Good and Bad Deficits

Feb 20, 2012 Robert Skidelsky

The distinction between capital and current spending (or between “good” and “bad” deficits) is old hat to any student of public finance. Nevertheless, we forget knowledge at such an alarming rate nowadays that it is worth re-stating, particularly with deficit hawks in power in the UK and throughout Europe.

LONDON – “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 lock step.

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Robert Skidelsky

Writing for PS since 2003
177 Commentaries

Robert Skidelsky, a member of the British House of Lords, is Professor Emeritus of Political Economy at Warwick University. The author of a three-volume biography of John Maynard Keynes, he began his political career in the Labour party, became the Conservative Party’s spokesman for Treasury affairs in the House of Lords, and was eventually forced out of the Conservative Party for his opposition to NATO’s intervention in Kosovo in 1999.

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parthasarathy Shakkottai Feb 25, 2012

MMT says deficits are always good.
"Role of the national government

Before we establish specific arrangements in the financial markets etc, we need a clear statement of purpose for any national government. I think some of the erroneous reasoning in the media and within the broader debate stems from a lack of clarity about what it is that the national government should be doing on our behalf.

From the perspective of modern monetary theory, the national government which issues the currency as a monopolist has a charter to advance public purpose (welfare) at all times even if, in doing this, specific private interests are impeded. In general, the advancement of public interest will provide a sound basis for private benefit also. But at times this will not be the case.

From that broad charter, full employment, poverty alleviation and environmental sustainability become the most significant expressions of public purpose although in choosing those policy targets I am expressing my values rather than making an economic statement.

However, it is highly unlikely that an economy will perform to potential if these policy targets are compromised."- from
http://bilbo.economicoutlook.net/blog/?p=5098&cpage=1#comment-1553”

The cumulative deficits lead to national wealth. The household net worth of USA is $58.5 Trillion. The national debt is $14 T. GDP is about the same, $14T/yr. The ratio of GDP/yr to govt spending/yr has been about 5 over the years. The same ratio holds for household net worth to national “debt”. Deficits grow the economy and there is no risk in maximizing deficit spending until the economy is operating with no unemployment and no idle capacity. If inflation begins, it can be stopped by interest rate control. There is no need to pay back national “debt” even if you could! GDP, national wealth, and national “debt” all grow together.
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Michael Bakewell Feb 22, 2012

Absent from this discussion is the current level of debt which must be serviced either from "current spending balanced by taxation" or worse, future borrowing. Before continuing or widening a deficit spending plan shouldn't some stress test be applied against economic downturn, raising interest rates, etc.?
- parthasarathy Shakkottai Feb 25, 2012
  
  Actually the national debt is held mostly by US citizens, pension funds,businesses etc and the interest circulates as private sector income. If the national debt is paid off lots of grand mothers will be unhappy!”
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William Wallace Feb 20, 2012

Excellent read. My hope is that leaders on both sides of the Atlantic, as well as their political opposition, will come around to the views expressed here sooner rather than later. The austerity panic has gone on long enough.
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