Don’t Fret over Deficits – Creative Accounting to the Rescue

While Tyler Cowen is playing the Ricardian Equivalence card, he opens with the central concern that an increase in consumption means a reduction in investment:

Assume that government spends some money today on consumption. That money could have been spent on a durable bridge, but it wasn’t. Some current people benefit from the consumption and future generations get nothing.

Michael Mandel reads Tyler and then writes:

But of course, there’s a big problem with his scenario. The latest budget pegs the FY 2006 deficit at $423 billion. But federal spending on major physical capital, research and development, and education and training – all long-lived investments – is estimated at $425 billion. We are not borrowing to finance consumption, we are borrowing to finance long-lived investments.

Not to be snarky, but there is a big problem with Michael’s ability to understand Tyler’s point. Let me put the point in terms of comparative statistics. Suppose that a nation was investing say 10% of its income in the form of private investment and public investment when the nation decided to increase its consumption from 90% of income to 95% of income. Simple arithmetic says national investment just declined from 10% of income to 5% of income.

The graph uses the much maligned national income accounts to show the ratio of private investment to GDP and the ratio of government investment to GDP (depreciation has not been deducted from any series). The simple point is that public investment has NOT increased even as private investment has declined. Mandel’s usual reply is that national income accounts fail to count investments in R&D and education, which is fine. But we have not dramatically increased the share of national income in either R&D or education.

The concern being properly raised by Tyler Cowen is not so much that one entity is running deficits – but rather when we “give people their money back so they can consume more” AND increase public consumption, we reduce national savings. Tyler is right – even if Michael fails to grasp his simple point.

Update: Michael Mandel replies with what he sees as partial agreement but then adds:

which is exactly why I am so insistent calling R&D and education investments! pgl wants the U.S. to invest and save more–so do I, but I just have a broader definition than he does. I want to encourage more resources devoted to R&D. I want to encourage more resources devoted to science and engineering education, and funding college for low-income and middle-income kids. I want to do the investment in the Knowledge Economy. From this perspective, I don’t like the latest Bush budget. The proposed 2007 budget takes a hacksaw to education outlays, cutting it by 18%, or 21% in real terms. Spending on R&D goes up slightly, but slower than the growth of the economy.

As I noted in a comment to his post, I would call R&D an investment as well. Actually, Michael and I are in complete agreement on this particular point.