The Competitive Edge: The Federal Deficit Comes Into Focus

The start of the new year brings renewed hope that the long-neglected federal deficit will be addressed in a serious way. While this problem may on the surface seem to be a distant concern to manufacturers, making significant progress on it could be surprisingly helpful to them. The midterm elections of 2010 brought scores of new members to Congress whose primary concern is the growth in federal spending and the burgeoning budget deficit. Soon thereafter the two co-chairs of the president's bipartisan deficit reduction commission released a bold proposal combining cuts in discretionary spending and entitlements, and tax simplification that would lower personal and corporate taxes to achieve a near-balanced budget within five years.

This proposal was followed in rapid-fire order by structurally similar proposals from the Bipartisan Policy Center and long-time budget hawks supported by the Peterson Foundation.

More pertinent, however, to real-world concerns was the decisive new budget of the coalition government in the U.K., which details budget cuts of about 4.5% of gross domestic product, equivalent to about $650 billion in the U.S. economy. If an entrenched European welfare state can cut public employment by nearly 500,000 jobs (equivalent to at least 2.5 million in the United States), reduce welfare and national health care payments, and increase the retirement age, while surviving politically, this should give hope to timid reformers in the United States.

Slashing the Deficit

Perhaps a better example of slashing a crushing national deficit is that of Canada in the 1990s. Laboring under an annual deficit of around 6% of GDP, with 25 cents on every dollar of spending going to debt service, and with its bonds being downgraded by the ratings agencies, Canada undertook a little-known (south of the border at least!) series of radical budget cuts. Its watershed 1995 federal budget cut one-third of payments to the health care plans run by the provinces, slashed the civil service by one-quarter, and instituted a 10% across-the-board cut in other discretionary programs. Two years later, Canada had a balanced budget and operated in surplus until the recent severe recession. Importantly, it reduced federal expenditures by about 6% of GDP (equivalent to about $885 billion in the U.S. economy), while applying some of the savings to reducing its corporate tax rate from 28% to 15% by 2012.

Manufacturing Benefits

If the example of two industrialized English-speaking nations can be followed in the new political environment in the U.S., it could have important benefits for domestic manufacturing firms. At the macroeconomic level, reducing the deficit from the current 9% of GDP to a more manageable 2% to 3% (or even to a balanced state) would keep interest rates from spiraling upward, lead to a stronger dollar, and ultimately to more stability in our economy. A stable dollar could also be helpful in reducing volatility in commodity prices. Additionally, reducing spending would take pressure off to increase taxes, and hard experience shows that taxing faceless corporations is easier for politicians to justify than it is for personal taxes. If the deficit control measures are as successful as they have been in Canada, then it may even be possible to find the means to reduce corporate taxes, as Erskine Bowles and Alan Simpson of the president's commission have suggested. Economic research consistently shows that the best stimulus to modern economies is through tax reduction and returning resources to the private sector, so such a program should raise growth prospects in the long run.

While deficit reduction is a hard job and will take time, recent real-world examples should give hope to the new reformers setting up shop in Washington. And such efforts certainly merit support from the industrial sector because of the many economic benefits which would ensue.

Dr. Duesterberg is president and CEO of the Manufacturers Alliance/MAPI Inc., an executive education and business research organization in Arlington, Va.