The U.S. Economy in a Global Context

The U.S. Economy in a Global Context

November 28, 2018
The U.S. Economy in a Global Context
Congress faces challenges in formulating policies to foster
A more fundamental issue with government debt is its
economic growth. The imbalance between federal spending
unsustainability given projected deficits. During the
and revenues will continue and grow in the long run if
recession and recovery, the debt grew from about 40% of
current policies are continued. This imbalance will lead to
GDP in FY2008 to 77% in FY2016 (the highest since
unsustainable growth in the federal debt. Nevertheless,
World War II). Although the debt to GDP ratio stabilized in
deficit reduction that is too large can temporarily slow
FY2017, it increased in FY2018 as revenues declined by
economic growth.
0.7% of GDP following the 2017 tax cut. Spending
declined slightly by 0.2% of GDP for a net increase in the
Near Term Outlook
deficit of 0.5% of GDP. CBO projects the debt to reach
The economy has recovered from the 2007-2009 recession
96% of GDP by FY2028, 118% by FY2038, and 152% by
with a historically low level of unemployment (3.7% in
FY2048. This projection (which assumes spending
October 2018). The labor force participation rate of 62.8%
reductions and the expiration of the individual tax cuts
is at its trend level. It has declined over time largely due to
enacted in 2017) depicts an unsustainable path. The debt
the aging of the population. The economy continues on a
can grow without increasing the ratio of debt to GDP as
growth path at an average rate of 2.2% from 2010 through
long as it rises at a rate less than or equal to GDP growth.
2017. Growth in the first and second quarters of 2018 was
For example, if the debt is 80% of GDP and the economy is
2.2% and 4.5 % with a preliminary estimate of 3.5% for the
growing at 1.6%, a deficit of 1.28% of GDP (1.6% of 80%)
third quarter.
will maintain the debt to GDP ratio. The 2018 deficit is 4%
of GDP.
The Congressional Budget Office (CBO) estimates a
growth rate of 3.1% in 2018, with the higher growth rate
The debt is projected to grow in the future largely because
reflecting the increase in government spending, reductions
spending grows faster than revenues, due to long-
in taxes, and faster growth in investment. The Blue Chip
recognized issues, such as the aging population and
Forecast consensus is similar with a projected growth rate
increased health care costs. Over the 30-year period (up to
of 2.9%.
FY2048), Social Security is projected to grow from 4.9% of
GDP to 6.3% and health spending is projected to grow from
Longer-Term Issues
5.2% to 9.2%, an increase of four percentage points, with
three-quarters of that increase due to Medicare. Moreover,
Economic Growth and the Debt
the compounding debt also causes a rapid growth in interest
Growth is expected to slow to trend in the future, with
payments, which rise from 1.6% of GDP to 6.3%, an
recovery complete, transitory effects of the 2017 tax cuts
increase of 4.7% of GDP. Other spending (including
(P.L. 115-97) fading, and various moderating forces
defense and nondefense discretionary spending) is projected
including reductions in government spending, increases in
to decline as a percentage of GDP, from 8.9% to 7.6%.
interest rates, and uncertainties about trade and trade policy.
CBO projects a growth rate of 2.4% in 2019, slowing to an
Revenues, after dropping to 16.6% of GDP in FY2018 due
average of around 1.6% to 1.7% from 2020 through 2028.
to the tax cut, are projected to grow over time, reaching
CBO’s projections are similar to those of private
19.8% of GDP in FY2048. About a third of this increase is
forecasters.
due to the expiration of the individual income tax cuts and
the remainder largely due to real bracket creep in the
In the longer run, economic growth depends on the growth
individual income tax, as payroll taxes, corporate taxes, and
of the labor force, growth of human capital in the labor
other revenues remain relatively stable as a percentage of
force (which depends in part on the age distribution given
GDP.
the importance of on-the-job training), growth of the capital
stock, and the rate of technological change. Federal
This long-term outlook for the debt might be considered by
government policies have limited influence on the
some as optimistic given the difficulty of maintaining
magnitude of most of these variables. Technological
spending cuts and the possibility of making the individual
advance can be encouraged through grants and tax subsidies
tax cuts permanent. Moreover, were the economy to
but probably cannot be significantly affected. Although tax
encounter a recession, the increase in deficits (through
cuts have often been aimed at encouraging savings and
automatic stabilizers that reduce revenues and increase
investment, the most direct effect on the capital stock may
spending as well as potential discretionary fiscal policy
be through government dissaving (or increasing debt),
stimulus) would add to the long-term debt.
which crowds out private investment. This crowding out
effect is moderated by borrowing from abroad, but the
The earlier measures are taken to address the debt, the less
returns to that investment must be paid to foreign investors.
difficult such measures will be, because interest payments
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The U.S. Economy in a Global Context
grow when the debt is not addressed thus requiring harsher
Foreign Holdings of Federal Debt
measures to achieve a given fiscal outcome. Measures
About half of debt held by the public is held by foreign
might require both spending cuts and revenue increases,
investors including foreign governments. Concerns have
although the two largest sources of spending increases,
been raised in the past about the large foreign holdings of
Social Security and Medicare, may prove difficult to alter,
U.S. debt, especially by China, and about the effects of a
particularly in the short run.
sudden sell-off. China holds about 9% of U.S. debt held by
the public. However, these concerns may be overstated.
CBO projects that to target debt at 41% of GDP (roughly
China benefits from holding U.S. debt, and an abrupt
the pre-recession level) by FY2048 would require a cut in
withdrawal and accompanying fall in security prices would
noninterest spending, an increase in revenues, or both, by a
be costly to China. Moreover, any funds withdrawn from
total of 3% of GDP in FY2019. This change would involve
the United States would have to be invested elsewhere and
a 15% cut in spending, a 17% increase in revenues, or some
restore overall worldwide demand for securities.
combination of both. If the target were the current debt
level of 78% of GDP, the reduction would be 1.9% of GDP.
Trade Policy in a Global Economy
Smaller short-run changes could be made but they would
International trade (exports and imports) is equivalent to
require larger longer-term ones.
more than 20% of U.S. GDP. The President has placed
increased emphasis on the trade deficit and bilateral trade
Growing Inequality
flows and has proposed or imposed tariffs under the view
There has been concern about the growing inequality in the
that trading partners, particularly China, are engaging in
economy. From 1979 to 2017, the income share of the
unfair practices. Bilateral trade deficits are, however, not
bottom quintile of families fell from 5.3% to 3.5%, whereas
considered to be meaningful and given flexible exchange
the share of the top quintile rose from 41.9% to 50.1%.
rates, the overall trade deficit is simply a consequence of
Shares also fell for the lower middle quintile (from 11.7%
net capital inflows, as incoming resources must be paid for.
to 9.0%), the middle quintile (from 17.2% to 14.7%), and
Imposing tariffs and other restrictions has the potential,
(slightly) for the upper middle quintile (from 23.8% to
however, to disrupt sectors of the economy and invite
22.7%). These effects occurred due to increasing inequality
retaliatory policies from other countries.
in the distribution of wages and a decline in labor
compensation as a share of income.
There are important trade issues to address, including
increasing market access to countries such as China and
Most economists view technological change as the major
protecting intellectual property rights worldwide. These
factor limiting the wage growth of workers without a
issues may be addressed in general trade agreements.
college education. Trade appears to have little effect except
However, the President has withdrawn from the Trans-
for the very highest incomes where larger markets may
Pacific Partnership that was addressing some of these issues
have increased the incomes of “superstars.” The decline in
(including issues with China) and has indicated an intention
the real minimum wage may have played a small role in
to negotiate bilateral agreements.
limiting wage growth at the lower end of the distribution.
Given the limited ability of government policy to affect
Although free trade is generally mutually beneficial for
distribution arising from market factors such as technology,
countries overall, it can affect the distribution of income. It
the main option for decreasing inequality is through the tax
can reduce jobs in import-sensitive industries, although it
and transfer system. Another option is increasing the
creates them in export-intensive industries. Concerns have
minimum wage, although that option might also increase
been raised about the loss of manufacturing jobs. Most
unemployment of less educated workers.
economists believe the major reason for this effect is not
import competition but automation, as manufacturing
The Global Economy
output has steadily increased while jobs have declined. In
The United States is increasingly interconnected with the
the long run, trade will largely affect the mix of jobs in the
rest of the world through trade and financial flows. As a
United States and not the overall number.
result, other countries affect the U.S. economy and U.S.
policies affect or are constrained by other countries.
Other Global Economy Issues
The interconnected global economy has led to focusing on a
Growth and Investment in a Global Economy
variety of other policy issues. The United States continues
Slower growth is projected for the world economy, which
to negotiate with other countries on the adoption and
could limit demand for U.S. exports and be a contributing
implementation of financial regulatory standards. Global
factor to slower short-term growth. The global economy is
economy concerns, including base erosion and profit
also a source of potential investment and some of the recent
shifting, motivated some of the recent changes in the
tax reforms were aimed at that objective, although their
corporate income tax, including lowering the corporate tax
effectiveness is uncertain. The global economy also is a
rate and instituting international revisions. The effects of
source of borrowing to finance the government debt.
these proposed tax changes would likely be small relative to
Capital inflows can increase the capital stock with small
overall economic growth given the relatively small size of
benefits for wages, but the investment earnings do not
the corporate tax, which is less than 2% of GDP.
benefit Americans as they are paid to foreigners.
Jane G. Gravelle, Senior Specialist in Economic Policy
IF11031
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The U.S. Economy in a Global Context

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