Money matters

The whole public debate about sequestration, cutting the deficit, and stimulating the economy is looking in the wrong directions. The broad solutions are simple: (1) the federal government should not spend as much as it does in relation to its income; (2) the government should target its fiscal policies in a way that makes the US economy expand. The details, of course, are where everybody bogs down.

I’m an engineer. I like to solve problems by looking at data and figuring out where to apply pressure to a system to get it to do what I want. Clearly, where I apply that pressure matters: it’s better to target the big-ticket items than the small fry. This approach means, simply, that cutting federal discretionary spending is almost completely irrelevant. Instead, proposals for managing federal spending should be looking at cutting things like the military. (This is one good thing about the sequestration plan: it forces the issue of cutting our ludicrous amount of military spending.) The politicians resistant to touching the military budget sometimes argue about the number of jobs involved – not just soldiers, but civilian contractors to the military. We wouldn’t want to hurt the economy by cutting military spending, right? Well, as it turns out, the military budget is not well-correlated with GDP growth. One reason for this result might be that, while the military is certainly interested in investments, infrastructure, advanced technologies, and new medicines – all things that can make for jobs and growth in the wider economy – the military also isn’t exactly interested in sharing those things with the civilian community through a commercialization process. It wants to invest in itself alone. This does not help make the economy grow. So, there is plenty of room for cuts in the military budget (and plenty of room to remain comfortably secure, too).

A well-crafted budget plan should also look at diverting spending towards programs that have the greatest positive impact on our economy and society. Yes, I’m talking about increasing some areas of federal spending as part of a deficit reduction solution. That’s because of multiplier effects – sometimes, the government can take actions that reverberate throughout the economy and generate positive benefits for everybody: jobs and wealth for citizens, increased tax revenue for governments. Win-win!

Increasing spending happens to be about the same in deficit and revenue terms as cutting taxes, but the multiplier effect from tax cuts isn’t going to be much to help. They provide some amount of economic growth, but there are a lot of studies that show that the effect is less pronounced than changes in government spending. Here is a good article outlining both sides of issue. In my opinion, the preponderance of evidence is that most economic growth for every dollar cut from federal taxes is lower than the economic growth from boosting spending. However, even the studies that don’t agree with me tend to show that most of these actions have multipliers up to about 1.6 – for every $1 of taxes cut or spending increases, GDP grows by $1.6. As long as this number is greater than 1, there’s a positive effect on the economy, but a 60% return on investment may take a while to have positive effects in society at large.

Fortunately, there are some slam-dunk areas where a little government investment goes a long way. One example is highway infrastructure investment: it may not be sexy, but it apparently carries a multiplier greater than two! This means the if the federal government cut $2 from the Pentagon budget, but invested $1 in the Eisenhower Interstate Highway System, then not only would the deficit shrink by $1 but the economy would grow by $2! (Plus, we would have bridges that don’t fall down.)

Even highway spending, though, isn’t as good as the government could do.

There’s this one government program that happens to provide a staggering return on investment, and is hugely popular with all demographics, but doesn’t really get a lot of federal budget love. It’s called the National Aeronautics and Space Administration. (I bet you were wondering when I would say something about space!)

For every $1 that the government spends on NASA, it spends about $200 on other things. But for every $1 the government spends on NASA, the economy grows by….well, a Freakonomics panel says that the economy grows by $8 – an 800% return on investment. A Rutgers University report posted on the Johnson Space Center web site puts the return at $7 (not just for NASA, but for research and development in general, as well). And here’s a link to a 2002 article that suggests that for $64 million of investment from the government through NASA, private companies received a “value-added benefit” of $1.5 billion, making a ratio of over 1 to 23. If a broker came to you offering an investment account with a historical 2300% rate of return, wouldn’t you take it? Purely as an engine of economic investment, without getting into any of the scientific, technological, or sociological benefits, NASA is a tremendous success!

Certainly, our national representatives should be engaged in a thoughtful and difficult discussion over what programs to reduce and which to expand. If they are smart about it, though, they should look at preserving – or even enhancing – those programs that benefit us the most. They should look at the data and target their actions.

Therefore, cut defense – I have enormous confidence that the Pentagon will successfully figure out how to prioritize. Cut some entitlements – there are certainly bloated programs out there. But fund infrastructure. Fund research and development. Fund the NSF, NOAA, NIST, DOE, and USGS. And fund NASA!

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