Structural Deficits vs. Cyclical Deficits
Now there's a catchy title for an article, almost guaranteed to
make the reader's eyes glaze over. And yet the distinction is of the
greatest importance if we hope to solve the problem of America's
burgeoning national debt. Here's a quick primer on the difference and
why it matters.
The federal budget deficit is, of course, the difference between federal revenues and federal spending in a year; the federal government must borrow this amount. There are two components of the deficit: structural and cyclical. What are these? The structural component represents the shortfall from the federal government conducting "business as usual" when the economy is exhibiting normal economic growth. The cyclical component represents shortfalls attributable to recession: decreased tax revenues and stimulus spending.
The cyclical component is dramatic; it has exploded the deficit as a share of GDP, and it has grabbed everyone's attention. But it also misleads. As soon as (if?) economic growth returns to normal, the cyclical components go to zero. Except for the additional interest payments they require, these have little effect on the long-run fiscal position of the U.S. government. On the other hand, "normal" involves structural deficits that are entirely unsustainable: assuming no new spending programs, no fix of the Alternative Minimum Tax, and no renewal of the tax cuts ushered in by George W. Bush -- the CBO's "extended baseline scenario" -- our annual outlays on Medicare, Medicaid, Social Security, and debt service alone grow to exceed annual revenues over the longer run. And under the CBO's more realistic "alternative scenario," in which discretionary spending grows as fast as GDP and the AMT is "fixed," deficits explode much sooner. Keep in mind that unlike the cyclical component, these structural deficits don't fade away; they grow faster and faster. (See the CBO's Long Term Budget Outlook for details. The chart on page 6 gives a good summary, and the graphic of the exploding debt on page 5 adds drama. I recommend familiarizing yourself with this document.)
This shouldn't make your eyes glaze over -- it should make your hair stand on end. Even an unrealistically conservative analysis of structural deficits tells us that the equivalent of national bankruptcy is in our future, if we maintain business as usual. For all the grave doubts I have about TARP, ARRA, PPIP, and all the other "stimulus" programs the Bush and Obama administrations have introduced, these are (I hope!) short-term cyclical programs that will fade away before long. In fact, there's nothing unprecedented in our current cyclical deficits: in recent history, when a country undergoes a banking crisis its national debt increases 86% on average, according to research by economists Ken Rogoff and Carmen Reinhart. (Full reference on request.) Our real danger is from the growing structural deficits, and there are no easy fixes for these.
President Obama's proposed freeze on non-military discretionary spending is a nice gesture, but not much more than that, since this essentially puts us on the "extended baseline" path. It's just a slower a road to ruin. Congress had better start actually tackling the structural imbalances, and soon.
Dr. Charles N. Steele is the Herman and Suzanne Dettwiler Chair in Economics and assistant professor at Hillsdale College in Hillsdale, Michigan. His publications include papers on the Soviet economy and economics of transition, economic growth, and institutional change. He received his Ph.D. in economics from New York University in 1997, and has subsequently taught economics at the graduate and undergraduate levels in the People’s Republic of China (China Agricultural University), the Russian Federation (Moscow State University), Ukraine (Economics Education and Research Consortium, National University Kyiv-Mohyla Academy), and the United States (Montana State University). He has also worked as a private consultant in design and review of USDA crop insurance programs with Watts and Associates, Inc.
In addition to economics, Steele's interests include trail running, mountaineering, snowshoeing, and similar outdoor pursuits. He's completed 26 ultramarathons, ten triathlons, and is a nine times finisher of The United States' oldest 50 mile race, the Le Grizz Ultramarathon.
Learn about Mr. Stolyarov's novel, Eden against the Colossus, here.