Lets Have Some Limited Government Please

After reading an article like this by Robert Kuttner, I find myself longing for a far more limited government.

Given low domestic savings rates, budget deficits of this magnitude require foreign financing. For years economists have been warning that the “co-dependency” between the U.S. and Asian central banks — in which the immense American budget and trade deficits are financed mainly by Japan and China as long as we keep importing their products — cannot be sustained indefinitely. Bush’s budget deficits have pushed this arrangement close to a tipping point and a dollar crash. The trade deficit is in excess of 5% of gross domestic product and heading toward 7%. At some degree of U.S. foreign indebtedness, the world will start dumping the dollar and shorting it in the currency markets.

The trade deficits would be smaller if China and Japan ran more open economies. But Bush’s heavy dependence on the central banks of these countries undercuts any leverage Washington has to induce them to open further to U.S. exports and to run more transparent economies. In addition, a weakening dollar scares off non-central bank private foreign investors in American securities. There has been very little private foreign investment in U.S. equities and government bonds lately.

I have always been rather frustrated (too put it mildly) by Bush’s spending. I thought No Child Left Behind was a huge mistake, and the prescription drug plan a nightmare. But, I also see these things as natural outgrowths of activist government.

Suppose there is some issue that the government decides to get involved in. They go talk to some experts and actually come up with a plan that will yield the best outcome. Now if everybody believes this plan the government will have an incentive to deviate from the plan in an attempt to make things even “better”. Example: the inflation/unemployment trade off. There is a concept known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU). The idea behind this awful sounding term is that there is a rate of unemployment that if maintained there will be a constant rate of inflation. So if policymakers (i.e., politicians) want a certain inflation rate, they can implement certain policies to achieve this. Now if everybody believes this, then there can be an improvement by deviating from those policies to achieve say a lower rate of unemployment. Now, the problem is that if people are forward looking, they will see this temptation to deviate and they will not believe the initial policy announcement. Thus, the initial plan is not achievable, and the later deviation for an even better outcome is also not achievable. This problem is know in economics as the time inconsistency problem. While time inconsistency usually crops up in regards to monetary policy (like the example just given) it also applies to things like spending as well.

For example, suppose there is a river that floods is banks every few years. Those living near the river suffer economic hardship whenever the river overflows. The people living there cannot get insurance since it is known the river regularly overflows its banks. So the government mandates that nobody should live within the areas that flood. Problem solved right? Nope. People realize that if they move in there and enjoy the river that when the river does overflow the government will step in and bail them out (no pun intended). So they move in. There is almost no way to commit to the best strategy of not having the government mitigate the economic damage. To pay for this taxes have to be raised, and taxes introduce inefficiences in the markets that are taxed, and the welfare of those not living near the river goes down.

Here is another one. Some people foolishly do not plan for their retirement years and don’t have enough money for prescription drugs. Now, one possible policy response is to not help these people and thus induce others to plan more wisely. But once everybody who is still of working age is saving for their prescription drugs, the government has an incentive to deviate and help the current foolish retirees. Not being stupid, the current workers would see this coming and not save. Hence the government ends up having to cover even more people.

Note that so far we have not thrown in things like elections and serving one’s constituents as well. Factor that in and you get rent seeking as well. Rent seeking is where a group tries to secure unearned economic benefits. A crude example would be where one group of voters secures a monetary transfer from another group of workers. Currently we call this program Social Security. Another example would be where specific consumption by one group of voters is subsidized by another group of voters. This program is currently called Medicare. Another example would be increases in protection of intellectual property. The last version of this kind of rent seeking was put forward by Sonny Bono and provides exactly no economic benefits to society and merely transfers income from those who want to consume intellectual property to the pockest of those who hold the rights to the intellectual property. Evnironmental lobbying/legislation is a type of rent seeking. The environmentalist want to obtain something and instead of buying it outright, they basically take via legislative fiat.

The bottom line is that activist government is usually going to be a mess. More and more spending, and when the voters don’t want to keep paying more and more in taxes for these kinds of things, you get deficits. The problem with deficits is that eventually it means higher taxes. Someday the debt will have to be paid off. A deficit is basically spending tomorrow’s government reciepts today, and then raising taxes in the future. One could argue that the tax increase under George H. W. Bush was a result of deficits. By having a limited government it would be harder to enacting policies like No Child Left Behind, the prescription drug plan, and other programs that basically suck up money and waste it. So it is with some amusement when I see people like Robert Kuttner, Brad DeLong and others bemoan fiscal irresponsibility and deficits. I can’t help but think that the Clinton years where we actually had surpluses were a fluke and not the result of careful and deliberate planning. Remember opposing parties had control of different branches of government, was that part of Clinton/Rubin’s grand scheme? Did they really set out to lose control of the House and Senate so that they could get a surplus years down the road? Was Clinton’s healthcare plan a clever ruse to help achieve a balanced budget? Somehow I don’t think so. In looking at Kerry’s platform it was breath taking in terms of the scope of spending. You want to do something about the deficit? Get rid of activist (discretionary) government.

FILED UNDER: Politics 101
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Anjin-San says:

    Why keep mentioning Clinton & Kerry when discussing Mr. Bush’s out of control deficit? A GOP congress has spent money we do not have with mad abandon.

    Bush, an alleged conservative has NEVER vetoed a spending bill. Non-defense discresionay spending has surged under GOP rule, not under Clinton or Kerry. Why not take the people who created this mess to task instead of endlessly invoking Clinton?

  2. Steve says:

    Endlessly invoking Clinton…let me see we have a post about budget deficits and surpluses and I’m not supposed to talk about Clinton.

    Are you nuts Anjin-san?

  3. McGehee says:

    Anjin, you really need to MoveOn(.org)

  4. Anjin-San says:

    I note you never really give Clinton credit for the record surpluses we enjoyed while he occupied the white house. Nor do you really hold GW accountable for the horrible deficit mess we are now looking at a mere 4 years later.

    You are a fine tap dancer… do you tango as well?

  5. ken says:

    It’s a conservative problem with personal responsibility. They cannot take responsibility for the deficits even though they gladly took the tax cuts that led to them. Blaming someone else for their failures is just part of what it means to be a conservative.

  6. Anjin-San says:

    Why should I move on? So you can all have an unbroken chorus of “of gosh, Bush is so swell” in here?

    Thats what they do in totalatarian countries. A little dissent & some contrarian viewpoints is a big part of what America is about.

    Why don’t you just get some of those old songbooks they used to use in China to praise Mao, cross his name out and substitute Bush’s? Anyone who does not get with the program can just be sent packing to a nice rehabilitation farm out in the country…

    The scary thing is this is the most tolerant GOP blog I have found…

    (now I do admit the same mind of close-mindedness exists on the other side of the asile)

  7. Attila Girl says:

    Ah, totalitarianism. Like China. So, McGehee getting tired of your incessant lefty hand-wringing, and implying as much, is JUST THE SAME as government crackdowns on freedom of speech in a Communist country.

    Anjin-San, your analysis is almost as good as your spelling.

  8. Steve says:

    Of course I didn’t give Clinton full credit for the surpluses. Rubin was more of the guy behind that and he admits part of it was just luck.

    As for Bush and his spending, you are quite ignorant. I have repeatedly said the Bush spends, spends, spends, and spends.

    Oh, and just in case you missed it…Bush spends alot…like a drug addict feeding a serious jones.

  9. Anjin-San says:

    Last time I checked, it was Clinton who hired Rubin. Divided goverment had something to do with good governance in the 90’s as well.

  10. Steve says:

    Clinton also wanted to nationalize health care an bring 1/7th of the U.S. economy onto the Gov’t budget. Would we still have surpluses if that had succeeded?

    Basically you are completely missing the point here. The strong economy, the divided government, and some deft manuevers by Robert Rubin helped result in the surpluses. It was a fluke. Clinton gets some credit, but giving him all of the credit is just plain vanilla stupid.

    If the above is a correct summary of the 1990s then the idea that surpluses are the result of a political party holding office is also plain old stupid.

    Feel free to hold these views Anjin-san, but does not reflect well on you.

  11. Anjin-San says:

    Steve,,, I clearly said that divided goverment gets some of the credit, so quoting me as saying Clinton “gets all the credit” must simply be a rather lame attempt to make me look biased.

  12. Steve says:

    Anjin-san,

    No, you were not clear. You merely said that divided government was responsible for good governance. There is more to governance than the budget deficit/surplus.

    You clearly seem to feel Clinton deserves a larger share of the credit for the surpluses. I think that is baloney. Clinton and Rubin get credit for taking advantage of the situation as it developed and making some smart moves. But the idea that it was some sort of grand plan is just ridiculous.

  13. Anjin-San says:

    Who mentioned a “grand plan”? Not I. This does not change the fact that the Clinton years were pretty much a good time for America & the Bush years have been pretty awful. Clinton took advantage of opportunities & made smart moves? Sounds like good leadership…

    The deficit is a disaster. Bush sails along like the captain of the Titanic, focused on really critical issues like tax cuts for billionaires and gay marrige.

    Bush calls himself a conservative. He spends money, not like a drunken sailor, but like a madman. Does anybody in the GOP give a damn about the future of this country?