The Dangers of Deficit Reduction JOsepH E. STIGLITZ EW YORK—A wave of fiscal (whether for the public or private sector). One into account impacts other than on the bud- austerity is rushing over Eu- has to look not only at what a country or firm get) makes such expenditures, even when rope and America. The mag- owes, but also at its assets. This should help debt-financed, even more attractive. nitude of budget deficits—like answer those financial sector hawks who are Finally, most economists agree that, apart the magnitude of the down- raising alarms about government spending. from these considerations, the appropriate Nturn—has taken many by surprise. But despite After all, even deficit hawks acknowledge that size of a deficit depends in part on the state protests by yesterday’s proponents of deregu- we should be focusing not on today’s deficit, of the economy. A weaker economy calls for a lation, who would like the government to but on the long-term national debt. Spending, larger deficit, and the appropriate size of the remain passive, most economists believe that especially on investments in education, tech- deficit in the face of a recession depends on government spending has made a difference, nology, and infrastructure, can actually lead to the precise circumstances. helping to avert another Great Depression. lower long-term deficits. Banks’ short-sight- It is here that economists disagree. Fore- Most economists also agree that it is a mis- edness helped create the crisis; we cannot let casting is always difficult, but especially so in take to look at only one side of a balance sheet government short-sightedness—prodded by troubled times. What has happened is (fortu- the financial sector—prolong it. nately) not an everyday occurrence; it would Joseph E. Stiglitz is University Professor at Columbia University Faster growth and returns on public in- be foolish to look at past recoveries to predict and recipient of the 2001 Nobel Prize in Economics. His most recent book Freefall: Free Markets and the Sinking of the vestment yield higher tax revenues, and a five this one. Global Economy is available in French (Le Triomphe De La to six percent return is more than enough In America, for instance, bad debt and Cupidité, Liens Qui Liberent) and will be available shortly in 20 other languages, including Japanese, Spanish, German, to offset temporary increases in the national foreclosures are at levels not seen for three- and Italian. debt. A social cost-benefit analysis (taking quarters of a century; the decline in credit in © The Berkeley Electronic Press / Project Syndicate The Economists’ Voice www.bepress.com/ev March, 2010 -1- 2009 was the largest since 1942. Comparisons Kingdom, for example, has had a harder time established “polluter pays” principle, taxes to the Great Depression are also deceptive, be- than other countries for an obvious reason: it should be imposed on it. Besides, well-de- cause the economy today is so different in so had a real-estate bubble (though of less conse- signed taxes on the financial sector might help many ways. And nearly all so-called experts quence than in Spain), and finance, which was alleviate problems caused by excessive lever- have proven highly fallible—witness the Unit- at the epicenter of the crisis, played a more age and banks that are too big to fail. Taxes ed States Federal Reserve’s dismal forecasting important role in its economy than it does in on speculative activity might encourage banks record before the crisis. other countries. to focus greater attention on performing their Yet, even with large deficits, economic The U.K.’s weaker performance is not the key societal role of providing credit. growth in the U.S. and Europe is anemic, and result of worse policies; indeed, compared Over the longer term, most econo- forecasts of private-sector growth suggest that to the U.S., its bank bailouts and labor-mar- mists agree that governments, especially in in the absence of continued government sup- ket policies were, in many ways, far better. advanced industrial countries with aging port, there is risk of continued stagnation—of It avoided the massive waste of human re- populations, should be concerned about the growth too weak to return unemployment to sources associated with high unemployment sustainability of their policies. But we must normal levels anytime soon. in America, where almost one out of five be wary of deficit fetishism. Deficits to finance The risks are asymmetric: if these forecasts people who would like a full-time job cannot wars or give-aways to the financial sector (as are wrong, and there is a more robust recov- find one. happened on a massive scale in the U.S.) lead ery, then, of course, expenditures can be cut As the global economy returns to growth, to liabilities without corresponding assets, back and/or taxes increased. But if these fore- governments should, of course, have plans imposing a burden on future generations. casts are right, then a premature “exit” from on the drawing board to raise taxes and cut But high-return public investments that more deficit spending risks pushing the economy expenditures. The right balance will inevita- than pay for themselves can actually improve back into recession. This is one of the lessons bly be a subject of dispute. Principles like “it the well-being of future generations, and it we should have learned from America’s expe- is better to tax bad things than good things” would be doubly foolish to burden them with rience in the Great Depression; it is also one of might suggest imposing environmental taxes. debts from unproductive spending and then the lessons to emerge from Japan’s experience The financial sector has imposed huge cut back on productive investments. in the late 1990’s. externalities on the rest of society. America’s These are questions for a later day—at These points are particularly germane financial industry polluted the world with least in many countries, prospects of a robust for the hardest-hit economies. The United toxic mortgages, and, in line with the well recovery are, at best, a year or two away. For The Economists’ Voice www.bepress.com/ev March, 2010 -2- now, the economics is clear: reducing govern- ment spending is a risk not worth taking. 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