allowed debt levels to spiral.

He did little to tackle the growth of America’s welfare state. And as the baby-boom generation hits retirement age, there is now a big question mark over the future funding of existing healthcare and pension schemes.

As a result of Bush and Obama’s profligacy, the US budget deficit is likely to reach an unprecedented $1.6 trillion for 2009, and there appears to be no realistic strategy to bring it under control.

Such high levels of government borrowing will have a devastating effect on the prospects for sustainable recovery. They will damage the productive part of the US economy by crowding out investment in the private sector. And before long they will lead to higher taxes and interest rates, as the government is forced bring its debt levels under control. This prospect will inevitably undermine economic confidence and deter the business investment that drives growth.

A new study by the Institute of Economic Affairs (IEA) suggests that in this regard there are strong parallels with the policy mistakes made during the Great Depression.

In the 1930s, another Democrat President, Franklin D Roosevelt, launched the “New Deal” in response to economic crisis. He increased government spending, ran huge deficits and launched an interventionist industrial policy which had eerie similarities to that of fascist Italy. Dramatic tax rises were also implemented, with the top rate of income tax eventually reaching 90 per cent.

Contrary to conventional wisdom, these measures delayed recovery by several years by deterring private-sector investment and stifling entrepreneurship.

As a result, the US had probably the deepest and longest-lasting depression of all the major countries in the 1930s. Even as late as 1939, unemployment was close to 20 per cent and real incomes were little higher than they had been at the start of the First World War.

Yet it would appear that today’s US policymakers have failed to draw the correct lessons from the failure of Roosevelt’s New Deal. Instead of moderating the burden of government on businesses by deregulating and keeping taxes low, they have focused on increased spending and state intervention as the solution to a faltering economy.

As a consequence, America is likely to lose its economic dynamism and will become more like the anaemic, state-dominated countries of continental Europe that have barely grown over the last 20 years.

In the worst-case scenario, the US could follow a similar path to Argentina, which less than a century ago was one of the richest countries in the world. Like Obama, when faced with economic crisis, its politicians turned to socialism, protecting and subsidising favoured industries.

The President’s policies will certainly increase the share of the US population that is directly dependent on government largesse. This risks nurturing the kind of destructive special interest politics that brought misery to Britain during the 1970s and helped to consign South America to decades of relative economic decline.

It also increases the chance of monetary instability. Historically, large budget deficits have often preceded periods of high inflation.

When powerful groups depend on public spending, politicians typically find it easier to print money to pay off debts, rather than implementing deeply unpopular cuts.

Such a scenario would not just be a nightmare for the US. The UK, as a major trading partner, would also suffer badly.

Many hope that next year’s elections will bring some much needed restraint to US economic policy by reducing the Democrats’ majority. Recent history suggests, however, that, as in the UK, there is little difference between the major parties – Republicans have been similarly devoted to borrow and spend.

If this proves to be the case and the US fails to change course, recovery is likely to be slow and America may lose its position as the world’s economic superpower.

Dr Richard Wellings is Deputy Editorial Director at the Institute of Economic Affairs

Further reading

Economic Contractions in the United States: A Failure of Government by Charles Rowley and Nathanael Smith.