Why governments are not like households and should not behave like them
I had been challenged by someone on Facebook to defend the notion of why governments shouldn't budget like households. This was very well-received on FB, so I figured I should share it here:
I know it's a popular visceral response to think that when times are lean governments should learn to "live within their means" like everyone else. The instinct here is appealing. In stressful times, it seems that the appropriate course is to hunker down and consolidate under the logic that you'll be stronger when things right themselves, if indeed such a thing occurs.
To some extent, this phenomenon exists because households behave in ways that they shouldn't where they overextend in times of plenty and are left in precarious positions when incomes fall and asset prices decline. In other words, I think a large number of people are projecting their own financial mismanagement onto government and declaring it to be a moral imperative. I know there are large numbers of people who cannot ever earn enough to really avoid this, but let's speak for the fairly large numbers who can and don't.
The data bear this out, actually, where we see household debt levels relative to income behave in a highly pro-cyclical manner. Not only do individuals seem to spend every dime they earn when incomes are growing, but they tend to radically increase borrowing in anticipation that incomes will keep growing in the future. This is a simple empirical observation of how households behave. When jobs are lost, pay is reduced, or asset prices fall, households are left precariously balanced with insufficient resources and are forced to retrench. Let us therefore not even entertain the notion that the actual real-world function of household finances is something that government should emulate.
Regrettably, a great many people involved in politics force government to behave this way because they indeed do apply household financial principles to the government, but that certainly is not how government should operate. Frankly, households should actually behave in a much more counter-cyclical manner than they do, meaning they should build up large savings during flush times and draw down savings and take on debt during more difficult stretches to smooth things out. Some actually do this, meaning that better operating households *gasp* run deficits while managing their bountiful years better. More should do this. This would cause considerably less grief for everyone, but I digress.
Governments, by their very nature, are not at all like households for a few reasons:
1. Governments are immortal. Individuals need to make provision for their retirement because they will have to draw down large amounts of savings to live on when they are no longer able to work. Individuals must also retire their debts before or on the event of their deaths. Governments, by contrast, are the closest thing to immortal beings we have among us in our mortal world. Governments do not need to make provision for retirement because they need to continue to function in perpetuity. Similarly, government debt never needs to be fully "paid off". Because governments are immortal, a dollar of debt taken out today can just be rolled over again and again and again into the future until that dollar of debt is insignificant in relation to the tax base from which the government derives revenue. Take our World War II debt. That was never "paid off", but the $250ish billion in debt at the end of WWII became peanuts compared to the growth in GDP that occurred over the next few decades. Since government will never have to simply close up shop and settle all of its accounts at once, it's not relevant that its debts are never fully paid off. It can take advantage of the wonderful march of time.
2. Governments can increase their income on demand. When there's a shortfall to pay one's mortgage, you can't exactly go to your boss and say, "Can you please cover the difference?" Well, I guess you can try, but it won't achieve much. Governments have close to an unlimited ability to tax if need be to cover their debts. Granted, this power should be used judiciously since taxes have consequences, but the basic point is that government can, if necessary, make good deficiencies except in truly extreme cases. It does not have to do the equivalent of sacrificing buying prescription drugs in order to have enough fuel to go to work.
3. Government spending needs are either "acyclical" (meaning insensitive to the economic cycle) or counter-cyclical (rising during recessions and falling during booms). Most government services consist of things like police and fire protection, road construction, education, and baseline regulatory activities such as building and food inspections. This is the bulk of what government does. It doesn't make much logical sense for government to pull back on these things when recessions strike since the demand for these services is pretty much a uniform constant with a slight upward trajectory. It similarly doesn't make sense to behave as households do and splurge on them when revenues are growing briskly. Further, at the federal level, many of the functions of government are counter-cyclical such as unemployment insurance, food stamps, etc. This tends to mean that expenditure needs are rising sharply at the same time revenues are falling. Again, it makes no sense to retrench in the face of this and because of the two factors listed before this (government's infinite time horizon so that it can wait for revenues to recover and borrow in the interim plus government's ability to tax to make good shortfalls) it also doesn't have to. For government to behave pro-cyclically in the face of acyclical or counter-cyclical service demands is in defiance of reason.
Governments are regrettably cursed with a pro-cyclical revenue stream and there's no avoiding that. Tax revenues increase when the economy is growing and shrink when the economy contracts. This means governments will appear strained at the precise moments their services need to be maintained. Conversely, government revenues will appear flush when there is lesser need for welfare programs and there is also no need to increase those acyclical portions of government spending. This is why governments must not give into the household temptations to spend your excess and pull in when times get tough. Governments both shouldn't do this and don't need to do this. All that does is sharpen the booms and deepen the busts.
4. Households don't issue their own currency. This is along the same general lines as the point about taxes, but the federal government (though not state and local governments) can just issue more currency if need be. This is a power it has. Granted, that's inflationary, but inflation is another tool open to the government to reduce its debt and right its finances. There are consequences to this and they should be taken into account because governments, unlike households, also have the ability to cause broader pain, but this is certainly a power not open to households.
5. Governments act as conduits for society at large and they are not utility-seeking actors. This is a point that doesn't get made often enough. The term "the Government" gets thrown around a lot, but the government is not a single actor trying to maximize its utility. Governments are societal constructs to provide mutual security, infrastructure, etc. Households seek to maximize their utility at all turns. Governments basically have no utility function, at least not beyond the jumbled mess of differing utility functions society tries to satisfy through it. They are a mechanism. This is a pretty basic point, but the fundamental purpose and functions of the entities are just entirely different.
So, to summarize these points I would say that, firstly, governments are not like households in any real way. They are immortal with infinite time horizons, they are conduits and not utility-maximizing actors in of themselves, and they have the means to generate their own resources to make good shortfalls (within reason). Furthermore, because of the nature of what they do, between acyclical and countercyclical service demands, governments SHOULD NOT behave like households. For governments to behave pro-cyclically makes absolutely no sense given their basic functions. That results in government expanding when it's not needed and shrinking when it is. The idea that government should retrench at the same time households are strained is feel-good nonsense based on visceral notions and completely at odds with logic and reason.
In very brief, governments should not follow the example of the typical household. Because of the different nature of government, it doesn't have to. Therefore, please, let's not have government behave like a household. This is not an exhortation to spend like drunken sailors and print currency with reckless abandon. Rather, it's a plea to please incorporate a sensible analytical framework when assessing government policy.
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[hr][font color="blue"][center]Stop looking for heroes. BE one.[/center][/font][hr]
I hope you don't mind; if you do, let me know and I'll take it down. I've got some family who sorely need to read it. My friends will enjoy it, but my friends aren't ignorant like my family is.
A little OT, perhaps, but your article caused a thought to pop into my mind concerning Welfare reform under Clinton.
Not only was it generally a bad idea, but by the precepts you present it was the wrong time to do it.
Nearly every household I know operates on constant debt. People buy houses they can't afford and live in them now but agree to pay for them over time. Most people buy cars the same way. To argue that reasonable people are perfect and never incur debt while the government is evil because it incurs debt is a patently stupid and ill-informed argument from my point of view. The Federal Government of the United States has been in debt through most of it's history. This is not new, nor is it inherently bad.
And, I would add, it's easier and safer for the Federal Government of the United States to borrow money than it is for individuals. I will also add that interest rates are at historic lows, and that makes it even less painful than ever for us to borrow money. In a fragile economy, when most people are suffering and when the private sector is not producing enough jobs, why shouldn't the Federal Government borrow and spend ... a lot?
-Laelth
