HOW BAD ARE BUDGET DEFICITS? One of the point that I made in class is that political discussion is limited by, in effect, placing certain philosophical and policy alternatives off limits. That is, because there is such consensus on the proper form and structure of government, we hardly ever hear of drastically different alternatives. People who do espouse new and innovative ideas are frequently dismissed as radicals or kooks. The budget deficit--its importance and how it could be handled--provides a case in point. What follows is an attempt to put the national debt and deficit "problems" in perspective. At the end, I suggest that there is a _bias_ in how Americans look at government spending. This bias arises partly from the overwhelming consensus on general-welfare liberalism and its attendant set of political myths and beliefs. No doubt nine out of ten newspaper editors, civic leaders, and ordinary citizens rank the federal budget deficit with famine and pestilence. Likening the government to a family, they are convinced Washington lives far beyond its means and sooner or later the roof will cave in. This is certainly the position most candidates in the 1992 elections take. In fact, H. Ross Perot has built his threatened candidacy largely on the charge that the government cannot get the deficit and debts under control. Since the national debt now exceeds $4 trillion, these worriers believe that their fears are more than justified. Politicians and journalists love to describe numbers like 1 trillion, a one followed by 12 zeros. One columnist compared it to a train: If you packed $1 trillion, in the form of $1 bills, into average-sized, 50 foot long railroad boxcars, you could get about $63.5 million into each boxcar. A train carrying $1 trillion would have 15,743 boxcars and be 167 miles long. Mainstream economists, though, warn against overly simplistic comparisons of the government and households. Public and private finances differ considerably, and it is easy to misunderstand the nature and consequences of deficits. Indeed, a few economic analysts question the seriousness of deficits and debts. Most economists, on the other hand, still maintain that deficits are a major threat to America's economic health, although not for the reasons commonly mentioned. Since economic policy for the rest of the 1990s will turn on how decision makers handle budget deficits, it is worth hearing both sides of the story. The Nature and Size of the Public Debt First, let's not forget that public spending is an important macroeconomic tool. Note that federal expenditures or tax cuts can stimulate aggregate demand. In the middle of a recession, this "pump priming" helps the economy get back on its feet, and running a deficit is generally considered a wise policy. Second, the size of deficits has to be judged in relative, not absolute, terms. A train carrying a trillion dollars might stretch for miles, but one holding all of America's national income would stretch hundreds of miles further. One way to estimate the magnitude of the government's indebtedness is to compare it to the gross national product (GNP). As a percentage of GNP, the deficit in 1950 was 1.2 percent; in 1980 it had grown slightly to 2.8 percent; by 1983 it was up to 6.3, but afterwards declined somewhat. Briefly stated, federal deficits at their worst have been only a small fraction of the country's total national product. Third, the budget is difficult to understand not simply because of its size and complexity but also because of the accounting practices that go into its presentation. The United States maintains a "cash" budget that only reports cash transactions. It does not, for example, record capital assets. True, over the years Washington amassed a debt of more than $2 trillion. What tends to be overlooked, however, is that it possesses a vast range of assets worth billions of dollars. The federal government, for example, owns millions of acres of timber and grazing land, offshore oil deposits, hundreds of thousands of square feet of prime office space, and countless other holdings. We should, therefore, measure not simply the accumulated gross national debt, the number most frequently cited in the media, but the net debt, the difference between what is owed and what is owned, just as any modern business does. Robert Eisner, an economist, points out that America's net debt is substantially smaller than the gross debt. Fourth, Eisner describes another shortcoming in the way people typically portray debt figures. The most accurate measure of the public debt is its market value. Most homeowners discover that paying off their mortgages becomes easier with each passing year. Why? Because inflation pushes up wages and salaries while monthly mortgage payments stay about the same. Someone who borrowed $30,000 in 1970 felt the payments were an enormous load, but by 1990 the burden of such a mortgage was considerably less. The same general principle, Eisner argues, holds for the government. The nominal or face value of the national debt has to be discounted because of inflation. He shows that when this adjustment is made, the real value of the net federal debt steadily dropped from 1945 to 1980 by about 58 percent. Finally, economists point out that just as in the private sphere one person's debt is another's wealth, government borrowing adds to overall income. After all, many Americans count government savings bonds among their safest assets. As Eisner and Paul Pieper explain, the public is responsible for the federal debt, but "it is also the public itself which would be paid off and which receives the interest payments." In short, it is easy to misperceive the problem. People imagine a bill collector suddenly appearing on the steps of the Capitol to declare the country bankrupt and send future generations to debtor's prisons. But government is in a different position than a family or a business. Its creditors--the banks, institutions, and individuals who hold federal securities--belong to the same community from which it extracts its resources in the form of taxes. Up until the 1980s, when foreigners began investing heavily in American assets, Washington did not transfer funds to outside parties; it simply moved them from one group (taxpayers) to another (security and bond holders), both of which lived in the same nation. The Real Dangers of Deficits. Conceding that Eisner and others make valid points, most economists nevertheless worry that when the federal government piles up deficits year after year, especially when the economy is reasonably robust, it causes the country grave problems. Whenever the Treasury writes a check that it cannot cover with its own funds, it borrows to make up the difference. But of course society does not have an unlimited supply of capital from which to borrow. Whatever is available comes from savings, and in a period of large deficits businesses, individuals, and the government all compete for this scarce resource. A respected economist, Charles Schultze, calculates that in the late 1980s private savings of households and corporations constituted about 6.5 percent of our national income. In the absence of deficits, this money could have financed investment in new factories, machines, technology, and the like--assets called capital stock. Yet because the government's books were so far out of balance, the net savings--the amount left over after subtracting the government's deficit--comprised less than 3 percent of total income. This fact greatly troubles Schultze and others since without adequate savings investment drops off, and without investment the capital stock that produces future wealth is not created. Sluggish investment, they fear, will inexorably lead to a decline in our standard of living. We, and especially the next generation, will live less well than our parents unless we revive the nearly stagnant growth in investment and productivity. Public indebtedness raises problems of another sort. During the Reagan years the deficits caused by huge tax cuts and enormous growth in military spending should have overheated the economy, causing prices to soar. But inflation did not get out of hand. In fact, it fell. No one has a complete solution to this mystery, but part of the answer lies in the massive infusion of capital from overseas. Foreigners found ideal investment opportunities in the United States: they received high rates of return on their money, and political and social stability made them feel their assets were safe. Generous interest rates and stability have therefore attracted billions of dollars in foreign investments. This influx of funds has, in effect, helped pay for the deficit and compensate for the shortfall in investment and savings. This dependence may turn out to be a time bomb, however. Large-scale foreign investments inevitably mean that a sizable share of our income has to go abroad for interest payments. (This undercuts the argument made above about the government owing only to Americans.) Worse still, if Japanese, German, and other investors decide to slow down or stop the transfer of capital, America could be in for a rough landing: we will be confronted with sharply climbing prices and interest rates and a declining standard of living. We will also have to find ways to increase savings and investments, and that means keeping the budget deficit down. But a reduced deficit can be achieved only by painful tax increases or cuts in popular programs or both. SUMMARY HOW THINKING ABOUT DEFICITS AND DEBTS AFFECTS PERCEPTIONS OF WHAT CAN AND CANNOT BE DONE Let me conclude by saying (and you can verify this) that there is a bias against public (governmental) spending, since outlays are inherently less productive or efficient or effective than private expenditures. Moreover, government borrowing is considered to be bad, where as private borrowing is often considered wise, shrewd, necessary, and/or productive? But is there any logic or reason behind these attitudes? Consider: if you or your parents borrow for your college education, most people would consider the loan an "investment" that will repay itself many times over. Yet when the government borrows for, say, educational programs, it's usually considered unwise, mortgaging our future, stealing from the future generations, and the like. But isn't this form of government finance really just a type of investment? The point is that there is a bias against government spending that arises from the widespread acceptance of the myths and beliefs generated by general-welfare liberalism. This bias is important because it limits what people consider to be viable or reasonable alternatives to solve national problems. For instance, many think that government debt, even if it is used to improve education, health, infrastructure, and so forth, is inherently undesirable. They would prefer to let the "private" sector solve problems in these areas if it can. But given what has been said above, can't one argue that government borrowing and spending is no "worse" than private borrowing and spending?