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Fred Block: After the Stimulus: Now What?

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Fred Block argues that the future of the U.S. economy might actually rest on the seemingly obscure issue of how Federal budget accounting is done. He argues that we need a Federal capital budget to make possible the continuing expenditures needed for economic recovery.
* Cross-posted from Dissent Magazine

After the Stimulus: Now What?

Fred Block - February 18, 2009


On Tuesday, February 17, President Obama signed the American Recovery and Reinvestment Act of 2009 (ARRA). Months will elapse before the legislation starts having the intended effect of generating new demand in the economy. But it is already time to start contemplating what more has to be done to restore prosperity. Some of the key steps are already in motion, but one essential issue has yet to be engaged or discussed: changing budget procedures to facilitate a long-term increase in government investment spending.

At this point, the battle against the economic downturn is taking place on four separate fronts: The first is the ARRA effort to increase demand and to stop the free fall of economic activity. The second is the continuing effort to rescue the banks and other financial institutions that is now being directed by Treasury Secretary Geithner. The third is the urgent task of stopping the foreclosures and keeping as many people as possible in their homes. The fourth is the much needed overhaul of the regulatory structure for financial activity–both domestically and globally.

But while each of these fronts is vitally important, it is urgent that a fifth front also be opened. As Paul Krugman and others have argued, the fundamental problem is that the ARRA is simply not large enough to turn the U.S. economy around. The total bill is measured at $787 billion, but when one subtracts a number of dubious tax cuts that were added to win Republican support–including the protection of upper middle class taxpayers from the Alternative Minimum Tax–there is only about $700 billion of real stimulus over two years. Given that the expected shortfall of GDP will be $1 trillion per year, $350 billion of stimulus per year can, at best, only stop the bleeding. It is not enough to set in motion the kind of economic growth that is needed to bring unemployment back down to pre-recession levels.

After all, simply restoring the pre-recession pattern of growth is not possible. The last economic expansion rested on a totally artificial and unsustainable foundation. From 2001 to 2007, most households experienced stagnating or declining real income while the top 1 percent of households continued to increase their share of total income.

But people felt richer because houses were appreciating dramatically in value and credit was more freely available than at any time in the past. So a great consumer boom that included a record pace of new housing construction was fueled entirely by borrowing. In the aftermath of the meltdown, this will not happen again. Consumers will remain cautious about spending even if they experience wage gains. And certainly, newly regulated financial institutions will not be permitted to inflate another housing bubble.

As both households and the financial sector remain cautious, business is not going to take up the slack. On the contrary, we can expect years of continuing downsizing of the overbuilt retail sector, and a revival of private sector construction activity–both residential and nonresidential–will remain hobbled by the caution of lenders. The conclusion is inescapable. The ARRA is just an initial down payment on needed increases in government spending. A vigorous recovery requires sustained increases in government spending for infrastructure, for research and development, and for education. To be sure, this spending has to catalyze an increase of private sector investments in the same way that government highway spending in the 1950’s catalyzed massive private investments in suburbanization. The government must put the infrastructure for a green economic transition in place so that businesses will invest heavily in alternative energy technologies and green vehicles.

But here is the problem: all of the arguments that the Republicans mobilized against the ARRA will be recycled again when the Obama Administration comes back to ask for permanent increases in federal investment spending. And in the absence of exploding unemployment, it will be even harder to overcome the objections. We can hear them already: “Running huge deficits is what got us into this problem; we can’t get out by doing the same thing.” “We can’t keep passing bills along to our children and grandchildren.” In fact, the minute the economy’s free fall stops, the voices of the deficit hawks demanding a balanced federal budget will start to reverberate across the land.

This is why the fifth front has to be a sustained battle against the obsolete economic ideas that have worked for more than a generation to block the kinds of spending that our economy desperately needs. Conservatives endlessly repeat economic dogmas that were created in a pre-industrial economy and which have zero relevance for a twenty-first century economy.

Think how many times you have heard conservative politicians say that since businesses and households have to balance their budgets, government should do the same. But individuals and businesses separate out their current expenses from their capital outlays; people don’t define themselves as running a deficit this year because they bought a new house for $200,000. No, they finance capital expenditures like houses, new kitchens, and automobiles by borrowing, and they count themselves as living within their means as long as they have income to cover all their expenses including interest payments.

Despite a half century of debates, the federal government continues to lump all expenditures including new buildings, new capital equipment, and grants to state and local governments for roads, airports, and sewer systems into the same budget. In 2007, all of these federal investment outlays came to something close to $325 billion. (This excludes about $100 billion of weapons procurement and military construction, but it includes military research and development outlays.) In that year, the federal deficit was recorded as $343 billion. In short, were the government like a business or a household that borrowed to finance capital spending and kept a separate capital budget, its current budget would have been close to balance–not running a large deficit.

Insisting that the government must balance its budget regardless of how it is spending money is crazy; it is part of the same anti-government ideology that causes conservatives to make the nonsensical argument that government spending does not create jobs. But it is even more insane when one considers the sources of economic advance in today’s economy. Infrastructure such as roads, harbors, and airports are essential for economic growth. Moreover, the computer and biotechnology industries were made possible by huge government investments in research and development, and our chances of growing new industries depend on similar investments. Finally, a more skilled labor force that results from government’s spending on education at all levels is also indispensable for productivity advances.

In a word, balanced budget ideology is bad economics that forces us to engage in false economies. Since there are many other pressing demands on government spending such as the military, social security, and health care, we end up artificially restraining what the government can spend on necessary infrastructure, vital research and development efforts, and support for education. In fact, our nonmilitary investment spending has fallen as a percentage of GDP from 2.7 percent in 1976 to only 1.8 percent in 2007. That is why we have a $2.2 trillion backlog of needed repairs to our decaying infrastructure. That is why our vital research and development machinery is generating fierce battles between different interest groups fighting for a piece of a shrinking pie. That is why our education system that once facilitated the American Dream is increasingly threadbare, dysfunctional, and ineffective in facilitating upward mobility.

The necessary step is to divide the federal budget between a current account and a capital account with the understanding that the current account will be in balance, except in recessions, while much of the capital account would be financed by borrowing. There will still be hard choices to make; just because something is called “investment” doesn’t mean that it actually produces results. Careful metrics and safeguards are needed to ensure that federal investment dollars are used productively and that the benefits are widely shared. Moreover, it will take time and practice to determine if the optimal long–term level of nonmilitary investment spending by the government is 3 percent, 4 percent, or 5 percent of GDP.

Without this reform, the chances are slim that the federal government will be able to sustain the higher levels of civilian investment spending needed to create a green and high-tech economic recovery. Opening up this new reform front involves two essential maneuvers. First, the Obama Administration needs to begin right away developing plans for big ticket infrastructure projects to assure that they will be “shovel ready” over the next three to five years. Now is the time to map out, prioritize, and secure public support for multi-year projects of building high-speed rail lines, modernizing mass transit systems, and facilitating the replacement of coal and oil with green energy. Second, there needs to be an “all hands on deck” offensive to persuade the public of the urgency of this budgetary reform. This has to bubble up from below so strongly that Congress and the President embrace the idea of new budgetary rules for the twenty-first century. Without this, the prospects for the U.S. economy are grim.

Fred Block is an economic sociologist at U.C. Davis. His current research focuses on U.S. government technology policies.


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