Implications of the Government Deficit for U.S. Capital Formation

Widespread concern, even alarm, over the U.S. government’s budget deficit has become one of the leading public policy issues of the decade. Talk about large federal deficits that will persist throughout the 1980s now dominates discussions otherwise intended to focus on specific spending needs--defense, for example, or medical care supports--or on tax restructuring. It also now dominates discussions about the proper course for monetary policy, about the effect of the dollar’s international exchange rate on U.S. competitiveness, and about the outlook for the U.S. economy’s continued expansion. These fears are warranted, at least in part. To be sure, much of the discussion has not been carefully put, and some of the ideas expressed have been simply wrong. The chief problem in this regard has been the failure to distinguish clearly between passive deficits that emerge as a result of depressed levels of economic activity and fundamental deficits that persist even when the economy’s labor and capital resources are fully employed. Many of the most frequently expressed criticisms of the U.S. government’s deficit during fiscal years 1981-83, when economic weakness accounted for much of the deficit that the government then ran, were either largely or wholly misguided. By contrast, the deficits in prospect for fiscal years 1984-88 are indeed cause for concern. The basic problem is that, under current policies or those now under active consideration, during 1984-88 the U.S. government will continue to run budget deficits at or near the recent unprecedented levels, even if the economy returns to a fully employed condition. (This prospect actually extends well beyond, the next half-decade, but official estimates are available only through fiscal year !988.) Increasingly during these years the deficit will reflect a fundamental imbalance between the government’s revenues and expenditures at full employment, rather than a passive response to economic weakness as was the case during the past several years. If for some reason the U.S. economy continues to fall well short of ful! employment of its resources, then the average deficit realized during 1984-88 will be all the greater. The principal reason why this indefinite continuation of unprecedentedly large U.S. government budget deficits is a problem is that, by sharply curtailing or even eliminating altogether the economy’s net investment in new plant and equipment, it will cut deeply into the economy’s ability over time to