How Boring Ol' Fiscal Policy Still Matters -- and Why Conservatives Refuse to Admit that Government Spending Can Be Good
The neo-Nazi party polled better than ever in Germany's federal elections yesterday, but the overall results will allow the two mainstream parties to form a coalition government that is much more stable than the uncomfortable alliance of three parties that is now going out the door. More importantly, this means that the "firewall" that Germany's anti-Nazi parties have created around the far-right AfD will apparently continue to hold, making both President Elon Musk and Vice-Vice President J.D. Vance both very unhappy. (Musk, in fact, decided to call the losing AfD leader to congratulate her, despite falling short.)
That is very good news, relatively speaking, and I will use it as a reason to spend today not thinking exclusively about the wave of awfulness that threatens to crash over the world. What to talk about instead? Economic policy, of course!
The one deep truth about market economies is that they are only partially manipulable by dictators, in large part because bad top-down decisions almost always have unintended side effects that the dictator refuses to acknowledge or believes that he can bully into submission. At some point, "the markets" speak, and even when individual market participants -- say, the bros on Wall Street or Silicon Valley -- truly are on board with the dictator, reality can be a b*tch uncooperative.
One of the few reasonably normal things that is going on behind the scenes in Washington right now is the budgeting process, with Republicans floating trial balloons for cutting some spending, increasing other spending, and cutting taxes -- but not increasing taxes, at least not that they will admit -- which will in turn determine required borrowing levels for the federal government. In short, they are making decisions now that will determine the sizes of The Deficit (cue loud booing) and The National Debt (spontaneous shrieking and swooning).
There are truly no new ideas in fiscal policy, but some ideas cycle into and out of the political conversation. In the early years of Dorf on Law, I spent a lot of time writing about a concept called "capital budgeting" (including these examples from 2010, 2012, 2013, and 2014). I had reason to mention that idea in passing in a column four years ago, but fiscal policy debates have mostly been focused in recent years on the effects of tax cuts and very basic anti-deficit buffoonery by the likes of the business reporters at The New York Times.
What is capital budgeting, and why is it relevant now? That 2012 Dorf on Law piece linked above summarizes the idea at manageable length, and I wrote a much longer article for a law review in 2011 in which I sketched out how it all could work. The essential elements of the idea are that it is possible for federal governments to spend money both foolishly and wisely and that there are two kinds of wise spending: (1) spending that should be used temporarily to fight against economic downturns (or, for a wild example, to support an economy that has been slammed by a pandemic), and (2) spending that represents public investment.
Is there anything radical there? The first argument for government spending is the central tenet of what became known as the Keynesian Revolution during and in the decades after the Great Depression, meaning that the argument was once truly not welcome in polite society before becoming widely accepted (followed by a conservative backlash). The second argument above, however, is about as un-radical as one could imagine. In fact, the only radical aspect of the public discussion about spending-as-public-investment is that conservatives have been able to convince far too many people that the most bland of all accounting practices is an existential threat to civilization.
What is a public investment? Spending money in a way that increases future aggregate income (GDP) by either making people or machines more productive. Why would I call that a bland accounting practice? Because nearly every state government in the US, most foreign governments, and every business in the world -- including the most profitable corporations out there -- use capital budgeting. When a governor brags about having "balanced my budget every year," that is highly misleading, because they are only saying that their "operating budget" has been balanced, while the capital budget (spending on public investments) was financed by borrowing.
In other words, deficits can be good. Very, very good! Government spending financed the creation of the internet, pays for advances in transportation and other infrastructure, and funds education at all levels. Businesses that are quite profitable carry large amounts of debt, because they can borrow money to fund investments and will do so when the expected return on the spending exceeds the cost of borrowing. That is why corporate executive offices include "debt management" teams, not "pay off debt no matter what, and as soon as possible" teams.
All of which means that the federal government should have been using capital budgeting, too. Again, it is radical for the federal government to be prevented from separating its spending into operating and capital accounts. The excuse from conservatives and budget hawks is entirely a political claim, not an economic argument. They say that we cannot trust politicians not to use this "accounting trick" to justify infinite borrowing -- even though, as I noted, state governments, other national governments, and the most sophisticated corporations use capital accounting without veering onto the highway to hell.
Interestingly, one of the other national governments that has not adopted capital budgeting is up here in what will never become the 51st state. With a national election campaign now getting underway, the front-runner to replace outgoing Prime Minister Justin Trudeau to lead the Liberal Party is Mark Carney, who is a former central banker in Canada (and who thus knows economics a bit better than most other politicians).
Carney recently said in a major network interview that he wants to "to invest and grow" Canada's economy while balancing the operating budget over the next three years. The CBC's print article about the interview is worth quoting at some length:
The taxpayer dollars would "catalyze many multiples of private dollars" to build homes, energy infrastructure, AI systems and trade corridors — "all of which are fundamentally necessary if we are going to grow this economy, irrespective of how President Trump is feeling on one day or another," Carney said.
Carney also said a federal government led by him would balance its operational spending — such as government-run programs, federal transfers to provinces and territories and debt service charges — over the course of the next three years.
"Where we are willing to borrow is to invest and grow this economy," Carney told Barton. "That is an absolutely crucial point."
Given my deep interest in capital budgeting, reading Carney's words is of course a pleasant surprise. It is even better to note that Carney's head-to-head polling numbers continue to rise, which means that the anti-"woke" Canadian right might not win the upcoming election. Rather than refusing to say anything that could be politically risky, Carney is saying what every honest economist knows to be true: good fiscal policy requires honest accounting, and honest accounting requires capital budgeting.
Interestingly, the public's misunderstanding of fiscal policy can be nonpartisan. People on the right will always scream bloody murder without making an argument, but even a very lefty YouTuber from Saskatchewan named Steve Boots missed the point when he responded recently to Carney's idea. Boots very understandably has an allergy to the neoliberalism that afflicts both of Canada's non-conservative parties, but here he simply gets it wrong, even after describing the idea (mostly) correctly:
[Carney] would be willing to take on debt to use government funds to invest in different sectors of the Canadian economy to drive private investment. Now, this is an interesting approach to getting rid of the constant pearl-clutching around deficits in Canada, but I'm not fully sold on it because why do we need private investment? Why can't the government just invest the money directly into its people? Why do we need to lure private dollars with public instead of just spending public dollars. But this is kind of what you'd expect from Carney. He's a pretty traditional Liberal: "market solutions" and using the power of the state to try to guide those markets.
Boots's objection is not fatuous, but he truly misses the point. Capital budgeting does in fact involve spending public dollars on the public. Doing so will indeed "drive private investment," not because the government is stroking the rich but simply because private investors will see more profitable investment opportunities in an economy that is not only healthier overall but in which the federal government has put in seed money and has increased the skills of its citizens to make them more productive. (We desperately need stronger labor laws -- and thus strong unions -- to make sure that those productive citizens see their share of the larger pie, but that is a separate issue.) That is what Carney meant when he referred to "catalyz[ing] many multiples of private dollars."
Again, however, the decades-long panicked resistance to public investment comes mostly from the right, because they are religiously committed to the idea that the federal government cannot do anything right. As far as they are concerned, even if we adopted a capital budgeting system, all government spending should be on the operating budget, while the capital budget would have nothing in it. Why? Because the government is presumed to be incapable of doing anything but waste money.
Interestingly and sadly, one of my go-to examples over the years to highlight the value of government borrowing is World War II, where the US joined the fighting (very late, but never mind) and ballooned the national debt by borrowing massively to build a winning war machine. When speaking about this topic, I would usually say something like this: "I think we can agree that when our parents and grandparents took on piles of debt to defeat the Nazis and other fascists, that was money well borrowed and well spent." Now, however, it seems that the new Administration believes that that whole defeating Hitler thing was not such a great idea after all. I can still argue that buying even eighty years of freedom was worth the borrowing, but somehow that is now an open question for some people. Oy.
On a much more mundane level, however, what is happening right now in the US when it comes to public investment? Another of my surefire examples of "good spending and borrowing" over the decades has been Head Start and similar programs, which save the public money hand over fist through the years by investing in children's futures, funding nutrition and related programs that support brain development and other essentials that allow children to become functioning members of society.
Color me not at all shocked, then, to see headlines like this: "Critical childcare programs being impacted by Trump's federal funding freeze." That is tragic, but what else should we expect? I recently called President Musk a "budgetary simpleton" because of his obsession with slashing government spending indiscriminately. In a subsequent column, I focused on the immediate dangers that such budget cuts pose in terms of leading to a deep recession, but even if that were not an issue, the Musk-Trump-Republican unexamined assumption that taking money away from vulnerable people is good for the economy is crazy in this additional way: immiserated people are not good for an economy.
One might offer the counterintuitive suggestion that there is an unintended benefit from the US's decision never to adopt capital budgeting. As I wrote above, "good fiscal policy requires honest accounting, and honest accounting requires capital budgeting." But because the Trumpists will never engage in honest accounting, should we not be happy that they do not have the additional weapon of putting all of their pet spending projects on a capital budget, which is what conservative have always falsely claimed liberals would do if given the chance?
Of course not. Whether or not the US ever adopted capital budgeting, Musk et al. would give to the rich and take from everyone else. In fact, if we had long ago adopted proper accounting, it might even be a bit more difficult for the Trumpists to do what they are now doing to Head Start and other underfunded programs.
In any event, as I noted above, economic reality is the enemy of dictators. Even the strongest strongman cannot simply announce that people will be more productive by decree. If the dictator starves the people and makes it impossible for them to rear their children to become healthy adults, the economy will be weaker and poorer. Private investors might be bullied into doing a bit more investing to please the regime, but they are still going to make decisions on the basis of economic prospects that are worsening with every day of federal layoffs, tariffs, and the rest of the general chaos that all undermine future prosperity.
As Professor Dorf also noted recently, if Trump were to take control of monetary policy to juice the economy, the result could well be hyperinflation. Plenty of dictators have tried to pretend otherwise, but they are always proved wrong.
The economy matters in ways that will ultimately be beyond the power of any oppressive government to reverse or control. That does not mean, of course, that innocent people will be spared unnecessary and cruel suffering. Even if Trump were somehow to come to the realization that siding with Russia and treating the Justice Department as a tool of retribution are bad ideas, however, he will still not be able to stop the short-term or long-term damage that is already being caused by his economic policies. Many dictators have unfortunately survived in such environments for years or even decades, but arrogantly ignorant economic policies always create fertile ground for regime change.