Post-Keynesian Observations

Understanding the Macroeconomy

Government Deficits as Necessary to Capitalism

with 4 comments

I thought I’d add a short addendum to my original post on the debt and the deficit so that I can drive home the central points.

  1. We have the ability to create plenty of goods and services, but, ironically, we can do so too easily. Because with our productivity we can satiate short-term demand without using the services of all those who are willing to work, unemployment is created. Even more results from the fact that no one is hired to produce the goods and services the redundant workers would have consumed, but now cannot afford. Because there is no profit in hiring any of those unemployed workers, the private sector is of no help in resolving this dilemma. Only a sector of the economy willing and able to spend without expectation of profit can help, which is, of course, the government. If they spend sufficiently to guarantee the hiring of the redundant workers, then this raises the overall standard of living without asking anyone to settle for less. In a capitalist economy, it is absolutely critical that the government play this role, that of the sector that is willing to spend without expectation of return, because it is the only one that can afford to do so. By acting in this way, they increase the real wealth of the nation, goods and services. Employment rises, output rises, tax revenues rise, and welfare and unemployment payments fall–deficits are ironically likely to be smaller than when the government foregoes this role (not that that’s really necessary).
  2. Government budget deficits add wealth to the private sector and allow firms and households to pay off debt and save; government budget surpluses drain wealth from the private sector, reducing the savings of firms and households and putting them in debt.
  3. Given 1 and 2, who would recommend that we should, in the midst of the worst economic crisis since the Great Depression–reduce the deficit? It makes no sense whatsoever, particularly in light of points 3 and 4:

  4. We did the exact same thing during the Great Depression with disastrous results. By 1936, we had finally reduced unemployment from 25% to 14% (can you even begin to imagine what that must have been like, particularly in the absence of all the social programs we have today?). But, there was a public outcry against what was, by today’s standards, a very small debt and deficit (and, just like today, people were calling it socialist and the destruction of America). The government heeded the call, and unemployment shot back up to 19%. It took three long years to get it back to 14% again (which is still well above what we have today). Shortly after that, WWII started, the deficit and the debt skyrocketed, and unemployment plummeted–and for some reason, no one was complaining! If we follow the same route (i.e., if we try to cut spending as we did in 1936), we are unlikely to be “saved” by a world war this time.
  5. The government is not a household and the essential logic underlying its operation is very different. Not only do they not need to balance their budget, we should not want them to do so. It is counter to the purpose they are supposed to serve. Consider this. In a capitalist system, members of the private sector cannot exist as viable economic entities if they are unable to convince other entities to give them something they are not allowed to make for themselves: dollars. In fact, they need to attract at least as many of these as the number they need to exchange for the goods and services they would like to consume–and hopefully more than that so they can accumulate savings. The means by which they convince other entities to give away their dollars is in exchange for goods or services. They key to the advantages of using a capitalist system is the word “convince.” If you want my dollars, then you need to make some good or service that I’d like to have (actually, this works properly only if several other conditions hold, relating primarily to the level of competition that exists, but I won’t go into that here–see my discussion of health care for more on that). Those who are successful must have been doing a good job creating goods and services other people like. Good. Those who go bankrupt aren’t doing things the rest of the society finds useful, and their bankruptcy acts as a signal: don’t sell what they are selling! That’s how the private sector is set up and, therefore, the fact that entities there can go bankrupt can, if everything else is set up properly, actually serve a useful purpose. It makes sense that we don’t allow private citizens or companies to print their own money becuase if we force them to make them earn it by selling things others are willing to buy, this creates wealth for all of us.  We don’t need the government to play this same role. It is supposed, in the first place, to do things that are inherently not profitable, but socially necessary: national defense, education, NASA, etc. Hence, by nature, the government is forced into a situation where it could not earn profit in the same way the private sector does even it wanted to. It cannot and should not play the same game. Second, because of the issue raised in point 1, we need it to generate more spending than it drains away in taxation. Taxes are a useful mechanism for altering spending patterns in order to achieve certain social and economic goals (giving tax credits for charitable giving, encouraging home ownership by making interest and property tax payments deductible, using a progressive system to keep income distributions more even and thus generate more consumer demand–the poor and middle class spend more of their incomes than the rich), but the government doesn’t actually need them in the same way WalMart needs to charge for stuff on its shelves. Why? Because the government, unlike agents in the private sector, may print their own dollars. The US government does not operate under the same sort of budget constraint and if they are to fulfill their role in society, they cannot. It’s not simply that it’s not set up like the private sector, it shouldn’t be–and the private sector is better off for it. Trying to understand the federal government budget process by thinking of it as a household or a firm is to commit a fundamental error of logic. They simply are not analogous. Unfortunately, because we are all so familiar with the way budgets work in our private lives, we cannot help but make the “obvious” but invalid leap.

Note, incidentally, that people are quite right to assume that state and local governments face a budget constraint similar to that of the private sector. The State of Texas does not print its own currency (at least not until we secede) and so if the state government does not collect in revenue as much as it wishes to spend, it faces a real problem. They can borrow, but repayment is a function of future tax revenues, period. They have no other option. Of course, if the deficits are financed by selling debt to Texans, then when the debt is repaid it is basically a redistribution of income within the state: taxes are collected from the population at large and some of those funds go to those who had purchased the bonds that allowed the state to spend in deficit. The situation in Greece was similar to that of a state or local government and hence has very little in common with the US. The primary difference is, they don’t issue their own currency–they are on the euro. Hence, Greece–which should never have been allowed entry into the EU because its periphery status almost guaranteed a problem like this would emerge–was put in the position of a private-sector firm. If they were going to pay their debt, they had to sell (export) more than they purchased (import).

The one and only useful purpose that the balanced-budget fiction plays at the federal level is this: it constrains the power of government officials who, if they realized there was no realistic constraint, might well go just a little crazy. I will not deny that this is a real issue. But, if the only means of solving it is to drain income from the private sector, causing unemployment and stagnation, then there simply is no hope. But surely not.

Say, maybe one of my earlier comments that realistic economic analysis cannot be reduced to something that fits on a bumper sticker is wrong:

Political Reform: Yes Budget Balancing: No


Written by rommeldak

July 15, 2010 at 1:02 pm

Posted in Uncategorized

4 Responses

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  1. Recently I’ve been having arguments with my friends (who know little of econ outside of the simple intro classes) about precisely this stuff–the deficit, government spending and why we need more. I point out that recently when economic growth was at its peak was precisely when most of the spending was actually translating into jobs in the economy. And as soon as that started to taper off (because the stimulus wasn’t large enough) is when the economic growth started to stagnate. I just cant seem to get it through to ’em.

    Before the stimulus was even passed, people were claiming that we would see two things, skyrocketing inflation and skyrocketing interest rates, neither of which has happened–quite the opposite happened in reality. Yet people are claiming we might be going into a double dip recession because of the spending!

    Anyway, thanks for doing this blog. I’ve been having harvey-lecture withdrawals and this will have to do in the meantime.

    Kevin Lioi

    September 3, 2010 at 6:14 pm

    • Alas, there is little that is more poorly understood by the lay public than the role of the federal government’s budget. The problem is that they, quite naturally, assume that it works the same way as their own budget. And quite right–there is very little correlation between the government budget and interest rates and inflation. That those become a problem when we spend in deficit is an argument based on a number of false premises.

      Looking forward to having you in class again!


      September 6, 2010 at 1:54 pm

  2. An excellent article.

    I think this is possibly the first article that I have read that explains why Deficit spending is required by Government and does not take an ideological stance on issue.

    It is great to read an article like this that explains the position of the government to the average person ,such as myself, who has no economic background.

    Ramal Gnanasekaran

    November 11, 2010 at 1:37 pm

    • I really appreciate that. Those are, indeed, my main goals, i.e., be pragmatic rather than partisan and explain it in terms a non-economist can understand.

      Thanks for reading!


      November 11, 2010 at 2:06 pm

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