Sadly, David Ricardo, the greatest economist of all time, died nearly two centuries ago. It would be fascinating to get his take on U.S. fiscal policy and debate in the 2004 presidential campaign. In particular, I’d relish his comments on the effects of the U.S. budget deficit, estimated at $442 billion Tuesday by the Congressional Budget Office.
Ricardo, the intellectual father of finance and trade theory, interpreted the effects of government budget deficits differently from most post-World War II economists. Anticipating the Rational Expectations school of thought by 150 years, he argued that prudent individuals’ reactions to deficits could offset the results others expected.
If a government cut taxes, Ricardo reasoned, rational individuals would anticipate that the resulting budget deficit must be paid off eventually. Rather than squandering tax cut windfalls, households would put the money into savings for when taxes inevitably were raised to pay down government debt.
If Ricardo was right, ongoing deficits won’t have the effect of stimulating consumption as claimed by the Bush administration when wearing its Keynesian suit.
Neither will it stimulate investment. A naive reaction to Ricardo’s assertion might be that if households save their tax cuts, investment will increase. After all, the money won’t be stuffed into the mattress — it will be plowed into stocks, bonds, mutual funds or certificates of deposit. These are all sources of funds for new business investment.
Note that there is no overall increase in national saving and investment in the Ricardoan story. Increased private saving is exactly offset by increased government borrowing. No net increase in funds is available for productive investments.
My conjecture is Ricardo would be amused by the administration’s claims that tax cuts alone — without any spending cuts — will stimulate either consumption or investment. I think he would be fascinated, however, by the amount of U.S. borrowing washing around world capital markets.
He was one of the few economists who ever got rich. Following his father into the London stock market at age 14, Ricardo became wealthy speculating in British bonds during the Napoleonic wars. Bond prices fluctuated sharply with political news. An astute analyst, he successfully anticipated price movements.
As someone trading government bonds when England was engaged in a desperate, often solitary, struggle against imperial France, he might snicker at our hand wringing over budget problems. As a fraction of gross domestic product, British military spending then far outweighed U.S. spending in the “war on terrorism.” England effectively had to borrow; a far richer United States is choosing to borrow.
Practical readers may scoff at Ricardo’s assumptions of rationality and prudence. Indeed, exploring the economic effects of human irrationality is one of the hottest areas in contemporary microeconomic research. Nevertheless, the old master’s insights should give us pause as each day we add nearly $5 per person to the U.S. national debt.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.