How Should We Run a Budget Deficit?

If it necessary to run a budget deficit then it should be spent in the interests of future generations, rather than on increased consumption to be paid for in the future.

It is very easy to demand the government should run, or increase, its budget deficit, that is, it should spend more than its revenue and (one way or another) borrow the difference. Many think that is what Keynes said, but the Keynesian analysis is more subtle than the crudities that the deficit advocates seem to rely upon.

This column looks at only one aspect of the rigorous analysis but it comes, I think, to a useful conclusion which does not compromise the issues which have been omitted.

Basically, borrowing has to be paid back. When you borrow for your own ends you either have to reduce your consumption in the future or your bequests will be smaller. When the government borrows to add to your consumption, you may not have to pay it back. Probably some future generation will, and they usually have little say in today’s decision; some are not even born.

Let me introduce a moral dimension – economic policy rarely ignores it – of whether it is right to consume at the expense of future generations. My inclination is no; I am consistent enough to insist this is not only true for financial borrowing but we should be trying to run an environmentally sustainable strategy as well. (I am acutely aware that the argument that future generations have moral entitlements is philosophically contentious. Allow me to skirt it; I guess I am grateful to past generations who took me into consideration when they made their decisions.)

From which one might conclude that the government should never borrow or borrow only temporarily and pay it back across the business cycle. There was a bit of this in the original Keynesianism but there was another case for borrowing.

Suppose that as well as stimulating the economy in the short term, the spending from the borrowing enhanced the wellbeing of future generations – that it was an investment which benefited the future. You might ask whether unborn generations will be better off as a consequence of the spending which induced the deficit.

That was the New Zealand practice, probably long before it pursued Keynesian policies. (The public accounts are difficult enough to interpret today; in the past they were much worse.) Indeed the practice was to run a surplus on the current account (current public revenue and consumption) and use the savings to invest for the future, so that total government investment exceed the borrowing (as it should for most of an individual’s life).

The investment was not always commercially wise although it may have contributed to economic growth. For instance, railways rarely ran at a profit, just as they do not today, but they played a crucial role in opening up farming districts. (This was before trucks and quality roads.) On the other hand, the government ran a number of big enterprises which would have run at a profit – or would have if they had been allowed to operate commercially. Most of these have been privatised, so the government cannot save or borrow to invest in them.

Today, non-economists use the term ‘investment’ rather loosely. You hear people saying they are ‘investing’ in the horses. If you enjoy following them and a flutter on the TAB enhances that, so be it. But it aint an investment. (There is a growing literature which suggests much of the so-called ‘investment’ by the financial sector which led to the Global Financial Crisis is little better than such flutters – or worse.)

So before you line up with your pet spending plans to be funded from the budget deficit, it is well to evaluate carefully the extent to which they are justified for future generations. For instance, I am passionately committed to giving more support to our children, knowing that spent wisely it will enhance their opportunities in the future. That should be treated as a consumption and funded out of current revenue not borrowing. (Incidentally, recent American research suggests the best bang for the buck is enhancing family income, although we still need to work on education and healthcare.)

Crippled for opportunities by the privatisation of state owned enterprises what should the government invest in from its borrowings? One sort of reply is to answer the question from the point of the view of the unborn. Here is my guess.

First, they want a sustainable environment. They would want us to address global warming and to take measures to protect our natural environment. Second, they would want improved infrastructure. I’m guessing they would welcome the broadband roll-out, but for them the development of a good public transport infrastructure is also critical. It takes ages for these networks to become viable; think of how long it will take to build high density housing close to a high density link. I guess too, they would like to address the shambles which is the government’s housing policy. Ideally that should give a commercial return in the long run.

As already mentioned, there may be a case for counter-cyclical investment. As the economy goes into a slowdown it makes sense to bring forward investment projects using the temporary slack in the economy to get them under way early. (The difficulty is that it is usually hard to slow down the construction activity as the economy recovers.)

Thus there may be a case for certain sorts of infrastructural investment funded from borrowing. The Reserve Bank has said it thinks so and because good economists tend to have similar analyses, I should not be surprised if some in the pubic bureaucracy are like-minded. But their approach would be the disciplined one of a fiscal conservative, not favouring a wild spending spree.

What abut the spending on children, on healthcare and on education which I think is so badly needed? The fiscal conservative says that it is basically consumption spending which should be funded out of current revenue and that if there is insufficient revenue taxes should be raised. A budget deficit should not be a means of avoiding raising taxation for public consumption.