This is the thinking, known in Washington as “cut and grow,” that Republicans have cited since 2010 to support their push for federal spending cuts. At times, party leaders have seemed to back away from it, warning that defense cuts could devastate the economy, for example. But the theory continues to carry large sway among conservative voters who cheered the sequester cuts and urged GOP leaders to allow them to start taking effect earlier this month.
Now, the academic godfathers of “cut and grow” say recent economic indicators are proving their theory correct. The Standard & Poor’s 500-stock index is up 9 percent since Jan. 1. Consumer spending remains higher than many forecasters expected. Nonresidential fixed investment rose by nearly 10 percent in the fourth quarter. The labor market added 119,000 jobs in January and 236,000 jobs last month.
“What could explain the booming stock markets, the latest data on private investment in the fourth quarter of 2012 and the January employment data?” Alberto Alesina, a Harvard professor who has written several papers suggesting that budget cuts done correctly can lead to better growth, wrote in an e-mail last week. “Sure the budget cuts [had] not taken place yet but investors and companies look into the future when they hire. Given that the future implies budget cuts, it must mean that they welcome them.”
To which many economists say: No. It does not mean that.
“There are plenty of other reasons why the stock market is up that have nothing to do with the U.S. budget,” said Arjun Jayadev, an associate professor at the University of Massachusetts at Boston who co-wrote an economic critique of Alesina’s work in 2010. “This is an old argument,” he added, “and I don’t think there’s any evidence that supports it.”
Alesina in recent years has written several papers, with a rotating crew of co-authors, that suggest deficit reduction that relies heavily on spending cuts and lightly on tax increases can lead to more investment and growth. His work highlights countries where growth increased after a substantial fiscal contraction, and it finds that the most successful growth rebounds occurred in countries that relied more on spending cuts than tax increases to reduce the deficit.
No advanced economy has proved Alesina correct in the wake of the Great Recession.
U.S. growth did not surge after Republicans won spending cuts in the spring of 2011, nor after they and President Obama agreed to the Budget Control Act — which eventually led to the sequester — later that year.