Over the last several years, there has been growing agreement that we should eventually bring the federal budget roughly into balance, eliminating deficits as a matter of policy and principle.
But one important consideration has been missing from almost all of this discussion--the critical role the federal government plays in financing important long-term investment needs of the economy. Once we pay attention to that crucial role, then an apparently unconventional conclusion follows directly: Under current accounting practices, the federal government should always run a budget deficit.
Because this conclusion seems so unusual, the argument supporting it needs to be developed carefully, in stages.
The first step requires distinguishing between the actual level of the budget deficit on the one hand, and what economists often call the “structural deficit” on the other. The actual level of the federal deficit will automatically fluctuate with the business cycle: If the economy is sluggish, for example, the deficit will tend to rise because tax revenue will suffer and expenditures for recession-related programs such as welfare and unemployment compensation will tend to increase.
In order to take these kinds of effects into account, economists estimate what the federal deficit would be if the economy were operating in conditions of relative prosperity, or at the level of what economists call “potential GNP.” The resulting estimate of the “structural deficit” helps highlight movements in the deficit that result from changes in the character (or structure) of discretionary federal spending and tax policy, rather than from short-term, cyclical fluctuations. Arguments about balancing the budget over the longer term almost always focus on the structural deficit.
The next stage requires distinguishing between two very different criteria by which we might evaluate the federal budget.
The first criterion concerns what is normally called either “fiscal policy” or “stabilization policy"--a concern for how government policy can help stabilize the macro-economy. In a recession or a period of stagnant growth, for example, it makes sense for the government to pump some stimulus into the economy.
The second criterion focuses on the role of the government in allocating economic resources over time. We can refer to this role as “long-run allocative policy"--encompassing policies (such as environmental and infrastructural programs) that influence the allocation of resources from now into the future.
What does “allocative policy” have to do with the deficit? Most people believe that it makes sense for businesses or households to borrow money if that borrowing will help increase the firm’s or household’s productive earning capacity in the future. (Factories and college loans are obvious examples.) Analogously, it may make sense for the government to borrow to help finance projects that will increase our economy’s productive potential in the future--to build schools and bridges or to invest in research and development. If so, it would make sense for the government to run what can be called a “structural capital deficit,” borrowing to finance investment projects in the short-run to support long-run improvements in productive potential.
The final stage in the argument follows directly: Society has some long-term investment needs that the public sector is better equipped to meet than the private sector, and this requires public borrowing to finance a structural capital deficit at the federal level.
Three obvious examples are infrastructure, education and certain kinds of research and development. The private sector in a capitalist economy does not naturally build highways, provide schooling for everyone or invest in certain kinds of research and development if the costs are too high or it cannot control the eventual stream of profit from those investments.
If the federal government doesn’t make some significant contribution to these kinds of investment needs, we will simply go without them, and our longer-term productive potential as an economy will suffer over time. Taking these kinds of investment needs into account, arguing that the federal budget should always be balanced and never borrowing to finance investment projects would be like arguing that one should never take out a mortgage to help finance purchase of a home.
How large a proportion of the current federal budget is presently accounted for by such capital projects? It is not easy to draw the line between investment projects and non-investment expenditures. The Congressional Budget Office provides estimates for four principal categories of federal investment projects--"long-lived assets that produce income or other benefits in the future.” These are physical investment in structures and equipment, investment in or acquisition of defense assets, federal investment in research and development and federal grants-in-aid to state and local governments used to finance capital projects, mostly infrastructural, at the local level.
The numbers are not trivial. Total federal investment, net of depreciation, for 1986 (in 1986 prices) totaled $63 billion, equal to roughly a third of the structural deficit in 1986 and the equivalent of about 1.5% of potential GNP.
Given a reasonable argument that we need more of such investments to finance programs such as the renewal of infrastructure, and that we need, as well, to shift some of the current federal investment out of the military and into civilian projects, it seems fair to conclude that roughly 2% to 2.5% of potential GNP might usefully be devoted each year to net federal capital investments.
Would this increase our public debt burden, which many feel is already too high? If the rest of the structural budget were balanced (again abstracting from fiscal policy considerations), probably not. We can run a structural deficit at modest levels without increasing the structural debt burden as long as the economy is growing sufficiently rapidly at the same time and as long as interest rates are not too high.
Let’s take a recent example: Between 1974 and 1983, the structural deficit averaged 1.9% of potential GNP without increasing the debt burden over time. (The debt burden didn’t start increasing until 1983.) This was a period in which the economy was growing relatively slowly, with real GNP growth averaging only 1.8% a year.
If we assume that a renewed federal commitment to productive civilian capital projects would help boost the real growth rate to at least 2.5% a year (it averaged 4.4% a year in 1948-66 and 3.2% a year in 1966-73) then structural deficits of 2% to 2.5% of potential GNP a year could be sustained indefinitely without increasing the structural debt burden (unless interest rates rose dramatically).
Our productivity has been limping, and our competitive edge has been slipping. “The remedy for these problems,” economist Robert L. Heilbroner said recently, “will require . . . a new approach to fiscal policy, but it need not be one that panics before the buzzwords debt and deficit .”