Covid War

It was recently announced that the US government deficit for fiscal year 2020 was $3.1 trillion, or 16.1% of the nation’s output for that year. In the previous year, it was a more normal, but still large, 3.1% of GDP. It averaged about 4% of GDP over the past 10 years. That’s quite a hop to 16.1% in 2020. The government deficit is defined as government spending minus government revenues. The main reason the deficit went up so much in FY 2020 was the 47% increase in government spending. You heard that right. The Federal government decided to spend almost 50% more in 2020 than in 2019.

Each annual deficit must be funded – so this means we added $3.1 trillion to our national debt. Our national debt is now more than 100% of the size of the whole economy. The figure for FY 2020 is 102%. We have not had such a large debt in the last 75 years. Around 60% might be considered normal.

One could say that Covid 19 is as serious as a world war. If we could have large deficits and debts in the 1940s, then it should be okay to have large deficits and debts in 2020. While I have argued in this blog that we might have spent less to save us from Covid 19, I won’t belabor that point here. My point today is about what happens next. Our political parties are arguing now about whether or not to add either another trillion (or so) or another three trillion (or so) to the debt.

Once our government saves us from Covid and recession, what will happen next? I decided to go back 75 years and ask what it was like in the US when the world war was over and how we addressed our huge debt of that time period. Maybe we can learn from history?

Below is a table I put together using data from several US government sources (Congressional Budget Office and the Bureau of Economic Analysis). The data start in September 1940 and go through 1955. World War II went from September of 1939 through September 1945. The Korean War kicks up then and goes to around 1953, but that war is not the topic for today.

The data in the table going from left to right are: Federal government expenditures as a percent of GDP, Federal defense spending as a percent of GDP, Federal government revenues as a percent of GDP, Federal government deficits as a percent of GDP, National debt as a percent of GDP, and the annual percentage change in real GDP.

What do we see?

            Defense spending went up dramatically in two years – in 1941 it was 418% of GDP and in 1942 it was 256%. We definitely went to war!

            Total government expenditures also increased rapidly and were growing at 40% per year by 1943, 1944, and 1945.

            While tax revenues also went up in those years – they did not go up as much, so we see huge increases in government deficits from 1943 to 1945 and similar increases in national debt in those years. The debt as a percent of GDP rose from 52% in 1940 to 119% in 1946.

            The table shows that it took until 1955 for debt as a share of GDP to return to 67% of GDP. It took at least 10 years to go back to pre-war levels. Focusing on the deficits column you see there were mostly annual surpluses after 1956, some near-balances, and only two years of small deficits.

            Upshot: To get back to something like “normal” debt, it took a decade of surpluses or budget balances.

            We also see in the chart how real GDP reacts when governments increase debt – during the war we had high double-digit increases in national output. That economic strength did not last, however, as you see pretty much 5 years of negative or near negative growth starting in 1945.

That’s lots of information to process, but what I see is that it takes time to reverse extreme cases of government deficits and debts. I also see that reversing them causes recessions. I also see that it took a long period of austerity in budgets to bring us back to normalcy.

My question to you: Will the aftermath of the war on Covid 19 be like the aftermath of WWII? Will our politicians, after fighting the war fiscally, move to several years of annual government surpluses? Will they do the hard things necessary to restore the economy? If they don’t, what will our economic growth be after, say, 2022?