November 22, 2003


Is the deficit too small? (Richard W. Rahn, 11/20/03, Washington Times)

The conventional wisdom is our federal government deficit is too large. However, the empirical evidence suggests the deficit might be too small. [...]

The total federal government debt held by the public (which is the relevant number to be concerned about) dropped from 42 percent of gross domestic product (GDP) in 1962 to a low of 25 percent in 1975, then rose to a high of 50 percent in 1993, and then dropped back to 33 percent in 2001. Currently, debt as a percent of GDP stands at about 35 percent.

Since 1963, we have had 14 years when debt has been below 33 percent of GDP and 26 years when it has been higher. Conventional wisdom is that economic performance should have been better in the years when we had less relative debt, but the facts are the opposite. Real economic growth averaged 3.47 percent in the high debt years, which was almost 1 percent higher than the 2.59 percent average growth of the low debt years.

Unemployment was also lower in the high debt years averaging 5.65 percent as opposed to 6.43 percent in the low debt years. Inflation averaged a whopping 7.6 percent in the low debt years, almost 3 times as high as the average 2.95 percent of the high debt years.

The Congressional Budget Office (CBO) estimates federal debt could grow to as much as 40 percent of GDP by 2005 and then begin declining again. From 1986 to 1999, it was above 40 percent, and we did quite well during most of those years. Recent data showing both much higher economic growth and higher inflation (meaning much higher nominal GDP) than the CBO forecasted means the debt GDP ratio in fact is likely to remain almost constant. [...]

Finally, the analysis of the historical data clearly indicates that if we had properly structured tax cuts (like the first Reagan and the most recent Bush tax cuts) in 1969, 1973, 1979, 1989 and 2000 we may have avoided the recessions, with all their human misery and unemployment, that occurred the year following each of the above dates. Unfortunately, policymakers in all of those years were more preoccupied with reducing the deficits rather than keeping the economy growing.

The lesson is clear, economic prosperity can continue, even if the federal government never balances its budget, provided it keeps government spending from growing as a percentage of GDP, and has an ongoing program of removing tax and regulatory impediments to growth.

This has only been obvious for two hundred years now.

Posted by Orrin Judd at November 22, 2003 7:51 AM

The fundamental question of American democracy: should we think of social security as a pay as you go government expenditure, or as a government sponsored savings plan? The first better fits the fact, but then we have to accept that we'll have to adjust benefits paid in any particular year to our abilit to pay. If the latter, then it truly is an "entitlement" and total government debt is much higher than 35% of GDP.

Posted by: David Cohen at November 22, 2003 9:06 AM


Besides, the economy's performance is driven by other factors than the level of government debt, so the conclusion is silly.

It is true that Britain, which deliberately created a permanent funded national debt in the mid-1800s, enjoyed its greatest economic growth during the next century, and that the growth was not much slowed at the highest period of debt creation (the wars with France). But nobody thinks debt created that growth.

Posted by: Harry Eagar at November 22, 2003 4:00 PM

I wonder what the parallel with business is?

I imagine most large companies have some level of debt, and that 40% of annual receipts would not be considered particularly large.

I'll bet it matters a lot more what the money is spent on.

Posted by: Jeff Guinn at November 23, 2003 2:42 PM

There are enough historical instances that contradict MacDonald's argument that we can safely disregard it.

I'll just mention three:

1. the Venetian montes de pieta

2. Sweden, most literate but poorest nation in Europe during the 19th century.

3. the drivers of British economic expansion during the French wars, which were many but included new supplies of raw cotton, inability of the Spaniards to enforce their colonial trade regulations and a several-fold increase in the availability of mechanical power in Britain. None of those had anything to do with debt or debt levels.

William McNeill has proposed that Athenian democracy was able to flourish, while it did, because of a monopolistic trade advantage in pottery, wine and oil (especially wine and oil).

If correct, this applies about equally well to British economic expansion around 1800.

Posted by: Harry Eagar at November 23, 2003 4:06 PM


Anyone with a pricey education or home has higher.

Posted by: oj at November 23, 2003 6:42 PM

Depending upon where they are in the lifecycle, yes.

40% debt to GDP ratio doesn't sound the least out of hand, though.

Posted by: Jeff Guinn at November 23, 2003 8:53 PM

Personal debt, corporate debt and government debt usually have different foundations, different prospects and different sources or repayment, so comparing them doesn't get us very far.

Posted by: Harry Eagar at November 24, 2003 1:01 AM

I know. I tried applying a personal example, and after a few paras ran into abject failure.

With only those two lame sentences above to show for it.

Posted by: Jeff Guinn at November 24, 2003 9:58 PM