Ambling through the archives: Don’t blame the deficit, 1983 edition

October 16, 2012

The battle over the amount and nature of government spending is the focus of the current U.S.presidential campaign and is unlikely to go away even after the November election is well in the rear view mirror.

In such a setting, a paper presented by economist Albert M. Wojnilower at the October 1983 Bald Peak Conference sponsored by the Federal Reserve Bank of Boston, sounds as timely today as it did then. Wojnilower, then chief economist at First Boston, prepared his “Don’t Blame the Deficit” talk as a commentary on “Implications of the Government Deficit for U.S. Capital Formation,” a paper by Benjamin M. Friedman, a professor of political economy at Harvard.

Here is the jist of Wojnilower’s argument, made almost three decades ago when the Ronald Reagan presidency was almost three years old: If the United States is under-investing, the “villain” is not the Federal budget deficit, he said.

We may be indeed piling up big trouble for the future by undertaking an excessive total of public and private spending commitments… But displacing the blame onto the (federal) budget deficit is a cop-out. It diverts attention from genuine issues to statistical abstractions and wastes our limited political attention.

In his talk, Wojnilower described how the U.S. national income accounting system tallies investment.

Only business purchases – but no government or household purchases whatsoever (other than of residences) – are permitted to be counted as investment. The Federal Budget does, however, report the amount of Federal outlays for what might be regarded as physical investment. Most of these turn out to be military (although some Federal grants-in-aid are noted as financial capital outlays by states and localities)… In one tabulation of outlays, the Budget also includes outlays for research, development and education.

“The facts are less than ironclad and the entire climate of the debate might be altered by making some statistical judgments differently,” Wojnilower said. The real issue is what kind of investment we want, he added.

The label ‘deficit’ is pejorative. It reeks of waste. ‘Investment,’ on the other hand, competes with Lincoln’s mother’s dog in its wholesome qualities. ‘Investment’ is productive and creative. These are the unavoidable semantic burdens under which this discussion labors.

But what matters is not what is spent, but what is produced, he said.

We already know that the correspondence between actual investment and what we define as investment in our national accounts leaves much to be desired. And why of all people should economists, who are suckled on the milk of ‘diminishing returns,’ take the view that when it comes to investment, more must always be better?

“Our recent history is replete with monstrous examples of misdirected, that is to say, wasted investment,” Wojnilower observed in October 1983, something he could have said today – with reams of additional evidence as the country struggles to recover from a monumental housing and banking crash. “It is possible for private investment, just like government spending, to be wasted.”

If misdirected private investments had not been made, “would we be worse off today — even if the same resources had been used up by pure consumption?” he asked.

The place of homebuilding in the investment discussion is ambivalent, Wojnilower said.  “Sometimes homebuilding is counted as investment, that is to say, with the anointed. Many writers, however, relegate it to consumption (thumbs down).”

Wojnilower cites the “standard analysis” that asserts that “smaller budget deficits would give us the same national income with lower interest rates and more investment.” (Today’s co-existence of a large federal deficit with – in the Fed’s words – “exceptionally low” interest rates should have demolished that “standard analysis.”)

“To determine whether we need more investment and what kind, we will have to overcome the handicap that our data define investment not primarily by what is produced, but rather by whom it is bought,” Wojnilower said.

The computer in my office is an investment, but the home computer on which I am drafting this paper is not. A new race track or casino is an investment, but a new public school or state university building is not. Indeed they fall into that most disreputable of the GNP categories, a nonmilitary government expenditure. A kidney machine in a private hospital is an investment, but in a Veteran’s Administration hospital it is not. A medical check-up or the cost of a college education, because the expenditure is by a household, is consumption. More casinos and more privately-owned kidney machines, no matter how desirable and profitable, will not help solve what worries many of us. For that we have to search our souls, not our statistics.

Do deficits hurt investments? Wojnilower asked.

“For a small corner grocery store, it is probably correct to assume a close correspondence between bank loans and inventories. But the larger the enterprise, the less likely is any close relation between particular sources of funds and particular expenditures.”

In fact, government deficits may well promote rather than deter investment.

The government may borrow to finance its own investment outlays. It may borrow to finance grants-in-aid that are earmarked for state and local investment outlays. It borrows to finance investment tax credits, accelerated depreciation allowances, and other subsidies that support private investment. Would narrowing the budget deficit by the abolition of these tax incentives promote private capital spending? It is hard to visualize realistic circumstances in which a larger deficit would not be associated with larger profits and investment than if the deficit were smaller.

A similar lack of a predictable relationship between borrowing and aggregate investment also exists for borrowing by other sectors, Wojnilower observed.

Borrowing by business isn’t necessarily for investment. Businesses do borrow to finance the extension of consumer credit or to pay dividends, with the result that consumption, rather than investment, is expanded. And consumer credit, like tax cuts, may stimulate retail sales, boosting the profits of industry and furthering investment.

In most circumstances, more borrowing and more spending raises the level of nominal income, investment, and saving, Wojnilower said.

“If greater borrowing enlarges income unduly, the result will be inflation, but as long as prices inflate faster than costs, profits and investment will thrive,” he said.

I question whether federal debt has been or threatens to be inimical to business borrowing or investment. Within a business cycle, surely, it is business borrowing to finance investment that, once having gathered momentum, is virtually impossible to deter except through a credit crunch. At such prosperous times, it is household borrowing, primarily for the purchase of durables and housing, that is the principal loser in these crowding-out episodes. Unhappily, once household borrowing declines sharply, soon private investment also falls in response to disappointing retail sales. When consumption is chilled, so is the rest of the economy. Could it be that the path to investment bliss is simply large borrowing by all sectors all the time?

What does it mean to reduce the deficit? Because radically transforming the budget “would expose us to a new set of hazards,” Wojnilower said in 1983. With the budget dominated by payments for retirement payments and Medicare, the military and interest, “talk of spending cuts that will be significant in aggregate is demagoguery.”

But let us suspend belief for a moment. Cutting military outlays would probably yield the most direct and reliable benefits in the release of financial and real resources for private investment. If this is what people advocate, let them say so outright. It is a subject well worth debate, even if it can’t be framed in an econometric model.

Moving away from the military, other spending reductions are much more problematic, Wojnilower said. Focusing on curtailing civilian outlays other than the transfers to the elderly would probably most hurt infrastructure and education outlays, just the sectors one would wish to spare if one were concerned with actual investment, rather than investment statistics.

“And if we cut expenditures for the elderly, who knows how the society might react? Large offsets to a reduction in governmental transfers surely would develop, including less saving by the elderly.”

What about tax increases? Well, a consumption tax would not encourage investment, Wojnilower said.

“Indeed, existing investments would be devalued. For what could be a prolonged transitional period, the net impact on investment might even be adverse…   Absent crisis, rarely if ever are people willing to impose genuine inhibitions on their own living standard,” Wojnilower said.

The deficit is a bogus issue. Viewing ourselves for the moment as a closed economy without international linkages, reductions in the budget deficit are meaningful only if the public recognizes and consents to material reductions in real military spending, in outlays for and by the elderly, and/or in the consumption standard of the population at large.

But, notes Wojnilower, theUnited States is not a closed economy. “We can and do draw real and financial resources from abroad. Thus we are not limited in domestic investment by our own saving, nor in our total use of resources by what we alone can produce… It is investors the world over who insist on stampeding into American assets.”

The budget deficit will further the inflows because the nature of international political and credit risks and market imperfections is such that U.S. Treasuries fulfill for the rest of the world, especially for official accounts, the same functions that money-market deposit accounts perform for our domestic public…Government securities are our most successful export. The instrument and the technical facilities for its purchase and sales boast incomparable comparative advantage.

“The budget deficit itself is not important – only how it is spent,” Wojnilower said. “If trees are to be planted whose shade is to be enjoyed, we need to chose the right trees (whether or not they happen to be labeled ‘investment’); to find mutually caring and respectful balance between young and old; and to avoid undue exploitation by and of others. Whether progress toward these goals increases or decreases the budget deficit is immaterial.”

Wojnilower concluded:

Let it be recognized, too, that every aspect of the task is a matter not only of calculation but also of conscience. The economic and moral decisions are duals: each economic decision implies a moral choice and vice versa. By conducting the national debate as though the moral dimension did not exist, we assure that the debate will remain fruitless and richly earn the burden of guilt the deficit inspires.

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