Beware the COVID-19 Debt Hangover

Biden's proposed stimulus spending might give a modest boost, but in the long run it'll slow the economy.


After the rush, brace yourself for the hangover. That's the warning from experts with the University of Pennsylvania's Wharton Business School, who caution that plans for massive "stimulus" spending by the Biden administration will administer only a brief boost to the country followed by a nasty and prolonged comedown.

The White House objects to the forecast, but it squares with earlier predictions from the Congressional Budget Office that accumulated debt, worsened by heavy pandemic-related spending, will hobble the economy for years to come.

President Joe Biden's proposed $1.9 trillion relief package would increase economic growth by 0.6 percent in 2021, according to analyses by the Penn Wharton Budget Model (PWBM). After that, though, it would start to slow the economy, decreasing GDP by 0.2 percent in 2022 and by 0.3 percent as late as 2040, showing lingering negative effects after the initial spending.

The big problem for the longer-term outlook is "the large amount of additional money that we're adding to our already very large debt," according to Efraim Berkovich, PWBM's director of computational analysis. "The existence of the debt saps the rest of the economy. When the government is running budget deficits, the money that could have gone to productive investment is redirected."

U.S. government debt is already sky-high, having increased by $7 trillion dollars in the last four years alone to reach 100 percent of GDP at the end of 2020. That burden threatens to act as a dead weight on economic growth.

Unsurprisingly, the Biden White House takes exception to Wharton's gloomy forecast. Press Secretary Jen Psaki insists the prediction is "way out of step with the majority of studies on this plan." In particular, she complains "the analysis concludes that our economy is near capacity, which would be news to the millions of Americans who are out of work or facing reduced hours and reduced paychecks."

In response, the Wharton analysts point to ongoing recovery in many sectors. They also point out that continuing lockdowns prevent some production and employment that would otherwise occur.

"[R]ecovery in the affected sectors is limited by pandemic-related shutdowns and individual behavior," they wrote. "There is no mechanism by which additional household spending will stimulate those sectors until pandemic-related restrictions ease."

Unemployment claims unexpectedly increased last week to 861,000. The official unemployment rate of 6.3 percent remains above its pre-pandemic/pre-lockdown rate of 3.5 percent (just one year ago!). But that's a steep drop from the April peak of 14.8 percent.

Industrial production, too, at 75.6 percent of capacity in January, remains about 4 percent lower than it was a year ago. But it's higher than it was just a few years ago and steadily rising. "At 107.2 percent of its 2012 average, total industrial production in January was 1.8 percent lower than its year-earlier level," according to a February 17 Federal Reserve update. So, while the economy isn't entirely back, it's moving in the right direction—a process that could be interrupted by massive government spending.

"[E]ffectively, what we're doing is taking money from [some] people and giving it to other people for consumption purposes," notes Berkovich of stimulus schemes. "That has value for social safety nets and redistributive benefits, but longer-term, you're taking away from the capital that we need to grow our economy in the future."

Stimulus spending also has the potential to delay the inevitable shakeout as businesses and workers scramble to adapt to a changing environment. Both the McKinsey Global Institute and the Bureau of Labor Statistics recently published studies predicting that remote work is here to stay for many people.

"In the moderate impact scenario, increased telework is the primary force of economic change and has both direct and spillover effects," notes the BLS report. "With more employees teleworking, the need for office space will decline, and so will nonresidential construction."

That's going to necessitate a lot of adjustment in sectors including restaurants, travel, and commercial real estate; government checks just delay the day of reckoning. That is already a problem in Europe, where economists and business owners worry that subsidies prop up "zombie" companies that would otherwise disappear and clear the way for healthier enterprises.

"These zombie companies…run their business for a couple of months below costs," Alexander Alban, managing partner at German mechanical parts manufacturer Walter Schimmel GmbH told the Wall Street Journal. "They ruin the market. Afterwards, it's very hard to get this business back. Usually it's good if the market is cleaned."

The result is a poorer and less-productive economy than would have existed in the absence of government spending sprees. That's in addition to the depressing effects of deficits and debt.

In analyses predating the latest stimulus proposals, the Congressional Budget Office voiced concerns similar to those of the Wharton Business School about debt-fueled spending.

"CBO estimates that the legislation will boost the level of real (inflation-adjusted) gross domestic product (GDP) by 4.7 percent in 2020 and 3.1 percent in 2021," according to a September 2020 report forecasting the impact of pandemic-related federal spending. "From fiscal year 2020 through 2023, for every dollar that it adds to the deficit, the legislation is projected to increase GDP by about 58 cents. In the longer term, the legislation will reduce the level of real GDP, CBO estimates."

That is, the CBO predicted two years of benefit, followed by each dollar spent producing far less than its value in return. The ultimate result is a smaller economy than would have existed without the addition of trillions to the national debt.

"The legislation will increase federal debt as a percentage of GDP, and in the longer term, CBO expects that increase to raise borrowing costs, lower economic output, and reduce the income of U.S. households and businesses," adds the CBO.

With the House of Representatives poised to consider the stimulus package as early as next week, we may soon have an opportunity to find out just how bad the hangover will be.