Saturday, December 04, 2004

Budget Deficits II: You Can't Blame Dogs for Eating Out of the Garbage

"Why does Camelot lie in ruins? Intellectual error of monumental proportion has been made, and not exclusively by the politicians. Error also lies squarely with the economists. The ‘academic scribbler’ who must bear substantial responsibility is Lord Keynes ...” Buchanan, Wagner, and Burton, 1978.

(Continuing yesterday's rant on deficits...)

Government deficits are not (usually) earthquakes or floods, the natural consequence of random or deterministic process. Instead, deficits are the aggregate consequence of the self-interested individual actions of hundreds of elected and appointed officials, the sine qua non of the public choice approach. A more traditional view of the “public interest” in political science, of course, imagines that government officials work to advance the public good, or at a minimum their own vision of that good. Keech (1995) describes the “public choice” alternative:

… [The] democratic process is not so benign. In that view, politicians are opportunistic, and voters are naïve. Incumbents manipulate their performance to appear misleadingly good at election time, and both challengers and incumbents make unrealistic and insincere promises. Voters are myopically oriented to the present, which makes them unprepared to hold incumbents accountable for their performance over entire electoral periods, or to relate electoral choices to future well-being in a meaningful way. Economic performance deteriorates. Politicians exploiting popular discontent propose superficial reforms that fail to solve the problems, such as the Gramm-Rudman-Hollings deficit-reduction acts of 1985 and 1987. (p. 3).

The public choice model of government decision-making predicts that government surpluses have the life expectancy of an adult mayfly. There have been several published collections that have made this point clearly, including Buchanan and Wagner (1977), Buchanan, Rowley, and Tollison (1987), and Rowley, Shughart, and Tollison (2002). Of course, Keynes himself accepted, and in fact was one of the foremost advocates of, the idea that ideas matter, in his over-quoted passage on how “the world is ruled by little else.” But it is worth quoting the entire passage, to show what argument (interest groups and self-interest) Keynes thought he was refuting.

But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. (Keynes, General Theory)

One key to understanding the public choice approach, particularly in its application to the study of debt and deficits, is this: Keynes is posing an absurdly false dichotomy. Ideas are not opposed to “the interests,” but are more often tools, even rhetorical weapons, used in service of those interests. That is not to say that ideas don’t matter, but rather to insist (contra Keynes) that interests do.

Let me link this back to deficits and the debt, and the contribution of the public choice school of political economy. It is easy to think that debt is not really a problem. For “functional finance” scholars (see, e.g., Lerner, 1943), deficits are simply the harmless means of accomplishing good ends. After all, we owe the debt to ourselves, and rational income earners will always save now to meet future tax obligations. As Abba Lerner famously put it, "national debt is not a burden on posterity because if posterity pays the debt it will be paying it to the same posterity that will be alive at the time when the payment is made." (Lerner, 1944: p.303).

What this idea implies, as Buchanan (1976) pointed out in response to Barro (1974), is the strong claim that the issue of new public debt is simply a form of new taxation. Barro had argued that the society could spend out of tax revenue now, or spend out of future tax revenues by borrowing. Buchanan notes that this is precisely the issue raised by “Ricardian Equivalence,” if taxpayers perceive future taxes as claims on the next generation, with the added understanding that the next generation is made up of our children. If we look “forward” in this way, it can be argued that debt will have no impact on total spending, because the spenders in a democracy recognize that they are also the payers, and are no more likely to authorize increased spending out of debt “revenue” than they are out of tax revenue.

The point is that the extreme form of Ricardian Equivalence, combined with the Keynesian policy prescription for deficit spending as a positive good, constitute an important “idea.” What this idea has enabled, however, is the empowerment of a set of interests whose political goals have little to do with the abstract utopian economysticism of the Keynesian macro-control scholars. In an important series of papers (Buchanan, 1958; Buchanan, 1976, and Brennan and Buchanan, 1980) James Buchanan took on the problem of “future generations,” and at a minimum showed that facile “equivalence” claims simply do not follow from the arguments given for them. In fact, he is able to show that some of the claims Barro made for equivalence imply absurd predictions about the world. On the other hand, the absurdities Buchanan points out highlight the debt and deficit experience of the last 30 years.

One implication of his analysis would be that the social security system as it has operated should not have modified the rate of private saving in the economy…If politicians are ultimately responsive to the desires of their constituents, we may infer something about constituents’ evaluations by observing the behavior of politicians. The 40-year history of social security financing yields ample evidence that politicians are extremely reluctant to adopt anything which smacks of full funding for the system. Under the Barro hypothesis, there should be roughly indifferent public reaction to a fully funded and to an unfunded pension system.

If we shift to the more general model, governments should be roughly indifferent as between financing current outlays from taxation and from genuine debt issue. There should be no effect of debt-financed deficits on aggregate spending... [The] behavior of legislators seems to offer indirect evidence against the capitalization hypothesis. Can anyone in the post-Keynesian world of 1975 seriously question the proclivity of politicians to expand the public debt in preference to tax increases? (Buchanan, 1976, p. 341).

From the vantage point of 2004, rather than 1975, it is easy to understand Buchanan’s skepticism. The level of under-funding of Social Security obligations has now reached the point where the discussion no longer centers on whether the system will default. What analysts wonder is when, and by how much, benefits will have to be slashed, or perhaps even eliminated. In this context, it is difficult indeed to sustain the claim that the constraint imposed by Ricardian equivalence describes political choices of either citizens or elected officials.
An interesting perspective, which connects the “public interest” and “public choice” view of budgeteering, is that of Higgs (1987), which argues that decision-making is motivated (or supported) by an ideology we might call “Keynesianism” or fiscal activism. Higgs describes “ideology” this way:

By ideology I shall mean a somewhat coherent, rather comprehensive belief system about social relations.... Ideology has four distinct aspects: cognitive, affective, programmatic, and solidary. It structures a person's perceptions and predetermines his understandings of the social world, expressing these cognitions in characteristic symbols; it tells him whether what he "sees" is good or bad or morally neutral; and it propels him to act in accordance with his cognitions and evaluations as a committed member of a political group in pursuit of definite social objectives. (Higgs 1987, 37)

Higgs incorporates Keynes’ claim that ideas matter, but there is a twist. The growth of government and the increase in the acceptable size of deficits, accumulated in the debt, are linked to a fundamental change in the conception of government. People changed their view of the obligations of citizens, and of the role of government in their lives. So, part of the reason that the size and scope of government has increased is simple interest group politics: every program creates an interest that depends on the program for its survival. But programs are also protected by the idea, now widely held among citizens, that it is right and proper for government to regulate and subsidize the everyday activities of citizens.

Charles Rowley (Rowley, 1987a; 1987b) independently develops a more specific, but related, set of analytic themes about the macroeconomy. He approaches Keynes and Keynesianism in a way that should receive more attention from macroeconomic scholars, because he links the ideas of what we now think of as Keynesianism to the “public choice” arguments that require attention to interest and political consequence. And there we have the reason that debt and taxes are quite radically different: even if one concedes the Barrovian logic of economic equivalence, the process is driven by political interest, in which debt is nearly always preferable to but they emphasize the political sense in which debt and taxes are radically different.

When one tries to draw together the independent strands of thought of Buchanan, Higgs, and Rowley on deficits, it is hard not to be reminded of von Mises’ famous observation about economic theory and its use in making policy prescriptions.

Scarcely anyone interests himself in social problems without being led to do so by the desire to see reforms enacted. In almost all cases, before anyone begins to study the science, he has already decided on definite reforms that he wants to put through. Only a few have the strength to accept the knowledge that these reforms are impracticable and to draw all the inferences from it. Most men endure the sacrifice of the intellect more easily than the sacrifice of their daydreams. They cannot bear that their utopias should run aground on the unalterable necessities of human existence. What they yearn for is another reality different from the one given in this world...They wish to be free of a universe of whose order they do not approve. (Mises, Chapter 4, Section 6, Epistemological Problems of Economics).

To most politicians, of any of the main partisan affiliations, it now seems established that deficits and large accumulations of debt are benign, or at worst only pose a danger far off in a distant future. The problem is that these political “leaders” may be sending a message that the electorate would take issue with, if it were presented as a package rather than piecemeal. The problem is not just that voters are too passive and disorganized to respond. The real problem is that voters want is perfectly sensible, but impossible to deliver because it is not feasible. Voters want three things: (a) lower taxes, (b) increased spending on “needed” programs, and (c) lower deficits.

Of course, I want these things, too. We just can’t have them, at least not all the time. And it now seems clear that the salience, or marginal utility (depending on whether you are a political scientist or an economist) of these three is not equal. Every time a politician offers lower taxes and increased spending, voters act they just got a prom date with the prettiest cheerleader, or that handsome striker, or maybe both. Voters actually want lower deficits, but only at the cost of raising someone else’s taxes, or cutting someone else’s needed programs.

Given what we now know, or think we know, about the problem of fragility and contagion in the remarkably interconnected and interdependent financial systems of the world, it is clear that voters are making a mistake, putting deficits last, or allowing political leaders to do so. Putting aside the (quite real) ethical problems of financing current consumption on the pocketbooks of future generations of taxpayers, one can make a strong argument that voters are being misled, or at least badly led. One cannot blame our political leaders for cravenly exploiting the political advantages of deficits, any more than one can blame dogs for eating out of uncovered garbage cans. It's what they do.

Here's the thing: my liberal friends often make two complaints....(1) We should use government to do pretty much everything, because it is better, more rational, and more responsive to the needs of the people. (2) We hate George Bush, because he pursues political advantage ruthlessly. Why don't liberals see that investing huge powers in government and trusting government to do the right thing is EXACTLY what causes George and his policies to be such a dangerous force in our lives.

"For they have sown the wind, and they shall reap the whirlwind.". ~ Hosea 8:7

Social scientists must do a better job of explaining the trade-offs that an economy, and a political society, make when considering the shadow their choices cast into the future.

References
Barro, Robert. 1972. “Are Government Bonds Net Wealth?” Journal of Political Economy. 82: 1095-1117.
Brennan, H.G. and Buchanan, J.M. (1980). “The logic of the Ricardian equivalence theorem.” Finanzarchiv 38 (1): 4–16.
Buchanan, J.M. ([1958] 1999). Concerning future generations. In Public principles of public debt: A defense and restatement, 27–37. The collected works of James M. Buchanan, vol. 2, ed. by H.G. Brennan, H. Kleimt and R.D. Tollison. Indianapolis, IN: Liberty Fund.
Buchanan, J.M. (1976). “Barro on the Ricardian Equivalence Theorem.” Journal of Political Economy. 84: 337-342.
Buchanan, James M., Charles K. Rowley, and Robert D. Tollison. Deficits. Oxford: Basil Blackwell, 1987, pp. x, 417
Buchanan, James M. and Richard E. Wagner, Democracy in Deficit: The Political Legacy of Lord Keynes. New York: Academic Press, 1977.
Buchanan, James M., Richard Wagner, and John Burton. (1978). “The Consequences of Mr. Keynes” Hobart Paper 78 (London: Institute of Economic Affairs, 1978).
Buchanan, Neil. (1996). “Which Deficit? Comparing Thirteen Measures of the U.S. Fiscal Deficit on Theoretical and Empirical Grounds,” Working Paper No. 170, Levy Institute, Bard College Department of Economics,
http://www.levy.org/docs/wrkpap/pdf/170.pdf
Federal Reserve Board, 2003, Household Debt Service and Financial Obligations Ratios,
http://www.federalreserve.gov/releases/housedebt/default.htm
Higgs, R. (1987). Crisis and Leviathan: Critical episodes in the growth of American government. New York: Oxford University Press.
Hinich, Melvin, and Michael Munger. (1994). Ideology and the Theory of Political Choice. Ann Arbor, MI: University of Michigan Press.
Ippolito, Dennis. 2003. Why Budgets Matter: Budget Policy and American Politics. Pennsylvania State University Press.
Keech, William. (1995). Economic Politics: The Costs of Democracy. New York: Cambridge University Press.
Keynes, John Maynard. (1936 / 1997). General Theory of Employment, Interest, and Money. New York: Routledge.
Lerner, A.P. (1943). Functional finance and the federal debt. Social Research 10 (February): 38–51.
Lerner, A.P. (1944). The Economics of Control: Principles of welfare economics. New York: MacMillan.
Mises, Ludwig von. (Buchanan, Rowley, and Tollison), pp. 114-142.
Rowley, C. K. (1987b). “The Legacy of Keynes: From the General Theory to Generalized Budget Deficits,” in Deficits (ed by Buchanan, Rowley, and Tollison), pp. 143-172.
Rowley, C. K., William Shughart, and Robert Tollison. (1987). “Interest Groups and Deficits,” Deficits (ed by Buchanan, Rowley, and Tollison), pp. 263-280.
US Office of Management and Budget (2003). Budget of the United States, fiscal year 2004: Historical tables. Washington, DC: US Government Printing Office.
http://www.whitehouse.gov/omb/budget/fy2004/pdf/hist.pdfU.S. Treasury Department. 2003. “REVISED SERIES: MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES.” http://www.treas.gov/tic/mfh.txt1933 / 1976). Epistemological Problems of Economics. 1976 edition, New York: New York University Press.
Muris, Timothy, (1999) “Ronald Reagan and the Rise of Large Deficits: What Really Happened in 1981.” Fairfax, VA: George Mason University Law School Working Paper,
http://www.gmu.edu/departments/law/faculty/papers/docs/00-05.pdf
North, Douglass. (1990). Institutions, Institutional Change, and Economic Performance. New York: Cambridge University Press.
Rowley, C.K., Shughart, W.F. II and Tollison, R.D. (Eds.) (2002). The economics of budget deficits, 2 vols. International library of critical writings in economics 153, ed. by M. Blaug. Cheltenham, UK, and Northampton, MA, USA: Edward Elgar.
Rowley, C. K. (1987a). “John Maynard Keynes and the Attack on Classical Political Economy’ in Deficits (ed by

3 comments:

Anonymous said...

I don't think what you say here refutes Keynes. You say:

Ideas are not opposed to “the interests,” but are more often tools, even rhetorical weapons, used in service of those interests. That is not to say that ideas don’t matter, but rather to insist (contra Keynes) that interests do.Keynes's argument, I believe, is that (at least some) ideas are exogenously developed. Nearly every idea of consequence will help some people and hurt others, to differing degrees. Obviously, "the interests" will favor those ideas that help themselves, but there are many varied "interests." If ideas themselves didn't help persuade people, there would be no need for "the interests" to deploy them in debate.

Now you may say that the sole purpose of debate is to convince other people that Idea X advances their interests, and you would probably be right. But if a new policy idea improves the welfare of more people than it harms, does this not increase the likelihood that it's a good policy according to some greater social welfare index?

In the world of vulgar marxism ideas are a means by which the powerful dupe the workers. That is, ideas are endogenously supplied to the ruling class (except, presumably, for marxist ideas). This seems to be your position. Perhaps your position is true, but merely asserting it does not refute Keynes, it simply proposes an alternative hypothesis. One which I think is demonstrably wrong.

debt free guy said...

I did a search for "be debt free" and I found this site. I just wanted to say you have a great site and have enjoyed reading it! Thanks again!

Debt Free Guy
be debt free

Steve Austin said...

Nice blog. Please check out my consumer debt counseling blog. It is all about consumer debt counseling.