Public Investment Works

Since 1993, balanced budgets have been liberals’ holy grail. It’s time to reconsider.

An important debate over fiscal policy is beginning to take place within the Democratic Party. For the past 15 years, deficit hawks within the party have argued that addressing America’s fiscal challenges should take priority over our public investment needs, suggesting that, in effect, we cannot afford to increase public investment until we have reduced the federal deficit.

But there is an alternate view, holding that the deficit hawk position neither accurately reflects America’s true economic strength nor represents good policy in light of the very significant changes that have occurred in the economy over the past decade and a half. In fact, the nature of the American economy today is radically different than it was in the early 1990s, when the current notion of fiscal responsibility took shape. Over the past decade and a half, the economy has become more globalized, knowledge-based, and wealth-driven. Behind this transformation have been major structural developments in the world economy, most notably the increased integration of the world’s financial markets; the dramatic improvement in productivity growth associated with the information-technology revolution; and the expanded supply of labor, savings, and productive capacity that has resulted from the integration of China, India, and the former Soviet Union. Together, these developments allow the American economy to grow more rapidly with lower wage and goods inflation than was possible in the supply-constrained, slower-growth period of the early 1990s.

Deficit hawks seem not to have fully incorporated these changes into their understanding of the U.S. economy, nor have they changed the way they measure the economy’s output to reflect the increased importance and value of wealth and intangibles. As a result, they underestimate the capacity of the economy. Misjudging the economy’s potential, much like misunderstanding the economy’s challenges, can lead not only to bad policy choices but also to missed opportunities for policy reforms that would help ensure future economic prosperity. This is the case today when it comes to the question of public investment in our physical and innovation infrastructure.

Contrary to the opinion of the deficit hawks, the United States can comfortably afford a robust public-investment program without first reducing the deficit. Indeed, given excess global savings and historically low interest rates, increased spending on productive public investment is a fiscally responsible and effective way to put excess global savings to work to ensure future economic prosperity. It is also a proven way to stimulate private investment and job creation and, at the same time, distribute more widely the capital and skills for wealth creation, thus achieving a fairer and more balanced society with higher living standards for all Americans.

New Economic Realities

The current conventional wisdom within the Democratic Party regarding deficit reduction is an outgrowth of the successful experience of the Clinton Administration. Faced with congressional opposition to its initial fiscal package, which included some added public investment spending, the Clinton White House opted for measures that would reduce the budget deficit in a bid to gain the cooperation of Federal Reserve Chairman Alan Greenspan to lower interest rates. No doubt the Clinton years produced outstanding results in terms of job creation, economic growth, and business investment. But how much the Administration’s measures to cut the deficit contributed to this economic performance is open to debate. Arguably, structural changes in the economy–such as improving productivity associated with the information revolution and the coming online of massive new production capacity in Asia–were more significant to the economy’s performance than were any of the Administration’s budget measures.

But even if one accepts that the budget deficit was a problem in the early 1990s and needed to be addressed, it does not follow that putting deficit reduction ahead of public investment is the correct policy today. Economic conditions are far different than they were in 1993, and what was appropriate 15 years ago is wholly inappropriate for 2008.

Deficit Reduction Is Less Important in Today’s Economy

to start, the federal government has much more room to run deficits than it did 15 years ago, when the budget deficit stood at 4.7 percent of gross domestic product (GDP). By comparison, the 2006 budget deficit of 1.9 percent of GDP is relatively small, and it is projected to decline further to about 1.5 percent of GDP this year. Even with President Bush’s tax cuts and the escalating cost of the war in Iraq, the deficit is below America’s norm of 2.2 percent of GDP over the last 40 years. Likewise, the federal debt held by the public is below its average for the 20-year period since 1987 and lower than it was in 1993. Gross federal debt in 1993 was 49.4 percent of GDP; by 2006, it had fallen to 36.8 percent.

The current budget deficit and federal debt would be even lower if we properly accounted for national income and the increased importance of wealth and intangibles in today’s economy. Business investment in intangibles, such as research and development, are critical to long-term profitability, but most economists don’t count them as national output. Yet, according to an estimate by BusinessWeek’s Michael Mandel, spending on unmeasured intangibles is almost as large as spending on physical capital and software. For the period 2000 to 2003, the annual average of investment in intangibles was $978 billion, or almost 10 percent of GDP. In other words, if we properly accounted for intangibles, national output would be nearly 10 percent larger, and the budget deficit and federal debt would be proportionately smaller as a percentage of GDP.

• 1
• 2
• 3
• 4
• 5

Post a Comment

Name

Email

Comments (you may use HTML tags for style)

Verification

Note: Several minutes will pass while the system is processing and posting your comment. Do not resubmit during this time or your comment will post multiple times.