The Deficit Scare: Myth vs. Reality

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Deficits and Debt can Encourage Economic Growth

Conservatives are also wrong when they argue that deficit spending and a large national debt will inevitably undermine economic growth. To see why, we need to simply look back at times when we have run up large deficits and increased the national debt. The best example is World War II when the national debt soared to 120% of GDP – nearly twice the size of today’s debt. This spending not only got us out of the Great Depression but set the stage for a prolonged period of sustained economic growth in the 50s and 60s. Massive investments were made in science and technology, American workers were re-trained and re-employed, private investment was encouraged, and consumer purchasing power was increased. That 25-year post-war economic boom, with the most rapid increase in living standards in our history, would not have happened without the stimulus of all this deficit spending.

History also shows that balancing the budget does not necessarily ensure a spurt of economic growth. In fact, in most periods when we have not had deficits, such as the 1990s, this was followed by an economic recession.6 So there is clearly little historical evidence to show that deficits and debt inevitably hurt economic growth.

But what about the conservative argument that public spending “crowds out” private investment, to the detriment of economic growth? They maintain that if the government is borrowing a lot money, that is money that the private sector cannot invest to increase its production and productivity. This has to undermine economic growth, right? The answer is “No, not necessarily.”

As most economists point out, government spending also has a “crowding in” effect that actually encourages more private investment. That is because much of the money that the government borrows and spends goes to the private sector. Private industry must then prepare to provide the various goods and services demanded by the government – such as weapons systems, green energy systems, new roads and schools, etc. In order to do this, these businesses must invest in new production facilities and greater productivity. This “crowding in” effect thus helps to mitigate any negative effects that public borrowing has on the private sector by indirectly encouraging more private investment and business growth.

Investing in America’s Future

But there is even a more important issue here – one often brought up by Joseph Stiglitz, a Nobel Prize winning economist. He argues that deficit spending, when it is done right, can be a major stimulus to economic growth and actually lower long term government debt.7 When economic growth is back on healthy terms, this leads to increased tax revenues, which eventually lessen the need for government to borrow money. For Stiglitz, the key is to spend that deficit money on things like education, technology, and infrastructure that lay the groundwork for future economic expansion. We will not remain competitive with other countries for long if we don’t have decent roads, efficient airports, adequate clean water supplies, and sufficient school facilities. Recently the American Society of Civil Engineers estimated that over the next five years it would take at least $1.6 trillion to bring our national infrastructure into an acceptable state. These are huge investments that the private sector is unwilling to make. Going into debt to pay for these things is a good investment in our collective futures.

We also need government to invest in emerging technologies that are vital to our economic prospects. We are falling behind many other countries in our public investments in high-speed rail, modern telecommunications technology, and an advanced electricity grid. Another area that will drive economic expansion in the future is green technology and alternative energy. Left to itself, the market has not been leading us in that direction. Several other countries, including China and Germany, have been spending billions in public funds to encourage consumers and industry to jump on the green technology bandwagon, and they are already beginning to reap the economic rewards of this strategy. We are trailing badly in this vital economic area and we are unlikely to catch up without substantial investments by our government.

Who Really Cares about Our Children?

One of the most common Republican complaints about deficits is that they will ruin our children’s future. We are saddling them with this enormous debt that they will have to repay – presumably to their great detriment. So if we care about future generations, we must severely cut spending to rein in this increasing debt. “Do if for the kids,” say the deficit hawks.

The main problem with this argument is that it focuses only on the costs of deficit spending for future generations, and completely ignores how that spending would actually benefit them. Would you be a good parent if you considered only the costs of buying braces for your child and not the benefits they would enjoy for the rest of their lives? Similarly, we must not just think about the national debt that we are handing down to our children, but consider also all of the valuable assets, projects, and programs that could be financed by that debt. Those benefits could make future generations much better off.

It all depends on what the deficits are spent on. If we are simply going into debt, as we did in the Bush era, to pay for tax cuts for the rich and wars like those in Iraq and Afghanistan, this will do little to help our descendants. But what if some of that deficit spending goes to make higher education more affordable? A study by the National Center for Public Policy and Higher Education gave the public college and university systems in 43 states a grade of “F” for affordability. This means that many kids who do go to college end up saddled with enormous student loans that will detract from their standard of living for years. More importantly, many low and middle-income students simply cannot afford college anymore – hundreds of thousands of kids are being turned away every year for lack of money. In contrast, public investment by many countries in Europe has made higher education there low cost or free. Whose kids are better off?

In addition, we are not doing our offspring any favors if they inherent a country whose infrastructure is in disastrous condition. They will not enjoy balanced budgets if that means living in a world of bad roads, dangerous bridges, failing sewer systems, questionable drinking water, and congested airports. Future generations might also be thankful if we spend some money now on lessening the potentially disastrous impacts of climate change. Global warming is already beginning to do enormous harm with unusually intense droughts and floods. If we do nothing now, the impacts on our children and grandchildren will be much more severe.

Finally, as noted earlier, government spending can be crucial for ensuring a prosperous and growing economy. A large part of the economic growth in the last twenty years has been fueled by various kinds of private sector economic bubbles. This is hardly desirable or sustainable. In the 1990s, there was a large technology bubble that created billions in apparent investment profits. Later, it was the housing bubble which encouraged consumers to borrow and spend much more money because of the rapidly increasing value of their homes. When these bubbles burst, they took the economy down with them. Today, we need a more stable and reliable way of encouraging economic growth. Public investments in emerging technologies, like alternative energy, could prove to be a valuable part of that economic strategy. If we can leave our children a sustainable growing economy, this could be their greatest inheritance.

 

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