Deficit Spending Displaces Private Economic Growth
There isn't clear evidence deficit spending leads to economic growth
March 14, 2013
The case for budget balance begins with economic growth. A number of studies have now found that nations with high debt—typically defined as debt in excess of 90 percent of GDP—tend to grow more slowly.
Some still argue that the U.S. is special: We operate our own currency and it happens to be the currency in which international business is conducted. This advantage may allow us to blow through the 90 percent mark without slowing growth. But the Congressional Budget Office is now projecting that—absent policy change—U.S. debt will reach 100 percent of GDP in about a decade and climb to 200 percent just 13 years after that. The U.S. might be special, but it isn't that special. There is some level of debt that will affect us. And there is no law that says international commerce will always be conducted in the U.S. dollar (just ask the British).
Even if economic growth is not your top priority, excessive debt should still concern you. It makes it harder for government to do other things that you might value. More debt means higher debt payments. And every dollar the government sends to a creditor is a dollar it might have spent on Social Security, Medicare, or infrastructure. Assuming interest rates remain moderate, the CBO projects that in just 12 years we will spend more on interest payments than on Medicare. In 16 years, we will spend more on interest payments than on Social Security.
There are many smart people who think that deficits are a problem, but not now. Right now, they say, we need growth. And growth, according to standard Keynesian theory, requires higher deficits today. This perspective has three problems.
First, the evidence that deficit spending yields lasting growth is nowhere near as clear as stimulus proponents make it out to be. In fact, there is good reason to believe that deficit-financed spending displaces private economic activity, even in the short run.
Second, the data suggest that there are diminishing marginal returns to stimulus spending: It is less effective the more you do it. And we've already done it a lot. The data also suggest that stimulus is less effective in highly indebted nations. So as we pile on debt today, we make future stimulus efforts that much less effective.
Third, the 'not a problem today' mentality is built on an unrealistic model of political behavior. It assumes that once the economy improves, politicians will find their fiscally conservative inner-selves and begin paying down the debt. Unfortunately, this isn't the way actual politicians behave. In the real world, every political incentive is to spend now and pay later. That's why politicians run deficits, even when Keynesians tell them not to.
That is why there is no time like the present to worry about the future.