Not All US Spending Is Bad – Public Investments in Infrastructure, DARPA, Basic Science R&D And Education are Good – But Impossible To Differentiate In A Climate in Which All Spending Is Either Bad Or Sacrosanct

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By Paolo von Schirach

August 3, 2011

WASHINGTON – In a piece in The Financial Times, (Washington’s battle is a diversion, August 3, 2011), Martin Sandbu points out that in the Washington anti-spending drama whose first act just ended with the August 2 compromise, we lost sight of the fact that not all US public spending is bad. There is so much focus on the evils of deficit and debt, the consequences of too much aggregate spending, that now, according to the fiscal purists, “all spending is bad” and thus we should cut everything –across the board.

Not all US spending is bad

Well, no. Some spending may actually be good, and that would fall under the category of “investment”. To put it in simple every day life terms, some spending, even if originating in borrowing, may actually be good. Suppose you get a commercial loan or borrow against the equity in your home to finance a new business or to build an addition to the house. Chances are that there may gain from this borrowing. The business may succeed. Your home value may increase due to the addition.

Borrowing to invest in assets not the same as borrowing to finance leasure

Suppose instead you borrow against your home equity to pay for a lavish, luxury vacation. Well, that is spending on leisure. It may be enjoyable; but that is pure spending to support a life style that you could not otherwise afford, as the money does not come from your income. And if you did this every year, in the end you may have eaten up your entire home equity with nothing to show for it, except that hopefully you had a good time.

US needs to spend on infrastructure

By the same token, whatever the bad reputation earned by the Obama stimulus plan , (“shovel ready projects” that were not), there is an obvious –in fact urgent– need in America to maintain aging physical infrastructure. Now, this is not sexy, futuristic stuff. It is highways, bridges, ports, airports. But spending for its upkeep is absolutely necessary, unless we want to descend into Third World conditions.

Borrowing to fund infrastructure maintenance is not the same as borrowing to fund transfer payments. In so doing, we are actually attending to the upkeep of the national physical plant. Good highways, ports and other facilities reduce the time it takes to move goods around. This will facilitate commerce and improve productivity, and thus it will have a positive impact on the economy.

Good US spending on R&D and education

By the same token, government funded basic research provides the underpinnings for additional private sector-led research that may piggy back and hopefully capitalise on the first wave of government funded outlays. Remember DARPA and the Internet early steps? Who funded it? Well, the US Department of Defense. And what about all sorts of electronics and your portable GPS device? Yes, the evil, spendthrift US government started all that. Not so evil stuff, after all, as it gave life to a variety of private sector, high technology industries that are still the envy of the world.

From the above it should be clear that even as we retrench and we cut down, as we must, it would be wise to keep spending on items that strengthen the economic resilience of America and/or its future innovative capabilities.

Most spending is for entitlements that America can no longer afford

Regarding the “bad” spending, we should note that most entitlement programs are based on political bargains in which the government determined that it was its responsibility to provide for the poor and for the elderly. Most of the money Washington spends, about 60% of the total federal budget, goes to entitlements that are essentially income support and health care support programs.

These programs are not “bad” in and of themselves. It is their overall size that is bad in as much as the amount of transfer payments, (mostly to an increasing number of elderly Americans), cannot be financed through the current revenue raising measures. In other words, Washington made promises and then overtime enlarged them, while it has not enough money to keep them. As entitlements cannot pay for themselves through the taxes devised to fund them, the difference between revenue and outlays is made up through increased borrowing.

Reforming social spending is politically explosive

Of course, we should add that the rest of the government has also run amok. Non entitlement, discretionary spending, (defense and non defense), has grown too much. But tackling discretionary spending, while complex, is not nearly as controversial as reducing benefits to tens of millions of current and future beneficiaries. It is not an accident that these are called “entitlements”. Try and yank them away from people who mistakenly believe that they “earned” them. All in all, these politically explosive items are the major reason why we are running large deficits.

If we focus only on the deficit we do not discuss the composition of public spending

But, as Sandbu points out, by focusing entirely on the deficits that are a consequence of all aggregate spending, we are not discriminating. Given a bias against spending per se, there is no debate about the composition of US federal spending and therefore we are not discussing which spending is useless, which spending we may want but can no longer afford and which spending may actually be beneficial to the US economy.

Staggering deficit growth due to the extraordinary circumstances of the financial crisis combined with ordinary spending already out of control

True enough, the rate of increase of all spending is unsustainable. But, first of all, we should be able to differentiate between one time extraordinary spending due to the need to counter the effects of the 2008 financial crisis, and the trends of ordinary spending. The current scary ballooning of the US deficit and debt is unfortunately due to a combination of the two: current expenditures, and extraordinary measures such as TARP to bail out banks, salvaging GM and Chrysler, money for Fannie and Freddie, extension of unemployment benefits, and so on. But the real long term problem is representated by ordinary spending that will continue to grow, unless changes are made, well after the end of the ad hoc programs aimed at containing the impact of the 2008 financial crisis.

Needed: a mature debate on the composition of spending

Still, confronted with a 14 trillion debt mountain, (and counting), the intelligent response should not be just: “Let’s cut all spending”. The sensible approach should be: “Let’s cut starting with whatever is the least useful and then continuing with reformulating entitlement programs so that they become affordable, even if this means reducing benefits, while preserving and perhaps even enhancing spending that may have a beneficial effect on the economy, like research, education and infrastructure“.

Impossible to have a relaxed conversation about emotionally charged issues

But, while sensible, this approach may be almost impossible. In the current highly politicised environment the Left argues that social spending has to be preserved, at current levels, come what may. The Right instead argues that all public spending is unproductive ands thus it should be cut, while new taxes to reduce the deficit are out of the question, as a matter of principle.

In this climate, we miss the opportunity to have any real debate about the composition of public spending and we may be unable to preserve and even enhance spending that may have aggregate beneficial effects for the whole economy.

In the end, the powerful lobbies will probably prevail

In the end, I suspect that we shall have neither a “slash everything” approach nor a sensible, selective cuts criteria based on merit. In the end, I suspect that, lacking a shared analytical approach to reform, we shall continue to spend on the programs that are best protected by the most effective lobbyists, whose patrons are also funding the campaigns of key decision-makers.

As always, policy decisions will be based on political bargains and not on cost-effectiveness. If the traditional approach will prevail, give or take a few bones thrown to the fiscal hawks, the federal deficit and debt issues may be contained for a while; but they will never go away.

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