The New Nasty: 1% Deficit Upper Bar
Nonfarm business sector labor productivity decreased at a 2.0 percent annual rate during the fourth quarter of 2012, the U.S. Bureau of Labor Statistics reported today. The decrease in productivity reflects increases of 0.1 percent in output and 2.2 percent in hours worked. (All quarterly percent changes in this release are seasonally adjusted annual rates.) From the fourth quarter of 2011 to the fourth quarter of 2012, productivity increased 0.6 percent as output and hours worked rose 2.4 percent and 1.8 percent, respectively. (See chart 1 and table A.) Annual average productivity increased 1.0 percent from 2011 to 2012. (See table C.)
The reason this is much nastier than one would like is that in the long run budget deficits on a sustainable level are inevitably tied to productivity improvements.
If economic output is improving in efficiency at 3% a year then you can have a budget deficit of 3% and the system will remain in balance. The government is essentially stealing the productivity improvement of the people, and this is wrong on an ethical and moral level, but it is mathematically stable.
The Euro Zone, for example, has a hard budget deficit cap of 3%. This has been routinely ignored and gamed, which is largely responsible for the mess they’re in today, and in fact the risks there are grossly under-appreciated (and likely to become realized risks soon enough!)
But here in the US I have believed for quite some time that we would be maintaining a rough 3% improvement in productivity over multi-year periods. This report throws cold water — and a warning — on that expectation, as it is the second year running that productivity has run at 1% or below.
This has a profound impact on sustainable deficits; if you can run a 3% deficit then on a $15 trillion economy you can run a $450 billion deficit on a long-term sustainable basis. Again, this may be immoral and theft, but it’s mathematically stable.
With a 1% productivity rate you lose $300 billion of that spending; now you can only run a $150 billion deficit. And this is the second year sequentially in which productivity has run 1% or less.
Should productivity go negative it gets even worse; you are then forced to run a surplus to remain in monetary balance.
The target, unfortunately, has to be moved to a 1% deficit from 3%.
And incidentally, that’s three times the size of the sequester in terms of the change required — and it has to be made right now.