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So, Do Deficits Matter? So, Do Deficits Matter?

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So, Do Deficits Matter?

History teaches that public debt can lift a nation to prosperity or bring an empire to its knees. It depends on what the borrowed money is spent on.

In political Washington, a rare consensus has been reached: Federal budget deficits pose the direst danger to the U.S. economy. The summer’s agony over striking a deal to raise the debt ceiling and the creation of a congressional super committee to whittle down the federal deficit have turned on its head the axiom that then-Vice President Dick Cheney reportedly propounded as recently as 2002: “[President] Reagan proved that deficits don’t matter.”

Americans, by and large, agree with Cheney. According to opinion polls, the public worries more about the loss of jobs than about mounting deficits. Nor has business stormed the ramparts because of the imbalance in federal revenue and spending. More than half of the entrepreneurs in a recent Harris Interactive poll cited “economic uncertainty” as a major obstacle to hiring; they regarded the federal deficit and debt as a source of that uncertainty but not as any immediate threat to their businesses. Even economists are of varying minds, depending on their political persuasion, about the significance of deficits to a nation’s well-being.


Let’s consider, then, another means of judging whether deficits matter: the dispassionate lessons of history. What do they teach? That sometimes, a public deficit lifts a nation to prosperity and strength; at other times, it can bring an empire to its knees.

At first glance, the historical record looks chaotic. The Byzantine Emperor Justinian the Great inherited a full treasury but exhausted it on military campaigns and elaborate buildings—notably, the grand cathedral Hagia Sophia in what is now Istanbul—and left a weakened state to his successors. Germany’s Weimar Republic, unwilling to cover its deficits with taxes or loans, printed more money instead; this brought hyperinflation (200,000 marks for a loaf of bread) and undermined its legitimacy, fostering the rise of the Nazis. In fighting the resulting war, President Franklin D. Roosevelt presided over a surge in the American government’s debt to 115 percent of gross domestic product. But this didn’t stop the United States from reveling in a postwar era of unprecedented prosperity.

Deficit-ridden nations have variously prospered, muddled through, or disintegrated, seemingly with no obvious pattern. Yet as the historical examples accumulate, patterns do emerge. Public deficits aren’t always bad or always good. A lot depends on the circumstances and, especially, on the purposes to which the government puts deficit spending.



Public deficits may be incurred, economic historians say, for any of four purposes: to help invest in a nation’s long-term prosperity; to merely keep pace with an economy’s growth; to sustain pleasing but unproductive “prestige” programs, such as social undertakings and foreign adventures; or, worst, to cater to social dysfunction such as by letting the moneyed classes exempt themselves from taxation.

Spending on long-term investments, even if it exceeds a government’s income, is the likeliest to prove beneficial—or at least benign—to the society’s future. The Louisiana Purchase, for instance: Thomas Jefferson’s 1803 acquisition doubled the size of the country and acquired all or part of 15 future states. The U.S. government paid France $3 million in gold but financed the other $12 million by selling bonds. Tangible, productive assets, bought for 3 cents an acre, proved a wise investment even though it added to the public debt.

Going into debt to build infrastructure can also add value. In ancient Rome, the vast expansion of the roads into a network of 29 highways facilitated trade and technological progress across Europe for the next millennium; it helped Rome keep its economic vitality long after its government had split into dysfunctional and warring states. Not so different was the U.S. system of interstate highways, championed by President Eisenhower in the 1950s, which fostered commercial development from coast to coast and ushered in benefits far exceeding its costs. This is China’s strategy now, as it speedily builds a high-speed rail system meant to link the huge nation’s disparate regions and reduce its dependence on oil.

Short-term deficits incurred in hard times have also been useful in bolstering economic vigor and protecting jobs. That was FDR’s strategy for easing the Great Depression, although it didn’t work as well as going to war. If the demand for products shrinks, government spending can pick up some of the slack until the private sector recovers—a Keynesian tenet that has lately become the object of partisan debate. A recent working paper for the International Monetary Fund examined the experiences of 17 industrialized nations from 1978 to 2009 and concluded that reducing the deficit in demand-constrained times, whether by cuts in spending or increases in taxes, had damaged the economy. Paring the deficit by 1 percent of GDP, the researchers suggested, reduced private consumption for the following two years by 0.75 percent and cut the inflation-adjusted GDP by 0.62 percent.


This article appears in the October 14, 2011 edition of National Journal Magazine.

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