Balanced budgets and the technocratic imperative

For ages we’ve seen an alliance between a pragmatic, basically scientific technocratic economics and conservative pseudo-economics. The former has always been essentially neo-classical-Keynesian and fairly empiricist. The impact of monetarism and the ‘new classicals’ on technocratic economics – the economics of Treasuries, central banks, the IMF, etc. – has been much exaggerated. But for a long time there wasn’t much of a difference between the technocrats’ practical policy and that of the conservative ideologues. What we’re seeing now is a divergence, and we see that the real power lies with the technocrats; conservative pseudo-economics falls whining to the roadside.

The ‘balanced budget’ ideology has its roots in the naive view that government finances are analogous to private finance, that deficits are reckless ‘spending beyond our means’ that ‘the taxpayer’ is one day going to have to pay back, and so on. But governments don’t really face a budget constraint. In boom conditions, balanced budgets and surpluses were technocratically rational for macroeconomic reasons however, so spreading the false idea that always balancing the books was a good idea for common-sense prudential reasons was useful to the technocrats.

It’s no longer a useful idea, and the balanced budget ideology becomes a political drag. You can sense its presence in all the headlines that had Rudd ‘admitting’ there would be a deficit, despite the journalists being hard-pressed to find a credible economist who thought it bad policy. It has still, of course, been running rampant through the opinion pages. And no doubt there is a fairly large proportion of the population that believes this stuff, or at least has a gut feeling that there’s just something dodgy about government debt, whatever the economists say.

Then there are the more sophisticated economic arguments. These acknowledge that the battleground is not the government accounts themselves but their interaction with the whole economic system. The ‘crowding out’ arguments on so many tongues in the 1970s and 1980s held that government deficit spending would be macroeconomically useless because it would simply displace the same amount of private expenditure. It does this either financially, because the government is borrowing from a limited pool of funds, or in the ‘real economy’ by pulling workers and other resources away from private employment. In some conditions there is something to the crowding out argument, at least in the latter form, and no-one doubts that in conditions of full employment, extra spending will raise prices rather than output. (Though there are devils in the definition of ‘full employment’, and anyway, we might rather have the public spending than the private.) But in conditions where private investment is holding back, it doesn’t make any sense unless you deny the reality of involuntary unemployment.

Then there is the even less-convincing argument  from ‘rational expectations’: that deficit spending is useless because taxpayers anticipate the future repayment of debt via future taxes and save accordingly. Even if you think people generally behave in this way – and personally I think it’s ludicrous – it does not rule out an impact from the expenditure, because people can rationally expect the future taxes to come out of future higher incomes.

Anyway, these kinds of arguments have been valiantly put forward by certain economists and whole armies of credulous conservative op-ed writers the world over. But their star has been falling because the technocrats have better arguments, and because the deficits are coming anyway, no matter what policymakers think. This has emboldened the technocrats within academic economics to stick the knife into the crazier elements of their discipline, the monetarist remnants, the new classicals, Hayekians, and so on. Witness the open civil warfare which has broken out in big-name American economics between the ‘freshwater’ (i.e. Chicago and mid-Western) and the ‘saltwater’ (coastal) economists. Paul Krugman has been particularly merciless in persecuting the Chicago School likes of poor Eugene Fama, likening him to a biologist who is not only a creationist, but one who is completely unaware of the existence of evolutionist arguments.

What we’re seeing is not the ‘end of neoliberalism’, because most practical neoliberals never ditched the idea of stimulatory spending in a downturn. We’re just seeing the widening of a split between technocrats and ideologues. The ideologues have become an obstacle to policy which is functional for capitalism; they are being cast adrift, but no doubt they’ll be useful again.

Published in: on 9 February, 2009 at 11:32 am  Comments (10)  

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  1. Hi Mike; glad to see you’re up and writing again. The ideologue-technocrat linkage is an interesting take; the reiteration of the ideologue line in the media through all the op-eds and interviews though certainly has a broad impact on the wider public’s understanding of economics, so I am not so sure that the break is going to be so clean. At least here in the States. There are a whole bunch of cranks–professional economists and not–who loathe the notion of a government deficit.

  2. Hi Mike,

    this is nothing if not a timely intervention. I must say I feel slightly shamed by it because I’ve found myself complaining about the public deficit and found myself nodding sagely at the comments of the followers of von Mises of late. I guess I have two complaints about the deficit which I wonder how you’d address:

    1. that the government deficit is, insofar as it results from bailouts, a transfer of ruling class debts onto the public at large;

    2. that the government deficit is unsustainable, that far from being a temporary expedient which can be paid back in times to come, there’s no reasonable prospect of paying it back. My feeling that the debt is unsustainable is based on my impression that, in a large part, the growth of public debt is about the government stepping in to pay for the current account deficit, which previously was being paid for by rising levels of consumer debt.

  3. Hey JCD,

    Thanks! We’ll see how long it lasts; I still have a thesis due in six months. Sometimes writing all day exhausts me from writing anywhere else, but other times it strengthens the writing muscles and I feel even more like writing outside the thesis… lately I’ve got the blogging itch back.

    I do agree that the anti-deficit ideology is a real material drag on fiscal stimulus action. But it is dysfunctional and I think there are more powerful forces selecting against it. Most powerful is the sheer weight of the automatic tendencies towards a deficit from the fall in revenue. It would take an enormous effort with the austerity chainsaw to bring spending in line, and if a government tried to do that, the op-ed pages would be just as full of people pointing out how stupid that would be. In Australia, for example, the Opposition has been forced to admit that despite raising a huge fuss about the deficit, its own plan would mean a deficit only an eighth smaller than the government’s plans:

    Then there’s the fact that an attempt to avoid a deficit might actually lead to larger deficits, because the spending cut-backs would be multiplied in the Keynesian fashion.

    I think in these material conditions what I called the technocratic line is at a great advantage against the anti-deficit ideology; it just makes more sense.
    I should be clear though that this does not mean the stimulus packages will necessarily work. I might come back to this question in another post. Though I think things would undoubtedly be worse without them, and that they won’t hurt, their impact may not be strong enough. I should also be clear if it wasn’t from the post that I don’t see the technocrats as our friends, just that they are functional for the system.

  4. Hey Mr AusWatch,

    Some good questions…

    1. First of all let’s be clear about what a government debt entails. Governments have a theoretical capacity to ‘print money’ to cover any deficit if they need to. Instead, these days government deficits are financed by issuing securities (i.e. bonds) of various dates, which investors buy. The reason governments do this instead of ‘printing money’ has more to do with managing the monetary impact of their debt than with actually needing to borrow resources from the private sector. Governments just don’t want to devalue the currency through inflation and/or depreciation.

    Two consequences: First, governments are never going to go bankrupt on debt issued in their own currency. Second, the impact of deficit funding is mediated by monetary policy. Central banks deal in government debt to maintain given interest rates. So if private buyers will not buy the whole government debt at the interest rate the central bank wants, the central bank picks up the slack. To the extent that it does, money has effectively been ‘printed’ – but if that is likely to have undesirable inflationary consequences, the central bank is likely to not be setting that interest rate. At the moment the private demand for government debt is pretty much insatiable, so no money is ‘printed’ at the moment when the deficit is incurred.

    It does leave an overhang of debt which might later have a monetary impact later. Say, in the next boom, when banks find they have a big stock of government debt, they can sell it to fund expansion again. Though in principle the central bank manages this, its capacity could be limited, especially since it deals mainly in short-term debt (though this is merely conventional, and could be changed).

    As for the tax impact of repayments – it’s true that the government is committed to paying back the principle plus interest. So in that sense future taxes will eventually go to repaying today’s debt. But this is manageable by the government – it is always possible for governments to keep rolling over debt, though it might have monetary consequences as explained above. At any rate, tax takes tend to increase at least as fast as economic growth, so the burden of future payments is diminished to that extent. As for the tax burden impact, who this falls upon depends on the structure, progressiveness etc., of the tax system.

    Anyway, all this is a long-winded way to make my main point: contradictions may well emerge over time from a deficit, but they are of a monetary nature rather than a budget constraint (i.e., to do with inflation and/or the exchange rate rather than with government capacity to pay). But, again, the attempt to avoid a deficit may lead to a larger deficit than a deliberate attempt at stimulus. So it’s an inescapable contradiction.

  5. 2. The question of the current account deficit is even more complicated. First, it’s an artificial figment of national accounts. No-one, neither the government nor anyone else, can be held responsible for it because it’s an aggregation of countless balance sheets. The question is, does it have any real effect? Is a current account deficit associated with any real causal countervailing mechanism that tends to close it? I think the answer is that it isn’t in itself, though it might to some extent reflect some other tendency which is.

    There’s a tendency to think of a current account deficit like this: it emerges as a consequence of a country’s population spending more than it earns and therefore resorting to borrowing from the rest of the world. But this is a bad way to think about it. The reason is that nations as a whole don’t borrow, individual units do. Any individual unit spending more than it earns must borrow from another unit (or run down its savings). Whether the borrowing comes from a unit in the same country or one in another country depends on the terms of finance in both places. Domestic lending of course need not be exhausted before units have recourse elsewhere.

    Someone’s borrowing is obviously someone else’s lending. That lending is a particular way of holding one’s savings. Decisions on how to save are also decisions about who to lend to. Just as the borrowing unit seeks the best available terms wherever they may be available, so does the lender/investor. Observed interest rates and flows of money reflect the outcome in aggregate of the interaction between borrowers and lenders, wherever they are in the world. That will have some imprint in the national accounts, but not necessarily a meaningful one.

    A current account deficit can’t be seen simply as a result of residents ‘spending beyond their means’. To the extent that the financial markets in that country are attractive because of their breadth and depth, perceived safety, etc, they may attract savings which have the consequence of cheapening borrowing on those markets, which may then cause the aggregate excess of borrowing. In fact it’s not something that’s amenable to thinking about in terms of one-way cause-and-effect.

    Anyway, the upshot is that a current account deficit can be sustained for a long time, indefinitely in fact, and if there are tendencies to reverse it, they can take a wide variety of forms, some painful and some not. Note that despite being the epicentre of the crisis, the US dollar appreciated against most other currencies.

    I don’t think I’ve explained this very well, which means it’s not really that clear in my own head! This is a decent article about some of these complexities, and covering people who think there will necessarily be a current account reckoning and people who (like me) don’t:

    I might come back to this in a post too.

  6. I still can’t really see how a current account deficit can run indefinitely, despite the mitigating factors you mention. Running a deficit of this type indefinitely is surely unsustainable at any level, whether between units, or between countries – any serious permanent imbalance means that the level of indebtedness will keep ratcheting up and eventually reach some kind of crisis point. And I take it that this point applies also to both private and public debts: high levels of debt can be maintained, but continuously increasing debts cannot – similarly the current account deficit is really a rate of change of the national debt, hence in itself problematic. The mitigating factors you mention are important, but the current account deficit is so consistent and enormous that I think it’s impossible to dismiss as a serious problem – unless the current account deficit figures don’t include substantial capital flows in the opposite direction.

    In concrete terms, what I mean is the following: America’s maintenance of a high current account deficit in the wealth-effect years was possible only by continuously increasing the level of national indebtedness, public and private (I fail to see what difference your units point makes to this – local flows could differ, as indeed they did, with the rich actually accruing capital while the poor and the state racked up debts) – which is one thing that led to subprime lending, which by definition wasn’t sustainable at all because it involved lending to people who just couldn’t be relied upon to meet their obligations.

    This takes us back to your first point, about the state’s capacity to shoulder debts. Here I’m not in disagreement with you, so much as just baffled. If the government can take on heaps of debts without necessarily having any problems, then is their attempt not to run debts just an ideological error caused by neoliberalism? It seems to me that what we have in governments running up higher and higher debts inevitably leads in the direction of hyperinflation: the only way to keep spending when you’re in deficit, once you’ve exhausted your non-government backers, is to print money, which can only serve to devalue the currency. Obviously, I accept the Keynesian point that the government should run a deficit in the lean times – but I feel the current account issue is so intractable that if the government keeps ‘bailing out’ the economy then we’re really on a road to ruin.

  7. Hey AusWatch,

    It’s possible I’m being too nitpicky about this… I don’t want to imply there’s no potential for some event involving a US dollar crash or necessitating high US interest rates… But the current account data is just a bad measure of any real forces that might cause such a reckoning. There’s nothing really to say a current account deficit is unsustainable indefinitely; historically they have been sustained for decades at a time.

    This is especially true for a country that is a global financial centre, and even more so for one whose currency is the basis for the whole world currency system, because people are going to hold assets denominated in it no matter what.

    Think about it this way: imagine you live by yourself way out in the middle of the outback and you make a living crafting ornate fake aboriginal art. (or whatever) You ship it to Sydney and order your food etc on the internet. You make enough to save substantially every year. But presumably you don’t keep your savings under the mattress; at least you keep it in a Sydney bank and probably you invest it in something in Sydney. Now if payments and capital accounts were drawn up for some reason within Australian borders, it would turn out that Sydney has a balance-of-payments deficit with you. Sydney keeps getting more and more indebted to you. But you can see how meaningless that is, and how it could conceivably keep growing as long as you keep working, and then presumably you pass the art factory along to somebody else. Typically within a country the places where people save will have a ‘deficit’ with other places… same thing on a world scale.

    As for your comment that ‘it’s impossible to dismiss as a serious problem – unless the current account deficit figures don’t include substantial capital flows in the opposite direction.’ It’s impossible for this to happen because current accounts are by definition balanced by the capital accounts. This gets to the heart of the issue… there’s a tendency to talk about the payments deficit as if its about ‘America borrowing beyond its means’ – but there is necessarily two sides to that, and the desire to borrow does not call the tune any more than the desire to lend/invest.

    You could say however that the conjuncture was such that interest rates fell within the US to the point where American residents were willing to borrow more than was sustainable. But it’s unsustainable because of their income flows compared to their outgoings, not because of flows recorded by the stats as crossing borders.

    As for the government borrowing – I fully agree that government deficits can cause problems of the kind you mention – inflation, currency devaluation – so neoliberal/Keynesian policies were quite rational to go for surpluses for macroeconomic reasons. My point was just that the reason had nothing to do with running a ‘balanced budget’ for budgetary reasons, and that it’s irrational even by neoclassical standards to balance the budget now given the macroeconomic circumstances… so the large but uninformed political constituency that supports balanced budgets for their own sake was once an asset to technocratic macroeconomic management but is now a liability.

  8. […] of weeks ago. Many perfectly orthodox, neoclassical-Keynesian economists would agree here also. Back in February I wrote another piece about how for many years technocratic economists who understood the budget as a cyclical stabiliser […]

  9. […] likes of Krugman and deLong are undoubtedly in the ascendancy. As I suggested a few months ago, I think we should see this as the victory of a rational technocratic economics over an ideological […]

  10. […] vs. ideologues revisited Back in February 2009 I wrote about what I saw as the break-up of a longstanding political alliance between “a pragmatic, basicall… The split was forced by the technocratic imperative to run stimulatory fiscal policy in response to […]

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