Deficit hawks think of government, and indeed all economic actors, as a household: just as households' finances improve when they spend less and save more, so will national economies do better if government saves more and spends less. Therefore, the best policy, they say, is austerity.
But an entire economy is very different from a single household. In these single household analogies, income is assumed to be fixed, but in a national economy, it is precisely the growth of income that makes an economy successful.
This is part of a three-part series that addresses three central issues that Romney is running on:
1. There is a debate over the role of government in the economy
2. The recovery has been slow
3. Obama has added to the national debt
Part One is here and
Part Two is here.
Unlike with household analogies, for government or the economy as a whole, income is not fixed: income is determined by spending. In fact, by definition, one person's spending is another person's income. When you buy a car, the amount of money you spent, dollar for dollar, is recorded as income divided between the car's seller, distributer, manufacturer, and the government for its share in taxes. When you earn your weekly paycheck, the exact same amount, dollar for dollar, is recorded by your employer as spending. Every economic transaction in our economy is an equal amount of both spending and income.
Without spending, there is no income. An individual household could get rich if it could somehow collect income without spending a dime; for the economy as a whole, if nobody spent a dime, nobody would earn a dime. The economy would grind to a halt. The precise strategy that would make a household rich would bankrupt the nation.
Edward Harrison at Credit Writedowns explains:
when we exchange goods and services with each other, from an accounting perspective, it’s a wash; if you buy my goods, I get money and you get goods of equivalent value. If you pay for those goods with an I.O.U., with a debt, your liability, your deficit in the year we made the transaction, is exactly equal to the asset on my balance sheet and my surplus for the year. I mean this is basic accounting, folks. There’s no hocus pocus. Any person’s, any household’s, any business’s, any group’s, any government’s debt is someone else’s asset. Any person’s, any household’s, any business’s, any group’s, any government’s deficit is someone else’s surplus. Again, it’s basic accounting.
What does all this mean then? Put simply, the financial sector balances framework means that when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. So, to move any sector balance in an open economy, you need to move the other two balances exactly opposite in equivalent measure. To reduce the government deficit in any period, the private balance and the capital balance must increase by the exact same amount in that period.
It's kind of like in football: when one team scores, another team is scored against. Any individual team can improve its standing by improving its defense while leaving its offense the same, but if all teams improved their defense equally, the net effect would only be fewer points scored. No team would be better off.
Earlier I argued that the reason this recovery is slow is that the private sector, having massively leveraging mortgage, financial, and consumer debt in the decades leading to 2008, is now deleveraging and cutting debt. For individuals, cutting debt means cutting spending. But if everyone tries to cut debt at the same time, everyone also earns less income, which makes it even harder to cut debt.
In a full-employment economy, if households save a bigger fraction of their incomes, the total amount of savings goes up. In a depression, saving more actually reduces the total pool of savings because cutting spending causes production and incomes-- and hence savings-- to fall. At less than full employment, "everything goes into reverse." The same applies to governmental thrift.
-- Sylvia Nasar, The Grand Pursuit: The Story of Economic Genius, describing the
paradox of thrift
Then you get the recessionary spiral that accompanies austerity. It's not the government but thousands, even millions, of private actors all engaging in their own private austerity. Even as they try to reduce spending, it becomes harder and harder to earn income. The debt they tried to pay off looms larger, and in the meantime there is unemployment, people sleeping in shelters while mansions go empty, banking crises, derailed careers, a Lost Generation.
[There is] no technical, financial reason why a national fanatically addicted to deficit spending should not pursue such a policy for the rest of our lives and even beyond.
--
Paul Samuelson, the first American to win the Nobel Prize in Economics
Where the government deficit come in? Well, if government runs a deficit during this time, it is paying out the private sector more than it is collecting in taxes. This allows the private sector to earn income while cutting its debt at the same time. Public payments in the form of Social Security, Medicare and Medcaid, Unemployment Insurance, direct provision of jobs, procurement, and all public spending constitutes income for the private sector. The debt issued to pay for public spending also constitutes assets on the private sector's balance sheets.
Government deficits are necessary to keep economic activity going while the private sector pays down debt. It prevents the private sector from going into a recesionary debt spiral, which would progressively raise unemployment and waste, reduce income, and destroy lives. Its purpose is functional (to keep as many resources, labor and capital, employed as possible) and ultimately all economic policies should be judged by their functional role. At this time, not only do deficits not matter, but deficits are actually necessary and good.