Tuesday, July 21, 2009

Under What Conditions Would I Conclude That Deficits Are Bad? Part 2

Last Thursday, in a post extending the analysis of my most recent FindLaw column, I asked whether the arguments that I regularly make in opposition to the conventional wisdom about federal budget deficits might have become my own version of conventional wisdom. The best way to answer that question is to ask whether there are any circumstances in which I would change my position and agree that budget deficits are bad. If not, then these arguments would be little more than a catechism, uncritically accepted as true.

In that post, I confronted the first of the two arguments that I outlined in the FindLaw column, examining the arguments for and against deficit spending during an economic downturn. I concluded that the real issue is whether deficit spending would tend to reverse the momentum of the economy, slowing job losses or (more optimistically) adding jobs as the economy changes course in response to the stimulus created by (certain types of) government spending and (certain types of) tax cuts. Near the end of the post, I wrote: "One should never, therefore, be 'pro-deficit,'" suggesting that the deficits are a side-effect of the only appropriate policy responses to a recession, not the preferred policy itself.

I should make clear that a parallel point is also true: One should never be "anti-deficit," either. If the choices that we face suggest that the best policy involves running a deficit (or a larger deficit), then so be it. Today, I will add that even when the economy is not in a recession, the choices that we face will literally always lead an open-minded policymaker acting in the interests of current and future citizens to enact policies that will result in deficit spending. In that sense, therefore, good policy will always involve some deficit spending. Again, however, the deficits are a consequence of good policy choices, not the policies themselves.

This analysis, by the way, in no way implicates the arguments in my work on intergenerational justice (discussed here, among other places), in which I call into question the twin beliefs that current generations are obligated to make sacrifices for future generations and that we are not currently meeting any such obligation. The issue here is much more simple: If the economy is relatively healthy (not in a recession, roughly speaking), then there will be spending programs uniquely available to the federal government that will have long-term payoffs, such that borrowing to finance those initiatives will increase future living standards notwithstanding the debt that we take on in the process.

Put differently, some things are so valuable that it makes sense to borrow money to buy them. Again, the logic of this proposition is so obvious that it is simply shocking to see how willfully blind politicians and pundits are willing to be when it comes to deficits. The late, great economist Robert Eisner often wrote about giving speeches to civic groups in which he would first ask whether the people in his audience thought that borrowing is a bad idea. Everyone would raise their hands, and he would then ask how many people in the room had borrowed money to buy a house, how many had borrowed money to send their kids to college, how many had borrowed money to finance a life-saving operation, to start or expand a business, etc. Did anyone think that their purchases had been foolish, given that all of them involved running deficits? Of course not.

The federal government, of course, is different from a family and different from private businesses; but the differences actually strengthen the case for deficit-financed spending rather than weakening it. Unlike people (but like businesses), governments have no expected date of death, meaning that there is no need to wind down debt in anticipation of retirement. More importantly, governments can operate under longer time horizons that allow them to engage in investments that might pay off in decades rather than during the next quarter or fiscal year, and they can make those investments without worrying (as businesses must) about preventing the benefits that will flow from their investments from being enjoyed by other members of society.

Thus, for example, while businesses and families certainly understand that they will be better off if everyone has a minimum level of education, private actors must use the government to overcome group action problems and other barriers to investing in mutually beneficial projects. Basic research in the arts and sciences, public health initiatives, transportation improvements, etc. all fall into this category.

To return to the question motivating these posts, then, when would deficit spending be unacceptable? Again, a simple cost-benefit approach is really all we need to answer that question. If there were no investment opportunities available to the federal government that promised rates of return greater than the cost of borrowing, then deficit spending would be a bad idea. Even if some such projects exist, of course, that is not a license to run deficits to finance projects that do not have sufficiently high returns.

Of course, as the government expands its borrowing during prosperous times, it does so at the expense of possible investments by private businesses. That, however, is what financial markets are for. If lenders (domestic or foreign) begin to require a higher rate of return from borrowers, fewer investments -- both private and public -- will make sense. Governments will finance only those projects with rates of return that continue to exceed borrowing costs, as will private businesses. The worry that "the Chinese" will stop lending to us, or that government crowds out private business, is not a separate concern. Such concerns will be mediated by fluctuations in interest rates, and the resulting allocation of borrowing between private and public uses will be sensible so long as both government and business apply cost-benefit rules appropriately.

Not all government investments will pay off. Not all private investments pay off. The fact is, however, that there will always be government projects available with rates of return that exceed borrowing costs (which are a proxy for the rates of return of the private investments that would be crowded out). That means that there will always be a reason to borrow money to finance those projects. Doing so does not burden future generations, because it makes them more than rich enough to pay for the inherited debt.

I wish that something in this post were breathtaking or innovative. The fact, once again, is that some deficit spending is good. Other deficit spending is bad. The issues are complicated enough that demagogues can play on people's fears with unfounded claims of economic ruin. People should not allow those fears to undermine sound economic policy.

-- Posted by Neil H. Buchanan