The Debt and the Deficit: False Alarms/Real Possibilities. - book reviews

The Debt and the Deficit. False Alarms/Real Possibilities, by Robert Heilbroner and Peter Bernstein. New York: W. W. Norton, 1989. 146 pp. $5.95.

What there is of value in this book by Robert Heilbroner and economic consultant Peter Bernstein may be briefly summarized: * The true public sector budget embraces all levels of government--federal, state, and local; and the net deficit has been running one-third less than the federal deficit because of state and local surpluses. * The effective size of federal deficits is further reduced by the share allocated to public capital formation like transportation projects, educational facilities, and water and waste disposal systems that enhance the nation's productivity, and by the share absorbed by government itself. Of the total value of bonds sold to finance federal deficits and still outstanding--in other words, the national debt--30 percent is owned by federal agencies, including the Social Security Trust Fund and the Federal Reserve banks (and another 11 percent by state and local governments). Inflation reduces the "real" size of this national debt, just as it reduces any debtor's burden. * The national debt amounts to considerably less than the value of all assets owned by the federal government, indicating a solid net worth position for the nation, and one that is underwritten by the productive capacity of the U.S. economy and the federal government's ultimate power to draw tax revenues from it. * The national debt held by the public has been rising relative to the gross national product (GNP) in the 1980s, and the ratio now stands at 43 percent. But this is no larger than in the early 1960s and a third lower than in the early 1950s. * The main burden of a national debt is the interest payments on it, because of their "impact on the distribution of income." Such interest is "a net expense for the lower three-quarters of the nation, and a net benefit for the upper one-quarter."

This raises a critical question, and the way it is handled symbolizes the entire book. Heilbroner and Bernstein show, in a statistical table, that interest on the national debt climbed from 1.9 percent of the GNP in 1980 to 3.2 percent in 1985-87. This is a sharp increase; by 1987 it meant that 1.3 percent more of GNP, or an extra $58 billion, was being rechannelled to "the upper one-quarter" (more likely the upper tenth). The distribution of income became much more lopsided in the 1980s, and one would expect the authors to probe the connections between the rising interest bill and rising income inequality. But they completely evade these issues, limiting themselves to the observation that while "interest payments have certainly gone up strikingly in dollar amounts," GNP has gone up even more in absolute dollars! They thereby manage to ignore the striking aspect of their own statistics--the 68 percent rise in the interest-to-GNP ratio in just five years. Heilbroner and Bernstein then conclude that "the more widely held the debt, the less the burden will fall on those in the lower and middle-income groups." This is an inappropriate piece of theorizing that deflects attention away from reality: exactly the reverse has been occurring, as the distribution of financial wealth has become more unequal in the 1980s too.

Nearly everything in The Debt and the Deficit confirms the political trajectory of the authors--reformism of the mildest and most superficial type, with limits defined by the neoconservatism of the 1980s. The authorities cited by Heilbroner and Bernstein are predominantly from the right--"such respected economists as Milton Friedman and Herbert Stein," along with members of the American Enterprise Institute. On the single occasion when the authors differ with "Nobelist Milton Friedman," on the desirability of high-level public investment, it is "with regret." Mainstream Keynesians, who have been outspoken on these issues, are conspicuously absent, except for Robert Eisner (the father of most of the points noted above) and Benjamin Friedman (whose opposition to the deficits, however, is barely visible). By contrast, "so distinguished a financier as Walter Wriston" is given credit for "protesting the general misperception" that the deficits of the 1980s are dangerously large. Citing Wriston in this context is opportunism of a high order. Wriston, an arch-conservative, spoke out against the deficits run up by the Carter and Ford administrations, stating in 1978, for example, that such deficits were "diverting available capital from productive private investments to finance public expenditures. Only a reduction in the Federal deficit would reverse this trend." (New York Times, May 13, 1978).

Heilbroner and Bernstein's treatment of the federal deficits themselves is inaccurate, and often misleading. "We would be seriously oversimplifying the [deficit] problem," they write, "if we laid full blame on the [1981-83] tax cuts and defense spending alone." The real culprit, they charge, was Federal Reserve Chairman Paul Volcker: his relentless anti-inflation policy from late 1979 through 1982 cause a "near-depression" and a deficit explosion, from $40 billion in 1979 to $128 billion in 1982, as the economic downturn depressed tax revenues and swelled expenditures for unemployment relief, welfare assistance, and loans to hard-pressed farmers.

Even were this the whole story, it would be wrong to imply that Volcker's tight money policies were pursued against the wishes of the Reagan administration. Heilbroner and Bernstein praise Reagan budget director David Stockman, as someone whose "mastery" would have allowed him "to compose this chapter [on the federal budget] more skilfully than we." Yet they fail to utilize Stockman's own history of the early 1980s (The Triumph of Politics, 1986): "Paul Volcker will surely go down as the greatest Federal Reserve Chairman in history for the masterful and courageous manner in which he purged the American and world economy of runaway inflation. This success turned out to require the traditional, painful, costly cure of a deep recession. . . . There is also little doubt that Volcker's feat would not have been possible without Ronald Reagan's unwavering support during the dark days of 1982."

But that is far from the whole story. From 1982 through 1986, the economy emerged from its three-year long slump, and real GNP grew a vigorous 4.1 percent per year. In the past, such recoveries have always reduced the federal deficit. Not this time. From 1982 through 1986 the deficit rose from $128 to $221 billion.

How do Heilbroner and Bernstein account for this wholly new development? They lay the blame on "unforeseen" factors, chiefly the 1979-81 inflation-driven increase in Social Security and Medicare payments, which are indexed to the cost of living, and the "post-inflation reduced tax revenues." But they are forced to concede that the sharp fall in the inflation rate after 1981 "slowed down the rise in entitlement payments [although] total entitlement disbursements continued to grow." They immediately add that "meanwhile, the drop in inflation played havoc with tax receipts. Despite the jump in real output, tax receipts actually fell from $618 billion in 1982 to $600 billion in 1983" and rose less than might otherwise have been expected through the rest of the 1980s.

For long-time readers of either author, the quality of this analysis is shocking. For one thing, a drop in the inflation rate will slow down the rise in tax collection, not decrease them. For another, the 1982 and 1983 tax receipt figures the authors cite are actually for those fiscal years (the government's fiscal year runs from October through September). From fiscal 1982 through fiscal 1983, real output (GNP) was not yet jumping--it was growing at only a 1.5 percent annual rate, not enough to expand tax revenues appreciably. On top of this sluggish economic growth came the Reagan tax cuts. Heilbroner and Bernstein make no mention of them in this respect; not until a footnote 25 pages later are we told that they represented "the largest tax reduction act in our history." And nowhere do the authors record the timing of the cuts. The first, 5 percent, was implemented from October 1981 through June 1982; the second, 10 percent each year for the two years beginning in July 1982, obviously dominated fiscal 1983--and all years since. By 1984 (in The Legacy of Reaganomics, C.R. Hulten and I. V. Sawhill, eds.), Harvard economist Lawrence Summers could demonstrate that "there is no mystery about how the large budget deficits have materialized. The Reagan administration reoriented but did not substantially change the level of federal spending. It legislated massive tax cuts that led to direct increases in deficits, and further indirect increases as interest expenses rose on the mounting debt. . . . it is clear that if 1981 economic policies had been maintained, no significant deficits would have arisen. Under current policy, however, the outlook is for large and growing structural deficits." Later Congressional Budget Office data confirmed this prognosis. The structural deficit (the excess of spending over tax collections even at the "high employment" phase of the business cycle) soared from $48 billion in 1981 to $185 billion in 1986.

Unlike their newly-discovered luminaries of the right, Heilbroner and Bernstein believe in a wider nonmilitary role for government in the economy. On their last page, they announce that they favor an annual deficit, meaning "growth-promoting expenditures on a capital budget, of 2 to 3 percent of GNP--perhaps $100 billion to $150 billion at today's values." This amounts to a back-door method of financing public infrastructure investment, since "the tax-hating public . . . will vote themselves to be undertaxed." Heilbroner and Bernstein have read George Bush's lips and accepted the message--period. It matters little that, for the U.S. "public," taxes are equivalent to a smaller percentage of GNP (about 30 percent) than in any advanced nation except Japan (catching up), Switzerland, and Australia. Nor it is so much as hinted that the Reagan tax cuts were loaded for the rich and left intact by the Tax Reform Act of 1986.

This stunted tax base, moreover, is used disproportionately to finance the military. Heilbroner and Bernstein refer to Reagan's "enormous buildup of our defense establishment" only to assert that it was "substantially offset" by cuts in social outlays and cannot be blamed for the deficit explosion. Even a first approximation of alternatives forgone suggests otherwise. Military spending took 26 percent of all federal receipts in fiscal 1981 and 36 percent in 1986. Had the increase not taken place, the 1986 budget deficit of $221 billion would have been reduced by a third. Heilbroner and Bernstein might respond that less military spending could have caused slower GNP growth and a wider budget deficit anyway. But the 26 to 36 percent revenue-share increase indicates a macroeconomic shift of major proportions that need to be analyzed, not dismissed.

One could hardly guess from this book that as federal deficits mounted through 1986, there was no corresponding increase in the nation's commitment to rebuilding the decaying infrastructure despite the widespread publicity given the problem; public investment actually fell as a share of the GNP. As the authors must have observed, the larger deficits went for higher military outlays and a grand consumption spree by the top layer of the income distribution. Can anyone imagine that future deficit spending will be absorbed any differently short of a radical shift in political priorities?

The broader focus of recent economic debate had been the "twin deficits"--the budget deficit and the foreign trade deficit, or the surplus of imports over export sales. To this, Heilbroner and Bernstein devote one-tenth of their book, almost exclusively to deny that we are "living beyond our means" by borrowing foreign funds to cover both deficits. They rightly dismiss the conventional wisdom that the cause of the deficits is inadequate national saving, since "the low rate of household savings is a result of the sluggish growth in real purchasing power." This insight is pushed no further. The authors' sole point is that the growing foreign indebtedness of the United States is no problem so long as foreigners are content to hold dollar assets (U.S. bonds, stocks, and other property) and do not sell them off wholesale, disrupting world financial and foreign exchange markets.

Not once is the pivotal financial event of the 1980s mentioned--the dramatic shift of the United States from the world's key creditor nation to biggest debtor. In 1981-82 U.S. residents owned $140 billion more in foreign assets than foreigners held in the United States. The crowning achievement of Reaganomics was to dissipate this balance in less than three years. At the end of 1985 the United States was in hock to foreigners for $111 billion, and $600 billion by mid-1989. Heilbroner and Bernstein make no effort to estimate the burden of servicing this ballooning debt, through interest, dividends, and profits flowing out of the United States and putting at least some strain on national income and living standards. They consider only the problem of financing the deficits, and they stress that so far foreigners show no signs of dumping their U.S. holdings and provoking a flight from the dollar. The United States, they explain, offers "an economic environment congenial to enterprise."

Heilbroner and Bernstein invoke Milton Friedman (again) to affirm that the continuing inflow of foreign to the United States is, for example, "a sign of U.S. strength and Japanese weakness." Here the authors forget what they have long known--that monetarists couldn't care less about financial-sector fragility as a possible source of capitalist crisis. In fact, it could be argued that a financial squeeze due to a withdrawal in foreign lending has already developed. Foreigners are now induced to purchase or retain U.S. assets only by high interest rates in the United States, a fall in the value of the dollar that makes U.S. assets cheap, or some combination of the two--given the state of foreign confidence in the United States.

This is a combustible mixture. High interest rates could trigger a recession in the United States, with dire consequences for erector-set debt structures not only here but in Latin America, the Philippines, perhaps elsewhere. A plunge of the dollar on foreign exchange markets could bring anything from a disorderly fire sale of U.S. assets to world-wide financial panic. Heilbroner and Bernstein reassure us that "no clear-cut signs of harm" have yet come from the twin deficits. But the drastically changed boundaries of American power seem to escape their notice. Relative to the rest of the world, the U.S. economy is smaller, more dependent on foreign capital, and far more vulnerable to international trade and speculative finance than it was twenty years ago. U.S. administrations simply are not free to pursue any fiscal or monetary policy of their liking. Most significantly, any effort to keep stimulating private consumption and business profits through deficit financing will no longer be seen by the rest of the capitalist world as an "external economy"--as a source of Keynesian demand stimulation for the whole international economy. Instead it will widen the U.S. trade deficit and strengthen the image of a fiscal policy out of control. With the "right" set of circumstances, all the nervousness barely contained since October 1987 could break out again.

In this environment, Heilbroner and Bernstein's solution--a budget deficit of 2 to 3 percent of the GNP annually--may not only be unsustainable, but ineffective as well. With the regressive structure of current fiscal policy, and the constricted investment propensities of corporate business, not even the Reagan-Bush deficits have succeeded in driving the U.S. economy to full employment. The authors notwithstanding, even a balanced budget could be more productive, if its revenues come from higher taxes on the rich and deep cuts in military spending, and its outlays go toward a wide range of public investments. That is the way to end the long night of social disintegration in this country and create some counterforce to private capital operating in unregulated markets.

For the past decade the increasingly integrated capitalist world has been destabilized by the debt-fueled expansion of the U.S. economy. The forces behind this development have been the underlying pull of stagnation, the attempt to reverse it in ways compatible with the existing distribution of income and wealth, and the new contradictions posed by the erosion of America's post-Second World War hegemony. Uncharacteristically, Heilbroner and Bernstein deal with none of these history-making events. As the center of political gravity has shifted to the right, they have come to terms with it, as this book shows. It is a sorry sight.

Richard Du Boff teaches economics at Bryn Mawr College.

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