Under What Conditions Would I Conclude That Deficits Are Bad?

In a FindLaw column that was posted yesterday, I discuss in some detail two arguments in favor of deficit spending: (1) During an economic downturn, deficits are appropriate and necessary (and beneficial) as a way to push the economy back in the direction of prosperity and full employment, and (2) At all times, deficits can be used to finance public investments such that the income that those investments produce will exceed the interest on the debt that is incurred to finance those investments.

Both of those arguments are relatively uncontroversial among economists, though they remain (mysteriously) unknown to the public and politicians, making it necessary for people like me to repeat those arguments in as many public forums as possible. (I might also note that the latter argument is the starting point for my next law review article, on which I am busily working when I am not blogging or learning how to get around the teeming metropolis that is Ithaca, New York.)

As always here on Dorf on Law, a FindLaw column is paired with a discussion of a related issue that did not arise in the column itself. Because my column puts in current context arguments that I have been making for well over a decade (and that the majority of macroeconomists have been making, in one form or another, for over half a century), it occurred to me that it is possible that I am simply being either stubborn or insistently out of touch -- that I am, in other words, repeating these arguments not because they are true or currently relevant but because they are simply familiar and comfortable. What would it take for me to change my mind? Given that I view myself as a pragmatist and an empiricist, what reality-based arguments or evidence could make me oppose deficit spending?

Regarding the short-term stimulative impact of counter-cyclical deficit spending, the question is whether the harms (if any) of that deficit spending exceed its benefits (if any). My support for deficits during downturns is essentially rooted in my belief that deficit spending will create economic activity that would not otherwise have occurred and that the additional federal debt incurred in the process does not create harms that outweigh the short-run benefits.

Therefore, if there were evidence that deficits during recessions do not result in increased economic activity, then that would be a reason to oppose deficits. This can only happen, however, if the deficits are incurred by giving money to institutions or people who will not use the money to produce things or to hire people. This means that deficits are a bad idea if they are spent on people or things that do not add to economic activity. For example, if the federal government were to run a deficit (borrow money) in order to buy a large tract of land from someone who then sits on the money, the sale (and the resulting deficit) would be pointless. Similarly, if the government were to cut taxes for people who will not spend that money, that would be a bad deficit.

Notably, this does not mean that deficits during recessions are bad if the money is spent to create jobs that produce nothing useful. Keynes's famous (and sarcastic) example of paying people to bury tubes of money, followed by entrepreneurs forming companies to hire people to dig up the tubes of money, was based on the idea that the people receiving money for doing something silly would spend that money on food, rent, etc., which will multiply as it ripples through the economy. The recipients, in other words, will not sit on the money but will spend it to keep themselves alive, resulting in other people's economic prospects improving as well.

Even if the borrowed money is spent, however, it is possible that the addition to the national debt will result in harms that exceed the benefits of mitigating the recession. This would be the case if the borrowing resulted in the diversion of economic resources from better uses to worse uses. Hiring people to bury tubes filled with money, if they would otherwise have been producing food, would be harmful in the short run (unless there is a glut of food, as sometimes happens during downturns). Hiring people who would have been performing cancer research would be harmful in the long run. Since the whole point of stimulus spending during recessions is to hire former workers who are currently doing nothing, however, neither of those harms will occur unless the spending is designed in an entirely perverse and counter-intuitive manner.

The point, therefore, is not that any deficit will do. Some policies that would increase the deficit are clearly a bad idea, even during a recession. Deficit spending, to be beneficial, must be targeted in a way that will result in the money being spent by its recipients. Both spending increases and tax cuts can be designed in that way, but it is a lot easier to guarantee that the money will be spent if it is given to government agencies (such as state departments of transportation) that will surely spend it on job-creating projects. Tax cuts are less reliably spent, not only when they are given to high-income people but even when given to non-rich people who fear for their jobs and thus hold onto every penny. (Of course, people who are truly on the edge economically will spend every dollar received, which is why any tax cuts need to be targeted progressively.)

Rather than making this post longer than it is already, I will defer discussion of my second point (deficits incurred in the name of public investment) until next week. For now, however, I will simply leave it here: Notwithstanding my persistent cheerleading for more deficit spending during this very deep recession -- a recession, I would add, that could well have a second life -- I am never in favor of increasing the deficit unless the money will be used to put people to work, directly or indirectly. One should never, therefore, be "pro-deficit." One should be in favor of policies that actually end or mitigate recessions. Some deficits do that. Others do not.

-- Posted by Neil H. Buchanan