I've Said It Before, and I Will Say It Again -- Everyone Please Read Buchanan and Wagner To Clarify What Is Going On

|Peter Boettke|

Robert Samuelson, writing in the Washington Post, argues that the Keynesian remedy of government spending might not provide the panacea for our current problems.  Why?  Well, because we are starting from a world of large public debt.

I would interpret this argument slightly different than the conventional wisdom --- Keynesianism is not a panacea because Keynesianism has dominated public policy making for half a century and has left us in such a state of public debt.  Keynesianism broke the old time fiscal religion of balanced budgets and fiscal responsibility, and changed not only attitudes of economists and policy makers, but also eroded whatever institutional constraints existed on public spending that had existed.  Keynesianism cannot work to solve our current problems because Keynesianism is responsible for our current problems.  Keynesianism provided an illusion of short term prosperity, but the reality of long term stagnation.  Of course, the revealing of the illusion can be put off, as I have pointed out before, if there is the discovery of new opportunities for gains from trade, and/or gains from innovation.  

But the governmental habit of spending is still there and the bill has to be paid as some point.  Keynesianism is a disease on the body politic because it caters to the natural propensity of politicians to focus on short run, and to concentrate benefits and disperse costs.

Nobody explained these problems better than James M. Buchanan.  Read his Public Principles of Public Debt, followed by his work with Richard Wagner, Democracy in Deficit.  Both of these exercises should help you understand our current situation, and I cannot imagine you spending your winter break in a more fruitful exercise given the severity of the problem facing the western democratic states (see The Economist March 17th, 2011 issue if you are still complacent, or the work by Vito Tanzi, Government versus the Market: The Changing Economic Role of the State).

 

HT: Don Boudreaux

Comments

[Daniel Kuehn]

Could you clarify this phrase: "But the governmental habit of spending is still there and the bill has to be paid as some point."

This is not exactly an uncontroversial claim.

It seems to me the only real budget threat in the United States is Medicare. While we could probably have a more fiscally responsible tax policy too, that's not of the same oncoming-freight-train nature as the problematic combination of very old promises and increasing medical costs.

Maybe you and I see what the problem is differently, but that's really what I see as "the problem", and I know a lot of budget watchers agree with me on that. What I'm struggling with is understanding exactly what that has to do with Keynesianism. Buchanan and Wagner don't even mention Medicare, which was of course on sound footing in 1977.

If "the problem" is more general than that - simply that we run deficits almost every year - then I think a lot of people are going to agree to disagree with you that it's even a problem. But if "the problem" is what most identify as "the problem" - Medicare (some would add Social Security) - I'm personally a little hazy on how we connect the dots.

[Josh S]

Daniel, one other problem is that the government's debt is at 100% of GDP, a point where a few points in interest rate significantly affect the government's ability to service its debt without currency devaluation.

Currency devaluation in turn affects the government's ability to consume resources. Sure, it can spend whatever nominal sum it wants--just print the money and spend it! But the prices of commodities are set by global markets. Entitlement checks then become the least of its worries--it make those disappear, or at least not so burdensome, with the stroke of a legislative pen. Getting the oil necessary to fuel fighter jets, however, is not so easy to do when markets get wise to the faling dollar.

The essential problem is that debt represents expectations, and other entities (firms and individuals) structure their activities around those expectations being met. In the case of government debt that includes the expectation that the currency will be worth something tomorrow. When those expectations prove false, massive dislocations result.

[mofo]

From the Saumuelson article

"Ironically, the past overuse of deficits compromises their present utility to fight high unemployment."

I totally agree, except for the Ironically part.

[Allan Walstad]

Daniel Kuehn: 'If "the problem" is more general than that - simply that we run deficits almost every year - then I think a lot of people are going to agree to disagree with you that it's even a problem.'

One is reminded of the guy who jumps out a 50th floor window, and as he passes the 20th floor says "so far, so good."

[K Sralla]

Daniel,

Take your eye off of the United States for a moment, and consider the larger group of Western governments and the direction of their fiscal conditions since the 20th century height of Keynes. Medicare is but a glaring symptom, but not the real causal problem.

The real problem is the rapid transition of the system boundary conditions, which in human society are represented by those key institutions and their associated rules and informal norms which bracket the range of beliefs and behaviors displayed by human beings making up a society.

For instance, as Peter Boettke points out, the old time fiscal religion pervasive in the minds of most citizens and intellectuals since before the days of Adam Smith up through the early part of the 20th century, largely confessed that public expenditures should be held more or less in balance with revenues in times of peace. Even FDR ran for his first term on the platform of a balanced budget. How many present-day economists seriously believe that the public should balance it's books for much the same reason that an individual family should balances it's own expenditures?

This is just one of countless examples where rules previously held more or less tacitly by the public and its elected officials began to come into open scorn my modern economists who "reasoned" pursuasively that public debt did not in fact represent transfer payments at the expense of future generations in favor of the profligate present. Those who held to the old-time religion were regarded as simpletons.

Do you in fact agree with Buchannan's premise in his paper on public debt?

[John]

While you are wrong about how we got here, that is completely irrelevant. (Fed debt as a percent of GDP reached its low point under Jimmy Carter. If you cannot understand all that such means, I cannot help you.)

What is relevant is what to do now. The World faces three tasks. (1) Putting the USA to work, which includes moving Fed research and investment from 2 to above 4% of GDP; (2) busting up the Euro (the South can ever compete with the north and only busting up a bad idea will work, long term) and (3) moving China and India into consumption.

None of these tasks can be performed, privately. It is going to take trillions. The money is there on the sidelines, not being used.

What is lacking is courage and imagination on the part of people like your

[Daniel Kuehn]

K Sralla -
I understand the argument that approaches to budgeting have change. What I don't understand is why that's a bad thing.

Certainly we can all agree that profligacy like the case of Greece are and always will be bad. But that has nothing to do with Keynesianism and cases like that long predated the 1930s. We've always had sovereigns getting in trouble.

We can all also agree that things like Medicare - structurally oncoming trains - are a problem. But again - what does that have to do with Keynesianism?

The biggest run up in debt after Keynes occurred because it's expensive to kill fascists overrunning Europe. That would have happened with or without Keynes. In the height of Keynesian influence, as John points out, U.S. public debt was reduced - because Keynesians have always been attuned to keeping the fiscal house in order and controlling inflation. It's inched up as Keynesianism has lost its influence, and of course now are biggest debt problems have to do with entitlements, which have nothing whatsoever to do with Keynesianism. Nothing.

So while I think you can credit Keynesianism with killing the "old time fiscal religion" that seems like a good thing to me, not a bad thing. The only problems associated with debt that we've had to deal with since the 1930s seems completely unrelated.

[Daniel Kuehn]

When you all hold up the same bad guy for every single problem that looms out there, that should give you pause.

[K Sralla]

Daniel,

I appreciate your response, but you did not answer my question about whether you think Buchanan's argument on public debt is sound. If you do not, where does he go wrong?

[K Sralla]

To answer John's challenge, I would ask him to plot up the debt to GDP ratios of the G8 economies during the last 100 years, and then examine the trend of the ensemble mean vs the trajectories of individual members.

If there is no systematic forcing boundary condition governing debt to GDP, then I might expect to see scatter among ensemble members, but no statistically meaningful trend in the ensemble mean.

[Jonathan]

Only a little more than decade ago our debt was falling. How does that fit with the argument against Keynesianism?

Did the beneficial changes in our fiscal position (both reduced spending and increased revenues) reflect a divergence from Keynesianism or consistency with the countercyclical policy that Keynes articulated?

[ksralla]

Jonathan,

Perhaps you miss the point made in my challenge to you above.

It is not surprising that any individual country expriences short-term changes in it's fiscal balance owing to the business cycle and resulting changes in revenues. These ups and downs admittedly are difficult to attribute to any particular policy.

However, the point above is that a statistically significant longer-term trend in the ensemble mean of the worlds largest economies over the last 50 or so years needs causal explanation. If the ensemble mean is up over a significantly long period of time, this strongly implies a forcing rule change. The noise of ups and downs in revenue are not likely to produce a significant trend in the ensemble mean.

Now while it is hard to nail down with complete certainty any particular change in rules that have driven the increasing debt load, a prime suspect must be the Keynesian revolution.

This signal associated with changes in the rules of the game would be expected to emerge from the noise associated with a shorter-term business cycle.

Another question which arises in response to Daniel's ambivalance of the trend might be to aske whether these changes in rules are acting on a more or less stable system, or whether these rule changes might be pushing the western governments toward some sort of critical tipping point of instability.

[Jonathan]

ksralla,
Thanks for your post. Note: my point on surpluses in the late 1990's was my first to the thread (I am not John who posted earlier). However, I do think that John makes a relevant point.

If you look at the post WWII era in the US there is a clear break in trend beginning with Reagan.

I am not a macroeconomist, but my understanding of Keynesianism (as noted in previous post) is that deficits in business cycle lows are paid back by surpluses at peaks. (I think Alex Tabarrok proposed a constitutional amendment requiring this).

The Bush tax cuts and abandonment of "paygo" spending rules (both implemented when Republicans had control of both chambers and the White House) have put us back in the rut that took us a decade to start climbing out of.

If that is really what "Keyensianism" is then yes, I agree it has put us in a world of hurt.