Monday, August 23, 2010

Good Deficits ...

-- Posted by Neil H. Buchanan

I recently completed a draft of a new article for law review submission: "Good Deficits: Protecting the Public Interest from Deficit Hysteria" (abstract and full text available here). Regular readers of this blog will not be surprised to learn that the article presents an extended argument against the idea that budget deficits are all bad, all the time. Looking back on how the article reached its present form, however, I am struck once again by the level of insanity that we have reached in the current U.S. policy debate.

As originally planned, the article was going to focus only on the value of deficits in the long-run: deficits that are run every year in perpetuity, to finance public investments in things like infrastructure, education at all levels, technology, pure research, preventive medicine, early childhood nutrition, and so on. Because the economic theory behind this idea is relatively unknown (but actually uncontroversial, among economists who study these things), my original idea for the article was to spend a great deal of time explaining how it is possible for a government investment program to improve long-run living standards, even if it is financed through deficit spending. This involves comparing a government investment project to what it would replace: if it replaces private consumption, then future living standards are definitely improved by the government's investment; and if it replaces private investment, then future living standards are improved if (and only if) the government investment project is more productive than the private investment project that it replaces.

Again, what is notable is how uncontroversial and non-tendentious this claim is, as an analytical matter. I do not bring into the discussion any of the theoretical debates about the "crowding out" thesis: I simply accept as a given that the economy in the long run will trend around full employment (surely a contestable assumption) and that there is a one-to-one trade-off between a dollar spent on government projects and a dollar spent on private projects. The argument is therefore not about whether there is a flaw in accepted macroeconomic theory. (There are many, but that is not the point here.) Just as important, however, the argument is not a variation on a familiar theme in the legal literature, that there is a cool-but-unappreciated economic theory out there that should be imported into the legal literature.

Instead, the larger point is that the American political process has failed to take into account the possibility that government spending can take the form of investment rather than consumption (or, as many would suggest, pure waste). Even if one accepts the most plain vanilla macroeconomic theory, in other words, our policy structures are set up in a way that systematically undervalues public investment -- which means, of course, that we systematically under-invest in public goods.

My original idea in writing the paper, therefore, had been to describe this simple (but largely unknown) concept, to describe why the policy regime in the U.S. has never been changed to take it into account, and to suggest a legal/administrative solution that would force information about public investments into the policy-making process. This would involve discussing not just the theory, but also describing some examples of public investments and their estimated rates of return (pre-school education having, for example, an estimated internal rate of return of 16%), and then describing my proposed administrative solution, which would separate government investment from government consumption (and thus allow high-return government investments to be financed by deficits, increasing their likelihood of being approved).

That is, in any event, where my thinking stood early last year, as I began drafting the article. (The overall idea had been rattling around in my head for years; but it was only last year that I was able to start in earnest to write it down in the form of a law review article.) After writing what amounted to about half the article, however, other interests intervened, and I put the project back in incubation. My plan was to return to the article to build up the discussion with additional specific examples of promising public investments, and to go into more detail about the form and functions of the administrative agency that I wanted to propose.

In the interim, however, the world discovered that the American policy-making process is even more uninformed about basic macroeconomics than we thought. My original plan for the article ignored short-term issues with deficit spending, because I thought (especially in the early days of the Obama administration, when even committed deficit scolds were admitting that deficit spending was a good idea in the face of a near-depression) that there was very little more to say about deficits as anti-recessionary policy (especially when monetary policy is all but tapped out).

With some exceptions, economists had little to say against anti-recessionary deficits. The concern was that such spending be targeted, take effect quickly, and not become permanent parts of the budget. All of those are (important) political considerations, but the basic notion that deficit spending can mitigate economic downturns was about as unremarkable an economic proposition as one could find. Indeed, the supposed turn away from Keynesian economics in the last generation or so was based on the idea that there was nothing new or interesting to say about economic policy in response to business cycle fluctuations, and that too much focus on the increasingly-mild recessions in the U.S. was leading economists to ignore long-run growth. One way to summarize the group-think among macroeconomists over this time would be: "We know how to deal with recessions, especially severe ones; let's now think seriously about how to improve long-run prosperity." (I might be taking a somewhat generous view here, but probably not too much of one.)

We now know, unfortunately, that the U.S. political process is capable of forgetting even the most basic lessons of the past. Even with very prominent economists like Paul Krugman warning people about the infamous double-dip nature of the Great Depression -- brought on by a return to balanced-budget orthodoxy (enthusiastically endorsed by FDR) before the economy had recovered in the mid-thirties -- we now have reached the stage where politicians (including far too many Democrats) are endorsing self-defeating austerity policies, with no economic justification.

Returning to my article this summer, therefore, I concluded that it was not enough to argue simply that the political culture in this country misunderstands, and therefore undervalues, public investments that can improve long-run living standards. The political culture now misunderstands everything about deficits, both in the short-run and the long-run. There are "good deficits" in both time frames, yet policymakers insist that deficits are the root of all evil. (And even those who, like President Obama, favor some good deficit spending, do so weakly and at levels that are far too modest.)

I do not pretend that my administrative solution (which I will not spend time explaining here) would be adopted today. I do, however, know that some administrative solutions have been adopted in the past that continue to discipline the policy process, preventing it from being even more insane. For example, all politicians accept the "scoring" of budget proposals through the administrative structure of the Joint Committee on Taxation, allowing technical expertise to replace politically-motivated economic forecasts. Once we muddle our way out of the current mess, it would be helpful to put more structures in place to prevent future Congresses and Presidents from engaging in yet more manic flights from sound economic policy.