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Does Better (and Maybe Bigger?) Government Require Giving Up on Deficit Reduction?

August 4th, 2008 . by economistmom

The short answer is “no.”

My last two posts mentioned a National Journal interview of House Appropriations Committee Chairman, David Obey (D-Wisconsin), and his critique of fiscal hawks as preoccupied with the federal budget deficit when there are much more pressing “deficits” to attend to.   As Chairman Obey puts it (my emphasis added):

I am very, very tired of one-dimensional politicians who simply talk about the deficit. In fact, we’ve got a hell of a lot of deficits. We’ve got a budget deficit. We’ve got an education deficit. We’ve got a health care coverage deficit. We’ve got a scientific research deficit. We’ve got an infrastructure deficit. This country has neglected for a long time so many of the basic investments that we need to make this country strong over time. And we also have an equity deficit, a fairness deficit. I want to know that we’re going to attack all of them.

The number that counts economically is not the year-to-year deficit number. If you have the heart of a CPA, then that’s the only thing that matters to you. But if you are a public policy person trying to figure out how to strengthen this country and how to strengthen the ability of this economy to produce for everybody in the economy, then you need to look at things in a hell of a lot broader way.

Chairman Obey goes on to explain that:

…When Henry Ford decided he was going to mass-produce cars, what’s the first thing he did? The first thing he did was to raise the wages of his workers to five bucks a day. He did that not because he was altruistic, he did that because he knew that you had to pay people good wages in order to get quality workers. Secondly, he knew that you had to create the ability for consumers to actually buy things. The economy doesn’t function if people can’t buy things, if they can’t afford to. And so he took the action that most businessmen should have taken in stimulating the ability of consumers to afford to buy whatever is produced. That example was not followed by a hell of a lot of people.

Well, yes, I know… you can see there’s a “hell of a lot” of Chairman Obey’s attitude in that interview…

But the point is that Chairman Obey is suggesting that having fiscal responsibility as a policy goal runs contrary to those other goals–such as adequate investments in our public goods and services, and a higher standard of living that’s broadly shared among Americans.

And Joe Klein, in this week’s Time magazine, seems to be suggesting a similar tradeoff, in his column on “The Recession Election” (again, my emphasis added):

[O]n July 28, Barack Obama held an economic summit with his covey of advisers — people like Bob Rubin, Larry Summers, Warren Buffett, Bob Reich; experts who seemed a sedimentary layer more recent than McCain’s crowd but still more a part of the past than of the future. They had cleaned up the Reagan-era mess. They had actually balanced the budget and created a surplus. They had — contra voodoo — raised taxes and yet produced an economic boom. There was a fair amount of argument behind closed doors, I’m told, between the two groups that sparred at the dawn of the Clinton era, the deficit hawks and the populists. In the end, though, there was a general agreement on the need for more government activism. Obama isn’t even pretending to balance the budget. His claim to pay for the things he proposes rests on loaves-and-fishes premises, especially the prospect of a Congress mesmerized into acquiescence on controversial issues like raising taxes to Clinton-era levels and closing corporate loopholes. But Obama’s economic proposals — especially the $21 billion per year he wants to spend on alternative energy and infrastructure projects — represent an acknowledgment that the economic conversation has to change, that the old order faileth.

I disagree with the suggestion that fiscal responsibility means setting aside those other priorities–in fact, I believe that those other priorities are exactly why fiscal responsibility is needed.  What our government needs to be spending more federal resources on–be it infrastructure, health care, education, or income security–is a separate consideration from how that additional spending should be financed.  There’s no reason to think that deficit-financing is a necessary part of a more “activist” government that “does better” for the people–even if such government is defined as bigger as well as better.  In fact, those other economic goals Chairman Obey lists–greater investments, higher real wages, and increased standards of living, are all best accomplished through higher national saving–i.e., reducing budget deficits, not increasing them.

Fiscal policies that require deficit financing in the proper execution of their economics are rare, unless you’re talking about short-term (countercyclical) fiscal stimulus rather than fiscal policies designed to produce longer-term economic benefits.   (Even then, in theory at least, one could design a countercyclical fiscal policy that did not add to the budget deficit, by simply redistributing income from the rich to the poor.  It’s also likely that short-term stimulus that is fiscally responsible over the longer term would have a bigger short-term stimulative effect than a similar policy that involves longer-term increases in the deficit.)

Now, I will admit it may be true that fiscal policies execute better politically when deficit financed, as that seems to create only “winners”–at least among current voters.  (That’s why deficit reduction is not a great issue to campaign on, even though it’s critical for the policy agenda of the next President, once he’s in the White House.)

Taking a fiscally-disciplined approach in pursuing those broader policy goals is likely to increase the chances that such policies will “succeed” in achieving those goals, even apart from the benefit from greater national saving and a richer economy from which to draw.  That’s because trying to live within a budget constraint forces more thoughtful policies, as we’re more likely to seek to maximize economic “bang per buck,” to prioritize our most critical spending needs, and to find the most efficient ways of raising revenue.

So fiscal discipline should not be considered a roadblock to better government, as in fact, better government can be encouraged by fiscal discipline.  Abandoning fiscal discipline would allow us to indiscriminately expand government, making it all the more likely that “bigger” would come without ”better”–and with the costs of those sub-optimal policies pushed off to our children and grandchildren.  A more thoughtful consideration of this better (and maybe bigger) government we desire would be one that comes up with a government we conclude is worth paying for.  And if at the same time such fiscal responsibility helps keep national saving and our economy strong, then paying for it becomes even easier over time.

13 Responses to “Does Better (and Maybe Bigger?) Government Require Giving Up on Deficit Reduction?”

  1. comment number 1 by: johnchx

    Agreed: I’ve always found it a little embarrassing that “my side” seems so eager to admit that the public will never accept the taxes required to finance the spending programs we favor. Strangely, it’s cold comfort that “the other side” has admitted that the public would never accept the spending cuts required to bring outlays into line with revenues generated by the current tax structure — let alone the lower taxes they insist we should have.

  2. comment number 2 by: Jeffrey

    The premise that bigger government can be better is absurd. By definition, bigger displaces the private and the individual; the whole purpose of the American revolution. By definition, the government is political which precludes efficiency. Too many consitituencies have to be mollified which rules out the ability for hard choices. The idea that we can manage and tweak our way to prosperity from above has been shown to be an historically losing proposition (think of all the great command economies like the Soviet Union, Cuba, etc). Your arguement continues to be that we have to live within your means. And what is your presciption? Raise taxes. That’ like a household saying it needs to live within its means and then goes out and demands a raise! Part of the beauty of the federal system is the natural laboratories of the states. And low taxes promote growth while high taxes inhibits growth. Even blue Massachussetts is beginning to see the light!

    http://online.wsj.com/article/SB121789224035011709.html?mod=opinion_main_review_and_outlooks

  3. comment number 3 by: Brooks

    Diane,

    While I wholeheartedly agree with and applaud your message, I’d like to point out that there is a theoretical argument – emphasis on theoretical — to address: that it is possible, in theory, that incremental, deficit-financed spending on X would be better for the nation (or world) over the long term than forgoing X and even better than financing X via incremental taxation. That’s why businesses borrow when they see opportunities with positive NPV if they lack the cash to pursue those opportunities. And it’s why, from a utility perspective, people borrow to buy a home rather than saving up cash over decades and then purchasing a home (essentially, buying the home via a mortgage yields positive NPV in terms of utility).

    Having said that, in reality, our fiscal outlook is such that, at least as a general rule, we will be much better off paying (now) for what we spend, for all the reasons you provided. But the point is the negative NPV for the nation of deficit-financed spending – in terms of both numbers and utility – and I think that’s an important case to make to the American people (although not literally in terms of “NPV” for a mass audience).

  4. comment number 4 by: economistmom

    Brooks: yes, indeed, having debt finance available to us–both publicly and privately–is better than NOT having it available. It allows us to “smooth our consumption possibilities” (as economists might say). But “smoothing” implies we’re aware of the cash flows in the future that we’re just “smoothing”, so that we can evaluate that it’s feasible to pay off that debt in the future–and so determine that choosing to pay for it later rather than sooner in fact maximizes that “NPV” of the investment. The problem is that the federal government doesn’t make the kind of economic calculation required for deficit-financing to be a choice that makes sense from a NPV perspective. Too often deficit financing is treated as a way NOT to pay for things, rather than a way to pay for things over time. And too often it’s NOT the case that there’s no other way to fund the desired spending, and that the deficit-financed route–as you said–ends up turning what would have been a positive NPV project, into a negative one.

    There are analogies one could make to the budgets of ordinary families and how debt can be used wisely, or not… For example, we might think hard about the best way to finance our children’s college educations, and do lots of calculations using the interest rates and terms of various loans, comparing with the option of tapping into current savings that might involve withdrawal penalties, etc… and then at the same time we might not blink an eye at carrying credit card balances and running up that debt to take advantage of a sale on a flat-panel TV. Not that I’d know anyone who would do that… ;)

  5. comment number 5 by: Blue Dog Staffer

    Bravo. I’ve heard this “one-dimensional” criticism a lot lately, and its follow-along that fiscal responsibility is somehow cruel (or, I suppose, CPA-hearted).
    Chairman Obey is right that many basic investments have fallen down the ladder of national priorities. But that’s just the point of those of us who are trying to promote deficit reduction. In order to be truly responsible - fiscally and otherwise - a real conversation about priorities must occur. Whether to make government bigger or smaller, while related, misses the mark. It ignores that some investments don’t exactly perform, or are sub-optimal, as you say. Just look at tax expenditures.
    The fact is, like it or not, we measure all of the deficits Chairman Obey refers to in dollars. They all come back to the budget. We can not make government efficient and equitable without coming to terms with the central mechanism that links them all together. If that’s one-dimensional, then so be it.

  6. comment number 6 by: Brooks

    Diane,

    Yes, absolutely (and well said).

    And it’s important to get the American people to recognize that negative NPV and to understand, appreciate and feel the magnitude of that negative the NPV in terms of both numbers and utility — the equivalent of getting a consumer or business owner who is considering taking on excessive debt relative to projected cash flows to envision the adverse impact of the resulting debt burden over time, such that he/she can see that, on balance, it’s an awful deal.

    As a mom, you probably have better analogies than the following, but they say that one way to distinguish the level of maturity of a child is to watch him/her eat a cupcake. The less mature child will lick off all the frosting, then be disappointed, frustrated, sad, and (perhaps) regretful. The more mature child will anticipate the consequences and overall utility of his/her options, and will opt to eat frosting and cake together.

    When it comes to fiscal policy, we are largely a nation of frosting-lickers. Fiscal responsibility will come when a lot more Americans can see that unless we change course, we’ll end up with some incredibly icky, dry, bland, frostingless cake. Yuck!

  7. comment number 7 by: economistmom

    “When it comes to fiscal policy, we are largely a nation of frosting-lickers.”

    Brooks: are you sure you’re not a mom? Love it…

  8. comment number 8 by: M Gilleland

    As context for the debate over the size of government, George Will frames the struggle between conservatism and modern liberalism in this online video and podcast: http://www.cato.org/event.php?eventid=4975, specifically the section from 10min to 13min on the podcast.

    His key insight is that the majority of Americans feel more and more that their individual and family security is threatened by globalization (”capitalisim on steriods”) despite the greater prosperity that it brings…and thus are turning more and more to the government to provide security. Prior to this period, George believes that most Americans saw increased security AND prosperity through capitalism (rather than collective action through government.)

    Draw your own conclusions about whether it is wise to seek security mainly from the government or your own self, family and friends (and insist that the government kindly step aside). Either way George frames the issue beautifully and notes BOTH the cultural contradictions of capitalism (Daniel Bell) and what George sees as the cultural contradictions of the welfare state. Pick your poisen.

  9. comment number 9 by: economistmom

    M — seems related to this Steven Pearlstein column from last Friday’s Washington Post:
    http://www.washingtonpost.com/wp-dyn/content/article/2008/08/01/AR2008080102977.html

  10. comment number 10 by: Brooks

    M Gilleland and Diane,

    What’s old is new. Reminds me of the chapters “Economics and History” and “Socialism and History” in Will & Ariel Durant’s The Lessons of History http://www.amazon.com/Lessons-History-Will-Durant/dp/1567310249/ref=sr_1_3?ie=UTF8&s=books&qid=1217999538&sr=8-3 , published in 1968, but timeless. I highly recommend it, and not only for those chapters. A lot of insight packed into only about 100 pages.

  11. comment number 11 by: B Davis

    Brooks wrote:

    While I wholeheartedly agree with and applaud your message, I’d like to point out that there is a theoretical argument – emphasis on theoretical — to address: that it is possible, in theory, that incremental, deficit-financed spending on X would be better for the nation (or world) over the long term than forgoing X and even better than financing X via incremental taxation. That’s why businesses borrow when they see opportunities with positive NPV if they lack the cash to pursue those opportunities. And it’s why, from a utility perspective, people borrow to buy a home rather than saving up cash over decades and then purchasing a home (essentially, buying the home via a mortgage yields positive NPV in terms of utility).

    I agree that we need to have some way to distinguish between deficit spending that funds pure consumption and deficit spending that funds investment which is likely to provide significant returns. That’s one reason that I find the The Financial Report of the United States Government interesting. It uses accrual-based accounting and attempts to measure the government’s liabilities versus its assets. In order to get a better understanding of it, I crunched the numbers from the last ten reports and posted the results here.

    Having said that, in reality, our fiscal outlook is such that, at least as a general rule, we will be much better off paying (now) for what we spend, for all the reasons you provided. But the point is the negative NPV for the nation of deficit-financed spending – in terms of both numbers and utility – and I think that’s an important case to make to the American people (although not literally in terms of “NPV” for a mass audience).

    True. It may also be helpful to address some of the other more common views of deficits that seem to be out there. One might be called the “free lunch theory”. If we can just continue to roll over our debt and borrow the additional money required to pay the interest on that debt (and maybe a little extra), we can theoretically continue without paying any obvious price for our debt. I think that simple mathematics would show that such a course would eventually lead to unsustainable, exponential growth in the debt. However, I’ve never heard this theory directly addressed and it might be useful to run the numbers.

    Another theory is that future generations will have so much higher a standard of living than us, that we should be able to “borrow” against that future prosperity. Concerning this theory, it might be useful to look back at what might have happened if our forefathers had subscribed to this theory and chosen to saddle us with a much larger debt. We might have not had the borrowing capacity to handle the huge expenses of the Second World War and other emergencies that have occurred before or since. For this and other reasons, I’ve always thought that we should leave any future prosperity to be employed by those in the future just as our forefathers generally left our prosperity to be employed by us. In any case, there seems to be no shortage of excuses for why we need to run deficits so I think that we need to address all of the reasons, the good ones as well as the bad.

  12. comment number 12 by: economistmom

    Brooks: Hey! I think my parents had that Durant book in our house when I was growing up (probably an original 1968 copy)–seeing the title and authors just sparked a deep corner in my memory!

    (Hey, Mom–that would be EconomistMom’s Mom, I bet you still have it?….)

  13. comment number 13 by: Brooks

    Sounds like your parents were wise folks, both as a cause and effect of getting that book.

    Several years ago I had one of those “sparks” of a “deep corner in my memory” about a book. I saw a TV ad featuring those monsters from Where the Wild Things Are, and I felt a slight chill and said “Holy Sh*t! I had totally forgotten about those awful things!” I remembered my mom reading that book to me after tucking me into bed when I was very little — and scaring the living hell out of me. The kid in the story goes to sleep and his bedroom turns into a dark, scary forest with huge, horrifying monsters — and that’s a good book for a bedtime story?? What kind of sick, twisted, sadistic mommery is that?? ;)