Real Deficit Is in Human Capital : Budget Looks Bad Because It Doesn’t Isolate Public Investment

<i> Robert Eisner is a professor of economics at Northwestern University and president of the American Economic Assn. </i>

We are told that the federal deficit is our No. 1 economic problem. It is not. It probably isn’t a problem at all. In a much deeper sense, our entire economy is in deficit. And that problem is being passed over.

The deficit probably is not a problem for two reasons. By proper measurement, we do not now have a deficit. And the deficits that we have had in the past six years have on balance, despite all the teeth-gnashing, been good for the economy.

Government accounting practice is, to put it simply, weird. If private companies followed it, some of the most successful ones would be in “deficit,” reporting losses. The federal government does not separate current from capital expenditures. Indeed, the way the budget is presented, we could eliminate the current deficit by simply selling off airports, petroleum reserves, off-shore drilling rights and the interstate highway system. We might even sell the White House and lease it back. That would reduce the deficit for one year. Then, the next year we could sell something else--perhaps a few national parks.

Aside from exposing such shenanigans, having the government move to proper capital accounting would have knocked the $155-billion deficit for the 1988 fiscal year down about $70 billion, by substituting depreciation charges of $136 billion for the Office of Management and Budget-estimated investment spending of $206 billion. That gets “the deficit” down to $85 billion.


But the federal government is in deficit in large part because it makes about $100 billion in grants to state and local governments. In terms of total government impact on the economy, we should take account of state and local government surpluses, which totalled $55 billion in the past year. That brings the total deficit figure down to $30 billion.

And yet the major correction is still to be made: for inflation. Our money and our government bonds are not worth what they were. With even the current modest 4% inflation, public holders of about $2 trillion of federal debt are paying an “inflation tax” of 4%, or $80 billion per year. The government maintains the nominal deficit on the one hand, but in real terms takes back most of the resultant increase in debt. But it is the real indebtedness of the government--and the corresponding real holdings of that government debt by the public--that impact the economy. Taking account of that inflation tax brings the total budget into a surplus of $50 billion!

The essential issue, though, is not these numbers. However measured, deficits or surpluses can be too large--or too small. The critical question is their impact on the economy. By now it must have dawned on a lot of people that the really large budget deficits that developed in the latter part of 1982 ushered in a major economic recovery. Unemployment declined from 10.8% six years ago to just half that figure. We must have been doing something right. And sober analysis makes clear that a major thing we were doing right was giving the public, by means of large budget deficts, the increased real value of their wealth in government bonds and the increased purchasing power to pull the economy forward.

But national deficits and debt are properly evaluated in relation to gross national product. The official deficit, more than 6% of GNP five years ago, is now about 3%. If we think of “balance” the way a private business might, in terms of keeping debt at a constant proportion of income, the budget is right there. The debt-to-GNP ratio has stabilized, with the debt growing no faster than the nation’s income and product.


Thus, reducing the deficit at this point, at least without substantial monetary stimulus, runs the risk of reversing the recovery to which the past large deficits contributed. Indeed, that is almost the stated purpose of some of the advocates of deficit reduction--to fight what in their view is an “overheated” economy. Such a slowdown is frequently urged as a way of freeing more resources for investment.

But that brings us precisely to the real deficit--in the capital on which our productivity and well-being depend. And here, many proposals to cut the presumed federal deficit go exactly the wrong way.

Reducing the deficit by either cutting spending or raising taxes, in turn decreasing public purchasing power and forcing consumers to pull in their belts, is not likely to increase private investment. If we stop buying Chryslers, Lee Iacocca is more likely to cut than increase expenditures for new plants.

But further, private investment represents only a small part of the capital to be provided to the future. The great bulk of that is the government capital of public infrastructure--our roads, bridges, airports, land and water--and, most important, the investment in basic research and the education and training of our people so vital to the success of a modern, technologically advanced economy. Our great, truly corroding deficit is to be found in millions of school dropouts, semiliterate or illiterate, and millions of school graduates, who fall increasingly behind their counterparts in Japan and elsewhere.


We probably are, as widely charged, saving and investing too little. But that is largely because the great bulk of federal investment has been for the military, while critical public investment in our physical and human capital has been starved.

There is the real deficit. The impassioned rhetoric about our mismeasured “budget deficit” has largely blocked most initiative to meet our real national deficiencies.