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« on: April 24, 2024, 04:33:03 AM »
The Ongoing Rise of U.S. Debt Amid Geopolitical, Financial and Economic Constraints
Apr 3, 2024 | 18:10 GMT
Political, financial and economic constraints will continue to limit the U.S. government's flexibility in adjusting spending in view of rising defense spending requirements, likely resulting in rising debt levels. In its most recent update of its long-term projections released in March, the Congressional Budget Office projected large fiscal deficits and a continued increase of the debt-to-GDP ratio in the United States driven by increasing entitlement and net interest expenditures. It is unlikely that the projected increase in government spending over the next two decades will cause any financing difficulties, let alone a financial crisis. This is because of the pivotal role of the dollar in the global financial system, the relative attractiveness of U.S. assets and a more favorable growth outlook than in most other advanced economies. Continued large deficits could, of course, lead to higher long-term interest rates, which might then lead the government to rein in the fiscal deficit to prevent too rapid an increase in the debt-to-GDP ratio. The current trend of more modest economic growth, at least compared to two decades ago, and large fiscal deficits will, however, translate into greater constraints on defense spending.
U.S. federal government debt stands at $35 trillion, which translates into more than $100,000 per citizen. U.S. federal government debt has more than tripled since the beginning of the century, increasing from 32% of gross domestic product in 2001 to 96% of GDP in 2023. The CBO currently projects the debt-to-GDP ratio will reach 116% of GDP by 2034 and 166% of GDP in 2054. Federal budget deficits will average about 6% of GDP.
Mandatory spending will increase from 13.9% of GDP to 15.1% of GDP over the next 10 years, while discretionary spending is projected to decrease from 6.4% of GDP to 5.1% of GDP, which would represent a substantial squeeze should it come to pass. If the decline in discretionary defense and nondefense spending were to be evenly split, U.S. defense spending would fall to less than 3% of GDP by the middle of the next decade — close to a post-World War II low.
A fiscal adjustment involving reforms to Social Security would help create more space for significant defense expenditure increases, but such reforms are highly unlikely in the short or medium term. Mandatory spending covers expenditures on entitlement and other programs, including Social Security, Medicare, Medicaid and several other programs related to health care or the elderly, which require Congress to approve separate legislation and cannot be modified as part of the annual budget process. Discretionary spending, on the other hand, is controlled by the annual budget process and pays for the operations of most federal agencies and national defense. It requires annual authorization. Discretionary spending as a share of GDP has declined gradually over time, while nondiscretionary (or mandatory) spending has continued to increase. An aging population makes it more difficult to substantially reduce entitlement spending, as the elderly account for a more substantial share of the electorate each year. Moreover, U.S. voters regard Social Security as almost on par with constitutionally guaranteed rights, making it very difficult to cut benefits or otherwise reform the entitlement program. At a minimum, this will require any entitlement reform to phase in a reduction of expenditure (relative to the baseline) very gradually so as not to upset actual and potential beneficiaries in terms of their accrued welfare benefits — and even this will prove politically difficult. That neither party supports reforming social security and other programs is evidence of these political constraints, with the last significant entitlement reform that sought to balance the books having taken place in 1983.
In FY 2023, the U.S. federal government spent $6.1 trillion. The U.S. federal government spends more than what the Japanese economy, the world's third-largest, produces.
Mandatory spending accounts for 60% of federal spending, discretionary spending for 30% and interest on debt 10%. Discretionary spending includes defense and nondefense spending with defense spending accounting for 13-15% of federal spending (or roughly half of discretionary spending).
As per the 2020 census, 17% of Americans were aged 65 or older. This share will increase to 23% by 2050. In absolute terms, this age group will increase from 58 million to 82 million.
The political, financial and economic constraints on U.S. defense spending will strengthen over time. Economically, high levels of defense spending are detrimental to long-term growth if spending reduces the availability of national savings and investment, which is typically the case. Even if investment represents a significant share of defense spending, it tends not to have much of an impact on civilian economic productivity. In the short run, however, a sharp increase in defense expenditure can help boost economic growth, particularly in the presence of ample spare capacity. Increased defense expenditures need to be financed through higher debt, increased revenues or budget cuts in other areas. With more resources allocated to consumptive defense spending and no offsets elsewhere, savings and investment will fall, and economic growth will suffer over the medium to long term. Faced with increased geopolitical competition, the need for increased defense spending will make for painful economic, financial and political choices, while increased defense spending (as a share of GDP) will weigh on the longer-term growth outlook. While none of this means that the United States will not be able to increase defense expenditure, it does mean that the economic, financial and political trade-offs and constraints will become more important over time.
In the short run, the government can almost always mobilize massive resources to support defense spending if flanked by appropriate economic and financial measures, such as capital controls, central bank purchases of additional debt issuance, increased taxes or reduced expenditures elsewhere. In 2023, U.S. defense spending (including Department of Energy spending on nuclear weapons) was 3.5% of GDP. In 1953 (during the Korean War), U.S. defense spending reached 11.3% of GDP; in 1968 (during the Vietnam War), 8.6% of GDP. In 1999, it fell to a post-1940 low of 2.7% of GDP before increasing again to reach 4.5% of GDP in 2010 (during the Afghanistan and Iraq wars). Defense spending exceeded 40% of GDP during World War II.
In the long term, however, there are economic limits to defense spending. The reduction of defense spending following the end of the Cold War led to the so-called "peace dividend" that allowed for lower government spending, higher national savings and lower interest rates. Unsustainable defense spending meanwhile drove the USSR into economic stagnation, financial failure and ultimately political collapse.
The United States remains the world's top military spender by a wide margin, but Chinese defense spending has been increasing rapidly on the back of rapid economic growth, which, in turn, is putting increased pressure on U.S. military spending. A decade or so ago, the United States spent more on defense than the rest of the world combined. Today, measured in current dollar terms, U.S. expenditure continues to account for nearly 40% of global spending, while China accounts for less than half of U.S. spending. The size of defense spending matters, but it is not everything. Several caveats apply. First, comparing military spending — even if adjusted for purchasing power parity to capture the effective spending power — is difficult, as different countries include and exclude different defense-related spending categories and items, and some countries' defense expenditure figures lack transparency. Second, even with a purchasing power parity adjustment, it is not obvious that one dollar of defense spending buys an equivalent amount of security. Leaving aside that security is a relative concept, even purchasing power parity is an imperfect metric to compare spending, both in quantitative and qualitative terms, even when adjusted for purchasing power. This is due to differences in terms of what the money is spent on as well as what adjusted dollars can buy, given that advanced military technology is not necessarily traded on international markets and local production costs differ, and sometimes certain defense-related technologies are unavailable for comparison. Moreover, not only what the money is spent on matters, but how it is spent, as well as the ultimate strategic value one gets. For example, directing funds to procurement and development rather than spending them on veterans' pensions or outdated platforms is likely to increase security, particularly in the longer term, and translate to greater military effectiveness.
The United States accounts for almost 40% of global military spending. China and Russia account for a combined 17%, with China accounting for 13% and Russia for 4%. The so-called Big Four European countries account for 9.5%, compared to Russia's 3.9%.
In 2023, U.S. defense expenditure accounted for 3.5% of GDP and China's official defense expenditure for less than half at 1.6% of GDP. Due to much more rapid underlying economic growth, Chinese defense expenditure has been growing much more rapidly in dollar terms without translating into higher expenditure as a share of GDP.
When comparing U.S. and Chinese defense expenditures, it is important to take into consideration differences in terms of force structure and military posture. The U.S. has worldwide commitments and a costly and extensive global security footprint. China does not, and its military forces are geographically much more concentrated. Military spending should therefore at best be seen as a proxy for defense capabilities. In this sense, the political and economic costs the United States faces to increasing defense expenditure act as a constraint. Yet this constraint can be alleviated, at least partly, via means other than increasing defense spending, including better resource allocation. In the long term, however, significant differences in spending will affect the military balance, especially in East Asia.
In current dollar terms, the United States spent a little less than $900 billion and China $300 billion on defense. In 2010, the United States spent $740 billion, compared to Chinese spending of $100 billion. In purchasing power parity terms, Chinese defense spending was about two-thirds of U.S. spending.
In addition to faster economic growth, China has also greater scope to increase defense spending as a share of GDP without jeopardizing its long-term economic outlook because it has excess savings and limited profitable investment opportunities. This should allow it to convert its excess savings into military consumption without unduly undermining the long-term growth outlook; the United States is far more constrained in this respect.