The current US Government seems ambivalent, at best, about deficit spending. In his State of the Union address President Barack Obama warned that, “If we don’t take meaningful steps to rein in our debt, it could damage our markets, increase the cost of borrowing, and jeopardize our recovery.” Yet besides offering a spending freeze that won’t effect the greatest expenditures of government—defense, Medicare, Medicaid and Social Security—the president volunteered no solution the problem.
In all fairness, the record debt that America now struggles with is not Obama’s fault entirely. Massive bailouts of banks, insurers and automakers as well as billion-dollar government guarantees produced an $8.7 trillion increase in federal obligations in the second half of 2008 alone. To put this number in perspective, consider that one year earlier, the United States’ entire debt amounted to $9.3 trillion; that the country’s economic output in 2007 was $14 trillion; and that government spent about $3 trillion that year.
The Obama Administration went with the current however and budgeted a spending of $4 trillion in 2009 which represents 28% of GDP, compared to 21% in 2008.
There are those, like economist Paul Krugman, who demand that government spend even more. Obama is “wrong”, he argues, to suggest that more spending isn’t “necessary” while the economy hasn’t fully recovered yet. The announced three-year spending freeze meets Krugman’s strong disapproval therefore.
Krugman is an economist of the Keynesian school which always promotes government spending whenever the economy suffers a downturn. Only the state can boost the flow of credit and the recovery of consumer demand under such precarious circumstances, say the Keynesians. As proof, they offer President Franklin D. Roosevelt’s “New Deal” which, supposedly, dragged the US economy out of the Depression through a massive expansion of government compulsion and controls.
The truth is that after two of President Roosevelt’s terms in office, the economy hadn’t recovered at all. Indeed, in 1938, five years after the “New Deal” was enacted, the United States underwent a second recession in spite of all of Roosevelt’s efforts to get the country moving again. The reason? Prosperity demands freedom. Men cannot and will not produce under restraint.
Compared to the trillions of dollars borrowed and owed by the US Government today, the New Deal was a fairly modest package, costing, adjusted to inflation, about $500 billion. If ever a Keynesian will admit that it didn’t work (and that it was, in fact, the massive production surge demanded by America’s involvement in World War II which prompted recovery), he will probably argue that Roosevelt spent too little; that the New Deal wasn’t big enough. Reiterating Paul Krugman: if the economy is in trouble, government must always spend—and spend more if things don’t get any better.
Yet, until the early twentieth century, the United States had largely done without Big Government. Throughout the century before, government spent little; it had to borrow little; and it interfered in few industries. Consequently, the United States prospered. As industrialism reached the American shores after the Civil War, the country experienced unprecedented growth and peoples’ lives improved significantly as a result.
This experience had its roots in the philosophy which the United States were founded upon. From its very inception, the United States were a nation of limited government whose Constitution didn’t so much dictate what government should, rather what government shouldn’t do: never restrict peoples’ freedoms nor infringe upon their rights; some of which the Declaration of Independence had even referred to as “inalienable”.
Portrait of Thomas Jefferson by Rembrandt Peale, 1800
The Founding Fathers were staunch proponents of small government and the principal author of the Declaration of Independence, Thomas Jefferson (1743-1826) explicitly warned against mounting government debt.
In July of 1816, writing in a letter to Samuel Kercheval, Jefferson declared that in order to preserve the independence of the people, on whom the “continued freedom” of the nation depended, “we must not let our rulers load us with perpetual debt.” According to Jefferson, “We must make our election between economy and liberty, or profusion and servitude.”
If we run into such debts, as that we must be taxed in our meat and our drink, in our necessities and our comforts, in our labors and our amusements, for our callings and our creeds, as the people of England are, our people, like them, must come to labor sixteen hours in the twenty-four, give the earnings of fifteen of these to the government for their debts and daily expenses; and the sixteenth being insufficient to afford us bread, we must live, as they now do, on oatmeal and potatoes; have no time to think, no means of calling the mis-managers to account; but be glad to obtain subsistence by hiring ourselves to rivet their chains on the necks of our fellow-sufferers.
Observe that many countries, in Europe especially, maintain a value added tax on all goods, typically adding 20% or so to the cost of products. Most American states know a retail sales tax instead which is more modest than their European counterparts but still follows the logic which Jefferson so dreaded. And note that House Speaker Nancy Pelosi suggested in October 2009 that a VAT is “on the table” to help the federal government garner needed revenues.
Jefferson warned against such endeavors. “A departure from principle in one instance becomes a precedent for a second,” he wrote; “that second for a third; and so on, till the bulk of the society is reduced to be mere automatons of misery, and to have no sensibilities left but for sinning and suffering.”
Then begins, indeed, the bellum omnium in omnia [war of all against all], which some philosophers observing to be so general in this world, have mistaken it for the natural, instead of the abusive state of man. And the fore horse of this frightful team is public debt. Taxation follows that, and in its train wretchedness and oppression.
Spain hasn’t managed to balance its budget since 2008 and the graph reflects that. Compare the situations in Germany and Spain, and I don’t see how you can maintain that deficit spending is a good thing.
Actually, I think the comparison is a decent one, for neither can keep on borrowing indefinitely.
The graph clearly shows Spanish budget balance, as a % of GDP, lies in (-1, 0) for period 2000-2005, trending to 0; then moving sharply into surplus, lying in (0, 2], for period 2005-2008 (roughly); before then sliding sharply into deficit position with onset of GFC proper.
Germany’s budget balance constantly in deficit pretty much the entire time from 2001, in (-4, 0].
Don’t you think this strange? How do you explain their trajectories?
Why is it strange?
What I think is remarkable about the differences is that Germany balanced its budget as soon as the recession started whereas Spain plunged further into debt. Of course, that’s not the only factor that should be considered when trying to explain the obvious differences in growth between both countries, but it plays a role.
You’re confusing the state with a household or firm.
I previously noted that I think the comparison is sound, at least to a certain extent.
But please, could you explain what point you’re trying to make with regards to the differences in German and Spanish deficit spending?
The Spanish deficit is obviously entirely due to the global financial crisis. It was running a surplus into the GFC and it still crashed through the floor. You might even use the word “cyclical” to describe it. The fact that the Germany budget was in deficit pre GFC explains none of its current behaviour.
You need to ask: what is a govt deficit? What determines its behaviour?
The fact that the state is not a firm or a household is a way into this conundrum.
Incidentally, I lived in Leiden many years ago. Nice place!
I’ve lived here for a few years now, and it is, indeed. Where you town for work?
You need to ask: what is a govt deficit? What determines its behaviour?
Again, you’re being to vague for me to get what you’re driving at. It seems as though you’re arguing that deficit spending is some sort of inevitability and that mysteriously, everyone profits from it. Please, either be more specific, or we’re going to have to agree to disagree on this one.
I went to school in Oegstgeest and lived in Leiderdorp in ‘94.
“you’re being to vague for me to get what you’re driving at”
It’s just a difficult issue to understand. You need at least some macro accounting & monetary theory to put it together, perhaps. I am trying to simplify.
Maybe we can take it in stages.
What is a deficit? In any given period, a sector’s deficit describes the amount by which the flow of spending exceeds the flow of income. Obviously any individual can be in deficit, any household, firm or sector. A government deficit means that its expenditure exceeds its income. A private sector deficit means that income exceeds expenditure for this period. In a closed economy, these two balances are equivalent and net to zero, so that for the whole, total income = total expenditure. You can also think of this as total output, GDP, or whatever.
Are you with me so far? Agree? If so we can explore what it means for the private sector if the government is in deficit, and what it means for the government if the private sector is in deficit. Or maybe you already know?
I am, if it makes any difference, quite sympathetic to classical liberalism, and even to the Austrian school. Just to be clear, I am certainly not advocating central planning here. In case you doubt this, here’s an anti-Castro rant that I wrote & think is quite successful: http://vimothy.wordpress.com/2008/02/27/castros-legacy/
I did take a few economics classes
As I pointed out earlier, you’re ignoring growth. The numbers don’t add up if the private sector is making profits on its own.
You’re misunderstanding. I haven’t said anything theoretical yet–I’m just giving you the national accounting identities that will set this exploration up. Nothing in our definition of a flow has anything to say about economic growth. And the numbers have to add up. By definition. I’m not sure if that was a colloquialism, but…
Start with this:
Total income = total expenditure
Are you familiar with it? It’s just an identity. It’s true by definition. If we’re on the same page with this we should go and look at what a deficit is again.
Of course, in our theoretical closed economy. As you mentioned, this is the way to look at a country’s GDP. It doesn’t add up if you throw in investments, savings and taxes, though, but I suppose you’re getting to that.
It still works if you include taxes, investment and savings. Adding a foreign sector is when it gets exciting.
If we divide our closed economy into two identical private sectors (no government just yet), when one is in deficit, the other is in surplus; that is, total spending in one exceeds total income, and total income in the other exceeds total spending by the same amount. That’s just rearranging what we’ve already said. Agreed?
If people are saving, money is draining out of the economy, whereas investments/credit injects “extra” money into the economy. The equation only holds if savings are exactly the same as investments.
What happens if one sector is doing its business poorly and losing money—but not borrowing?
Nick,
Obviously, there are leakages. That’s what we’re discussing! So the question is, how can total income exceed total expenditure? Alternatively, how can total expenditure exceed total income?
Probably out of time on this for now…
Maybe just a couple more things:
So a govt surplus (T > G) implise a leakage such that total expenditure is greater than total income. Alternatively, a deficit (G > T) implies that total income is greater than total expenditure–because the government is a net addition to the economy as a whole, raising total income without raising total expenditure.
The further impliactions are obvious. And are the borne out by the empirical record? Why, yes:
1. 1817-21: In five years, the national debt was reduced by 29 percent, to $90 million. A depression began in 1819.
2. 1823-36: In 14 years, the debt was reduced by 99.7 percent, to $38,000. A depression began in 1837.
3. 1852-57: In six years, the debt was reduced by 59 percent, to $28.7 million. A depression began in 1857..
4. 1867-73: In seven years, the debt was reduced by 27 percent, to $2.2 billion. A depression began in 1873.
5. 1880-93: In 14 years, the debt was reduced by 57 percent, to $1 billion. A depression began in 1893.
6. 1920-30: In 11 years, the debt was reduced by 36 percent, to $16.2 billion. A depression began in 1929.
Oh, and add the Clinton surpluses–but it wasn’t like these were followed by any kind of crash, right?
Correlation does not imply causation!