“Deficits are always bad,” thunder fiscal hawks. Not so, replies strategic investment analyst H. Wood Brock in an interesting new book, The American Gridlock. A proper assessment, Brock argues, depends on the “composition and quality of total government spending.”
Government deficits incurred on current spending for services or transfers are bad, because they produce no revenue and add to the national debt. Deficits resulting from capital spending, by contrast, are — or can be — good. If wisely administered, such spending produces a revenue stream that services and eventually extinguishes the debt; more importantly, it raises productivity and thus improves a country’s long-run growth potential.
From this distinction follows an important fiscal rule: governments’ current spending should normally be balanced by taxation. To this extent, efforts nowadays to reduce deficits on current spending are justified, but only if they are fully replaced by capital-spending programs. Indeed, reducing current spending and increasing capital spending should be carried out in lockstep.
Brock’s argument is that, given the state of its economy, the US cannot return to full employment on the basis of current policy. The recovery is too feeble and the country needs to invest an additional US$1 trillion annually for 10 years on transport facilities and education. The government should establish a National Infrastructure Bank to provide the finance by borrowing directly, attracting private-sector funds, or a mixture of the two. (I have proposed a similar institution in the UK.)
The distinction between capital and current spending (and thus between “good” and “bad” deficits) is old hat to any student of public finance. However, we forget knowledge at such an alarming rate that it is worth re-stating it, particularly with deficit hawks in power in the UK and Europe, though fortunately not (yet) in the US.
According to proposals agreed at an informal European Council meeting on Jan. 30, all EU members are to amend their constitutions to introduce a balanced-budget rule that caps annual structural deficits at 0.5 percent of GDP. This ceiling can be raised only in a deep depression or other exceptional circumstances, allowing for counter-cyclical policy, so long as it is agreed that the additional deficit is cyclical rather than structural. Otherwise, violations would automatically trigger fines of up to 0.1 percent of GDP.
The UK is one of two EU countries (alongside the Czech Republic) that refused to sign this “fiscal compact,” acceptance of which is required to gain access to European bailout funds. However, Britain’s government has the identical aim of reducing its current deficit of 10 percent of GDP to near zero in five years.
An argument commonly heard in support of such policies is that the “bond vigilantes” will demand nothing less. The finances of some European governments (and Latin American governments in the recent past) have been so parlous that this reaction is understandable.
However, that is not true of the US or the UK, which both have large fiscal deficits. And most countries that were adhering to reasonably tight fiscal discipline before the crisis of 2008 undermined their banks, cut their tax revenues and forced up their sovereign debt.