The budget deficit will shrink to its smallest level since before the Great Recession in 2013, and it will continue shrinking through 2015, according to revised estimates from the Congressional Budget Office released Tuesday. In reality, the deficit is even smaller than the CBO predicts, since its “current law” projections assume that funding for the war in Afghanistan and federal disaster relief for states hit by Hurricane Sandy will continue in perpetuity. But that funding isn’t endless, and it will bring the deficit down to even smaller levels.

Still, under CBO’s projections, the deficit is now half as large as it was in 2009, the year President Obama took office:

If the current laws that govern federal taxes and spending do not change, the budget deficit will shrink this year to $642 billion, CBO estimates, the smallest shortfall since 2008. Relative to the size of the economy, the deficit this year—at 4.0 percent of gross domestic product (GDP)—will be less than half as large as the shortfall in 2009, which was 10.1 percent of GDP.

The deficit is shrinking so rapidly because of spending cuts and new revenues and because CBO continues to revise down projected health spending. But that the deficit is shrinking so rapidly isn’t necessarily good news — as U.S. News and World Report’s Pat Garofalo put it, it is instead “one more piece of evidence showing that the economic discussion that has gripped Washington recently is absurdly backwards.”

Despite smaller deficits, congressional Republicans remain focused on spending reductions, and the most recent round of cuts has kicked children out of preschool, left cancer patients without needed screenings, and gutted programs that help low-income Americans in a variety of ways. Those cuts have also threatened to derail the economic recovery, which has sputtered along despite the headwinds created by a consistent focus on deficit reduction. In past recessions, increased government spending has pulled the U.S. to recovery. In this one, it has only made recovery harder.

The crisis the U.S. is facing isn’t the deficit. It’s that the unemployment rate is still 7.5 percent, and more than 4 million of those workers have been off the job for at least six months. A shrinking deficit might be good news in the long-term, but it isn’t putting people back to work or sparking a robust economic recovery. And yet, even with evidence that stimulus policies like the American Jobs Act would help, and despite the fact that the deficit continues to subside, congressional Republicans aren’t just ignoring the devastating impacts of sequestration — they are pushing for even more spending cuts in the immediate future.

Credit: The Associated Press

Conservative U.S. politicians continue to press for austerity, but on the other side of the world, Australia’s government is moving in the opposite direction. That country largely escaped the economic downturn thanks to its abundant natural resources. But now Australia anticipates an economic contraction, and the government is adjusting its priorities accordingly.

Treasurer and Deputy Prime Minister Wayne Swan announced the shift from deficit reduction to economic investments in a speech to parliament, Bloomberg reports:

Australian Treasurer Wayne Swan will eschew European-style austerity as a stronger currency slows growth, wagering the government can win a Sept. 14 election fought on jobs and absorb the pain of a broken surplus promise. […]

“To those who would take us down the European road of savage austerity I say the social destruction that comes from cutting too much, too hard, too fast is not the Australian way,” Swan told parliament. “The alternative, cutting to the bone, puts Australian jobs and our economy at risk.”

Swan outlined a longer path back to the black that funds pledged spending on infrastructure, education and disability care, while saying restraint gives the Reserve Bank of Australia scope to cut record-low interest rates even further.

The reversal, forecast in December, acknowledges the economic reality that rapid austerity exacerbates economic troubles.

Meanwhile, the American fiscal policy debate has veered the other direction since 2011. Without the austerity measures Republicans have pushed and President Obama has signed over the past two years, economists say the U.S. unemployment rate would be a full percentage point lower. Obama’s American Jobs Act was projected to spur over two million new jobs when the White House proposed it in the fall of 2011, but Republicans blocked the bill. The U.S. will create 700,000 fewer jobs this year alone thanks to House Republicans’ decision to go ahead with massive “sequestration” cuts.

Congress shouldn’t need the Australian example, though. The contrast between the American recovery under fiscal stimulus and Europe’s austerity-driven return to recession is widely reported. The economic research Republicans have cited as motivation for immediate and sharp deficit reduction was proven entirely bogus just weeks ago.

America’s budget deficit is shrinking at a faster pace than at any time since World War II, and it is now projected to fall below 5 percent of GDP this year, 3 percent of GDP in 2014, and 2 percent of GDP in 2015, according to a Potomac Research report released Wednesday. That may please Washington politicians who have ignored jobs and unemployment over the last three years, but it isn’t good for the economic recovery.

The immediate deficit reduction efforts Washington has pursued repeatedly since Republicans took control of the House of Representatives in 2011 have in fact dampened the economic recovery, economists told the New York Times, and without the spending cuts and tax increases enacted in the last three years, unemployment would be a full-point lower and economic growth two points higher:

The nation’s unemployment rate would probably be nearly a point lower, roughly 6.5 percent, and economic growth almost two points higher this year if Washington had not cut spending and raised taxes as it has since 2011, according to private-sector and government economists.

After two years in which President Obama and Republicans in Congress have fought to a draw over their clashing approaches to job creation and budget deficits, the consensus about the result is clear: Immediate deficit reduction is a drag on full economic recovery.

Hardly a day goes by when either government analysts or the macroeconomists and financial forecasters who advise investors and businesses do not report on the latest signs of economic growth — in housing, consumer spending, business investment. And then they add that things would be better but for the fiscal policy out of Washington. Tax increases and especially spending cuts, these critics say, take money from an economy that still needs some stimulus now, and is getting it only through the expansionary monetary policy of the Federal Reserve.

The spending cuts have been especially damaging, as they have made up the vast majority of deficit reduction efforts since the end of the Great Recession. Modest tax increases targeting the wealthy went into effect at the beginning of 2013, but it is the expiration of the payroll tax holiday, which will raise taxes on the median American family by roughly $1,000 this year, that will hurt the recovery, the economists and analysts said. Nonpartisan reports have said the income tax increases on the wealthy would do little to affect growth.

That deficit reduction is holding back the recovery should not come as any shock. The stimulus bill President Obama signed into law in 2009 put the U.S. on a path to recovery that far outpaced the austerity-laden European economies, but as focus has turned to deficit reduction, growth has turned tepid. While rises in government spending have traditionally added to growth and pulled the U.S. out of economic downturns, it has plateaued since 2010, hampering recovery efforts this time. Reduced spending, in fact, “has detracted from growth in five of past seven quarters,” one investment bank wrote in a midyear report this week.

Republicans have blocked efforts, such as Obama’s American Jobs Act, that would have further stimulated the economy. That legislation would have led to the creation of a million jobs and added to growth, according to independent analysts, and would have aided states and local governments and federal agencies that have laid off more than 500,000 public employees, many of them teachers and public safety workers, since the end of the recession. With government borrowing costs at historic lows and unemployment still high, it’s that sort of shot in the arm the economy needs. But after Congress let sequestration, the damaging budget cuts that could wipe another 700,000 jobs out of the economy, take effect in March, it is now focused on finding even more deficit reduction in the immediate future.

Adam Smith, godfather of austerity

Ed. note: This is the second post in a TP Ideas symposium on Mark Blyth’s Austerity: The History of a Dangerous Idea. The first installment is here and the third installment is forthcoming. You can read our previous book symposium here.

Mark Blyth’s intellectual history of austerity should be required reading for all progressives -– and in particular, the center-left policy elites who run the country.  There are many good books out there on the origins and aftermath of the financial crisis and the intellectual collapse of neoliberal thought (John Cassidy’s How Markets Fail: The Logic of Economic Calamaties, Justin Fox’s The Myth of the Rational Market, and John Quiggin’s Zombie Economics: How Dead Ideas Still Walk Among Us being standout examples.)  But few books today provide the political context for how a long discredited idea such as austerity gained institutional and political traction in the aftermath of the global financial crisis to become the preferred course of action among leaders despite its manifest failures in producing economic growth and reducing debt.

Blyth provides a clear and digestible historical tour of the ideas behind austerity, defined as “a form of voluntary deflation in which the economy adjusts through the reduction of wages, prices, and public spending to restore competitiveness, which is (supposedly) best achieved by cutting states’ budget, debts, and deficits,” from John Locke and David Hume to Joseph Schumpeter and contemporary advocates of austerity in Germany and the U.S. He also provides some much needed spice and anger when describing how it all works. It’s rare to read a book on economics that distills centuries of neoclassical economics into these choice words about the upside-down morality of those who believed markets could do no wrong prior to the financial collapse: “[Adam] Smith’s invisible hand had just given the public the finger.”

Most importantly, Blyth’s analysis implicitly raises critical points about how the progressive left failed to coalesce around a single solution to the financial collapse in 2007-2008, thus paving the way for the advocates of austerity to turn a private sector banking failure into a “crisis” of public debt and spending after nations such as the U.S. and U.K. intervened to save their banks.

How did this work? Blyth explains:

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Ed. note: This is the first post in a TP Ideas symposium on Mark Blyth’s Austerity: The History of a Dangerous Idea. A second and third installment are forthcoming. You can read our previous book symposium here.

Arguably, there is no greater obstacle to progressive change than the idea of austerity. Austerity dominates economic policy discussions in Europe, resulting in policies in country after country that ensure continued slow growth (or outright contraction) and high unemployment. These conditions have produced demoralized electorates that lack faith in all politicians, including those on the left, a cynicism that has only been deepened when left parties have attained power and failed to revive growth. In such an environment, progressive change is not possible and the left is reduced to purely defensive actions.

In the US, things are slightly better. Nevertheless, our economic policy discussions are still dominated by variants of austerity. The fiscal cliff deal at the beginning of this year slowed the economy and the sequestered spending cuts are slowing it more. Yet with unemployment still at 7.6 percent, growth projections for the year halved to 1.4 percent and the latest jobs report coming in at an anemic 88,000 jobs created, policy discussion continues to focus on the need to cut the deficit more (despite the fact it has already gone down dramatically) and solve a national debt “crisis” whose effects, if any, are many years away (and may never appear). Of course, such a focus precludes any progressive economic policies, including critically, spending programs that would help revive the economy and invest in our economic future.

How did we get into such a pickle?  Does the current mania for austerity make any sense whatsoever?  And could the recent discrediting of Carmen Reinhart’s and Kenneth Rogoff’s influential pro-austerity paper provide any hope for defusing this mania?  Mark Blyth’s timely new book, Austerity: The History of a Dangerous Idea, provides answers to these questions. They are not necessarily comforting ones.

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Washington has spent much of the last three years focused on how to bring down the nation’s deficit, and that has extended into the ongoing debate about immigration reform. Conservative opponents have argued that immigration reform will be too costly for both the nation and domestic workers, despite studies showing that it will boost gross domestic product and workers’ wages.

The White House Office of Management and Budget (OMB), however, estimates that increasing the number of legal immigrants will itself reduce the deficit, as this chart highlighted by Quartz’s Tim Fernholz shows:

The OMB estimates (pdf, p. 56) that increasing immigration by 300,000 people a year, to 1.3 million, would be the equivalent of 0.6% of GDP in deficit reduction, or about $100 billion, each year between 2014 and 2088. Sounds like plan to tackle the debt to me.

Other studies have shown that immigration reform will have a net positive effect on the overall economy. The Center for American Progress, for instance, found that reform with a 10-year path to citizenship would lead to a $1.1 trillion increase in GDP over the next decade while boosting income, tax revenues, and jobs created over that period as well. Even a reform plan like the Gang of 8 proposal, which includes a 13-year path to citizenship, would boost the economy by $832 billion, growth that would naturally bring down deficits and debt with it.

The President’s new budget recapitulates earlier fiscal negotiation strategies, going back to the debt limit fight of 2011, where he proposes bold action on deficit reduction and goes quite far in Republicans’ direction by including cuts to Medicare and Social Security benefits (the chained CPI).  The goal now, as then, was to somehow broker the elusive bipartisan Grand Bargain on debt reduction.  Based on previous experience, how much payoff can Obama expect to get from the current strategy?

Not much. If history can be a guide, there are three clear lessons from past deficit fights. First, the “adult in the room” theory is a fallacy. That’s the idea that the President, by appearing to be reasonable and willing to make big concessions to his opponents, will gain a commanding political position. But taking the high road didn’t work last time and it won’t work this time either. Back in 2011, the public did indeed perceive Obama as being more willing to compromise and blamed him less than Republicans for the difficulty of reaching an agreement. But his overall approval rating nevertheless plunged as the public got sick of teetering on the brink of disaster while the economy sputtered. In fact, his approval went down the most (16 points) among political independents, supposedly the audience most receptive to the adult in the room act.

Second lesson: Cutting popular programs is unpopular. Last time around, significant cuts to Medicare, Medicaid and Social Security made their way made their way into various “Grand Bargain” proposals floated by Obama in negotiations. These were ultimately spurned by Boehner and colleagues, but Obama might not be so lucky this time. Better to avoid the trap by remembering these findings from a July 2011 CNN poll on possible components of a debt ceiling deal. While two-thirds of the public supported, in the abstract, the idea of cutting spending to solve the deficit problem, the public opposed cutting spending on Medicaid by 77-22, cutting Social Security spending by 84-16 and cutting Medicare spending by 87-12. And nothing’s changed since then: in a late March CBS News poll, 80 and 79 percent, respectively, opposed cutting spending on Medicare or Social Security to reduce the budget deficit.

Third lesson: Economic growth is much more important than deficit reduction. Obama, by virtue of his temperament, pressure from elites and, of course, the priorities of Congressional Republicans, will be tempted to privilege debt reduction over economic growth as he reaches for that elusive Grand Bargain. But he should remember that, as far as the public is concerned, you can’t eat Grand Bargains. That is, no matter how much the public says it cares about deficit reduction, ordinary people, unlike elites and their pressure groups like Fix the Debt, care far more about the state of the economy and how it is progressing. That has not changed since 2011: in Democracy Corps’ post-election poll, voters, by a thumping 62-30 margin, said that our biggest priority after the election should be growing the economy, not a plan to reduce the deficit.  And just two weeks ago, in a Marist/Morning Joe poll, 62 percent chose creating jobs as the top priority for Congress and Obama, compared to just 35 percent who chose deficit reduction. Note that among independents — supposedly the key group that gets excited about Grand Bargains — sentiment for creating jobs over reducing the deficit was an almost-as-overwhelming 60-36.

These are the lessons of our past deficit battles. Will Obama heed them? Well, he’s already getting the predictable cold shoulder from the Republicans, to be followed shortly by ever-escalating demands for more cuts and increasing public disgust with the whole process.  Perhaps some of the truths I’ve outlined here will then start to sink in and he will turn away, as he did in the fall of 2011, from fruitless attempts to reason with the GOP and advocate instead for the policies this country really needs.

That means taking his case to the public.  As John Judis recently put it:

When Obama takes an issue to the country, as he did financial reform in the spring of 2010, or as he did during the debate over the fiscal cliff, conservative Republicans complain vociferously that he is degrading the office of the president — forgetting, of course, that Ronald Reagan and George W. Bush campaigned energetically for their policies. And lo and behold, the pressure works. Obama needs to get back out there and fight the budget battle. He has to make clear to the country that the cuts are threatening the recovery, and he has to make clear that what Republicans want to do is make further cuts to Medicare and Social Security. These are popular programs. These are not Solyndra or the Post Office. Obama can win this fight, but he has to get out of the White House and carry it on.

Exactly.  We can only hope that the day is not far off when he realizes that this approach, while not without risks, is considerably less risky than trying to strike a Grand Bargain with today’s Republican Party.

Deficit mania has officially taken over Washington—again. Both Republicans and Democrats, while they have different preferred approaches, are heavily focused on cutting budget deficits and relieving the long-term debt situation of the country. Yet unemployment remains at an unhealthy 7.6 percent, with declining labor force participation, and the modest economic recovery that’s underway has shown signs of sputtering — witness the latest jobs report which indicated only an anemic 88,000 jobs were created in March.

The simplest explanation for Washington’s monomaniacal focus on the deficit would be that politicians are responding to a shift in priorities among voters. The electorate, in other words, is now more worried about the budget deficit than the economy, so politicians have shifted their focus accordingly. But that explanation is simply not borne out by the facts.  The public’s concern for the deficit still lags far, far behind their concern for the economy and jobs: In a late March CBS poll, 41 percent of people in an open-ended question thought the economy/jobs was the most important issue facing the country, compared to just 9 percent who thought the deficit/debt was the top issue.  And in a late March Marist/Morning Joe poll, 62 percent chose creating jobs as the top priority for Congress and Obama, compared to just 35 percent who chose deficit reduction.

Another possibility that fits the “responsive politicians” explanation for current deficit mania is that voters, while perhaps not prioritizing deficit reduction, are particularly likely to punish politicians who do not take action on the issue. That is, even though deficit reduction is not the top concern for voters, voters will nonetheless turn against politicians who fail to make progress in this area. But this appears to get things backwards, especially when it comes to the incentives facing incumbent politicians. In reality, countless historical examples and empirical studies suggest that the surest route to getting booted out of office is poor economic performance — and this is the case regardless of whether politicians make progress on the deficit. Conversely, if the economy performs well, but little progress is made on the deficit, the incumbent party is still likely to benefit.

But if Washington’s deficit obsession is not simply a product of politicians responding to a shift in the public’s mood, where does it come from? The likeliest alternative is that, as political scientists Lawrence Jacobs and Robert Shapiro argue in their influential book, Politicians Don’t Pander, elected officials don’t so much seek to know public opinion in order to follow it, but rather so they can manipulate it to support their agenda and minimize any electoral damage that might result. This clearly fits the way Republicans are handling the deficit issue: Cutting spending on government programs is at the top of their policy agenda, so it follows that they wish to keep the political and media conversation focused as much as possible on deficits. Over time, they hope the incessant hysteria will move public opinion to their side, allowing them to pass more and more of their preferred legislation. Moreover, they are betting that their unresponsiveness to the jobs issue will not hurt them because the media will mostly cover the endless battles over deficits and spending, creating a news vacuum where the public is likely, lacking other information, to blame the party that holds the presidency for inaction on jobs.

Democratic complicity in today’s deficit-obsessed political climate is less easy to understand. Democrats, one might think, would place the jobs issue at the top of their agenda and exploit the clear public opinion preference for jobs to move their policies. But the assumption that jobs tops the agenda of all Democratic politicians is likely not warranted. There is a very significant section of the Democratic Party, including many moderates but also some liberals, that is not convinced by the standard Keynesian argument that deficits, even at their current levels or higher, are not a problem in the short run, while weak demand and slow job growth definitely are. These Democrats appear to be more impressed by arguments, retailed by the Bowles-Simpson Commission, the Committee for a Responsible Federal Budget, and a veritable army of editorial writers and pundits, that the country’s deficit and long-term debt problem is so severe that an immediate agreement to tackle the problem is necessary. Lacking an agreement on the debt, the argument runs, the U.S. will lose the confidence of its creditors and soon become an unstable, impoverished country. By this hysterical logic, an agreement on debt becomes far more urgent than dealing with the jobs situation.

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President Obama will release a budget next week that replaces the automatic budget cuts known as sequestration with other spending cuts while also raising $580 billion in revenue and making cuts to Social Security and Medicare. The budget plan, as the Washington Post notes, is almost identical to the offer Obama made to congressional Republicans in an attempt to reach a “grand bargain” to offset sequestration at the beginning of March, and it is aimed at reaching a similar bargain in the near future.

“The president has made clear that he is willing to compromise and do tough things to reduce the deficit,” an administration official told the Post, “but only in the context of a package like this one that has balance and includes revenues from the wealthiest Americans and that is designed to promote economic growth.”

Under Obama, the U.S. has already cut $2.5 trillion from the deficit over the next decade. This plan would offset sequestration with roughly $1.8 trillion in other deficit reduction, including $580 billion in revenues, $400 billion from Medicare and other health programs, $130 billion from applying a new inflation measure (chained CPI) to Social Security, $200 billion from defense and domestic spending, and $200 billion from farm subsidies and retiree programs, the Post reported.

But while Obama remains committed to deficit reduction, there is little evidence that the U.S. needs to continue cutting spending, which has plateaued since he took office in 2009. As the following chart shows, government spending has typically driven economic recoveries, but spending cuts made over the past three years have held back America’s current recovery:

With borrowing costs at historic lows and unemployment remaining persistently high — the economy added just 88,000 jobs in March, according to the Bureau of Labor Statistics — the government could be making stimulative investments into the economy to help boost the recovery. That’s the path Obama originally sought in 2009 with the American Recovery and Reinvestment Act, and it worked: the stimulus turned around the economy and put the U.S. on a faster pace of recovery than Europe, which has consistently pushed to reduce deficits, has experienced.

Sequestration has already begun taking its toll on local economies, kicking children out of preschool programs, hurting schools, closing air traffic control towers, and leading to furloughs and job losses. But it is unclear how replacing it with a “grand bargain” that still cuts spending at a time when the country is experiencing a glut of long-term unemployment and tepid economic growth would make the situation much better, especially if the budget also includes cuts to Social Security and Medicare. There may be a consensus in Washington that cutting the deficit is the top priority, but evidence suggests that the U.S. may benefit more from the pursuit of policies like the American Jobs Act, the legislation Obama sought in 2011 that economists said would have boosted growth while creating more than a million jobs.

The 17-nation Eurozone set another dubious record in the opening months of 2013, as its unemployment rate continued to climb from its already record-high rate. The jobless rate also rose for the European Union as a whole as austerity efforts continue to plague the continent’s recovery from the Great Recession:

The jobless rate reached 12 percent in both January and February, the highest since the creation of the euro in 1999, Eurostat, the statistical agency of the European Union, reported from Luxembourg.

The January jobless rate for the 17-nation currency union was revised upward from the previously reported 11.9 percent.

For the overall European Union, the February jobless rate rose to 10.9 percent from 10.8 percent in January, Eurostat said, with more than 26 million people without work across the 27-nation bloc.

Despite clear warnings that austerity isn’t boosting growth, some of the continent’s largest economies remain committed to deficit reduction. The United Kingdom, now on the precipice of its third recession in four years, has indicated that it will continue efforts to reduce the deficit, even as it has fallen far short of its past goals. The UK, in fact, has largely failed to put a dent in its deficit because austere policies have inhibited economic growth. Even Germany, the continent’s stalwart economy through the initial recovery, is lagging, and France announced last month that it would not seek to hit its deficit targets in 2013.

The United States took a different approach to recovery, boosting the economy with President Obama’s stimulus plan in 2009 and putting itself on a better path for growth than Europe has experienced. But it too has since embraced austerity. Government spending has traditionally boosted the economy out of downturns, but it has plateaued in recent years and has instead hamstrung the current recovery. Further budget cuts, such as the across-the-board sequester that went into effect March 1, could only make that worse.

Thus far, a rising housing market and strong retail sales provide evidence that the U.S. is still recovering, but manufacturing numbers slumped in March largely on concerns about how budget cuts would effect the economy. And while conservatives still claim that America’s “runaway spending” is harming the recovery, the truth is that the U.S. isn’t spending enough to give its economy the boost it needs to leave the Great Recession fully behind it.