Henry Hazlitt: Do Deficits Make Jobs?

Henry Hazlitt (1894-1993) was one of the 20th century’s greatest writers on economics. His 1946 classic Economics In One Lesson is still an excellent introduction to the subject for the general reader. And, for a number of years, he was columnist in Newsweek, bringing economic insights to the issues of the day and expressing them with clarity. The article below is a classic example of this. It appeared in Newsweek on this day in 1963.

The dominant argument of the Administration for tax cuts and bigger deficits is that these deficits are necessary to speed up “growth,” to reduce unemployment, and to save us from an economic tailspin.

This theory, now treated in Administration circles as an axiom, receives no support from experience. I have several times in this column referred to its crushing refutation in the ’30s. In the ten fiscal years from 1931 to 1940, inclusive, there was a deficit every year. The average annual deficit was 3.6 percent of the gross national product of the period, equivalent today to an annual deficit of $20 billion. Yet the average unemployment in that ten-year period persisted at 18.6 percent of the labor force. The same percentage today would mean nearly 14 million jobless.

Now the Machinery and Allied Products Institute, in testimony presented by its economist, George Terborgh, to the Joint Economic Committee of Congress, has made a careful and detailed statistical analysis of the relation of budget deficits and surpluses to changes in the GNP for the sixteen-year period from 1947 to 1962 inclusive. The comparisons are broken into three-month periods. Surpluses and deficits are measured in terms of the “national-accounts” budget, which the Administration favors, instead of the conventional “administrative” budget.


What does the comparison show for these 64 quarter-years? “Of 51 quarters with a rising GNP, more than half (28) were associated with a Federal surplus, 23 with a deficit, while of 13 quarters with declining GNP, nearly all (12) were associated with a deficit. “It may be objected that there is a lag between the budget position and the response of the economy, hence that we should `lead’ the former by a reasonable period. If we lead it by six months, the picture is not greatly altered. Of 51 quarters with rising GNP, 24 show budget surpluses in the second quarter preceding, 27 deficits. Of 13 with falling GNP, 7 show surpluses, 6 deficits.”

Let us interpret these comparisons. If Federal budget deficits really stimulated the economy, and surpluses depressed it, as the Administration assumes, we should expect to find expansion predominating during deficit periods and contraction predominant during periods of surplus. We find no such correlation. On the contrary, for simultaneous comparisons we find a slight positive correlation between surpluses and rising GNP (or deficits and declining GNP).

But we did not need the statistical record of the ’30s, or of the sixteen years from 1947 through 1962, to show us that the theory of growth by deficits or reducing unemployment by deficits was unsound. The only thing that deficits can produce is inflation. Inflation can temporarily stimulate an economy (at a high cost in the long run) only if, during the inflation, wages and other costs stand still, or at least rise less than prices. In that case the restoration of profits, or of the prospect for profits, can stimulate increased production and re-employment.

But this result is altogether unlikely today, when unions are encouraged to make ever-greater demands and when strikes are encouraged and even subsidized by legislation that takes the chief risks out of strikes and even pays unemployment insurance to strikers. 

Unemployment could be sharply reduced, without deficits and without inflation, if unions ceased to be encouraged to make demands that price their members out of the market.

Unfortunately Terborgh, in spite of his own statistical results, comes to the wrong conclusion that what is really needed to stimulate the economy is to increase the money supply by monetizing “enough” of the deficit. This is an inflationary recommendation, particularly ill-advised in our present gold and balance-of-payments dilemma. But Terborgh is right in insisting that if there is to be tax reduction, “first priority should be given to two long-overdue reforms, a reduction in the corporate rate and a scale-down of high-bracket personal rates.”

John Phelan is an economist at Center of the American Experiment.