HOW TO FEEL GOOD ABOUT THE DEFICIT Just sidle up to these economists' seductive arguments about the blessings of borrowing. But don't think about them too much.
By TODD MAY JR. REPORTER ASSOCIATE Joan Viebranz TODD MAY JR. is FORTUNE's chief economist.

(FORTUNE Magazine) – Want to worry less about the federal deficit? Have I got the book for you. Robert Heilbroner and Peter Bernstein have just published a slim and readable tome called The Debt and the Deficit (W.W. Norton, $12.95) in which they argue that most of us are worrying way too much about those subjects. Both men are professionally trained economists with long experience trying to understand the U.S. economy, so they are hardly kooks to be ignored, unless you place all economists in that category. The book is primarily for a general audience interested in public affairs and, secondarily, for other economists, who the authors feel will find its conclusions ''perhaps hard to take.'' To at least this economist, that is an understatement regarding some of their positions. Heilbroner and Bernstein give short shrift to the popular arguments that the Reagan tax cuts or military buildup are responsible for the large deficits. Instead they seem to accept the supply-siders' argument that former Fed Chairman Paul Volcker is mainly to blame. They grant that in late 1979 the economy was ''suffering from the symptoms of an increasingly worrisome inflationary ailment.'' They go on to say that ''our present troubles began'' when ''rightly or wrongly -- there are arguments on both sides -- the Federal Reserve slammed the brakes on the expansion of money and credit.'' That rapid slowdown of inflation cut tax revenues just after prior years' price rises had hugely enlarged the government's entitlement and interest bills. The authors conclude that ''the deficit explosion was thus an unexpected -- and very unwelcome -- consequence of anti-inflation policy.'' This position smacks of a growing minority view that inflation is less of a problem than the effects of policies to restrain it. Late in the book they label the inflation threat the second-gravest issue facing the nation (after restoring America's competitiveness), but they seem to fault inflation because the financial markets react badly to it rather than because it is bad in itself. As for America's national debt, the authors are on much more solid ground when they point out that it is not a major problem. It is about the same percentage of GNP that it was in the early 1960s, when growth was rapid and inflation low. Should anyone worry about the highly unlikely possibility of paying off the debt, then the old cliche that we owe it to ourselves applies, at least to 87% of it, the part not held by foreigners. BACK TO THE DEFICIT: In their most intriguing assertions, the authors dispute the claims most often made by those who fear the deficit, including the claim that it has been crowding out private investment. They suggest that one way of gauging the crowding-out argument is to look at the correlation of large budget deficits with big increases in interest rates -- if crowding out is real, they reason, the two ought to go together. A rather simplified analysis of seven industrial countries from 1980 to 1986 shows almost no correlation, and numerous studies of the U.S. give similar results. But these authors should know better. Budget deficits usually wax in recessions, when Fed policy is pushing interest rates down, and wane in recoveries, when the Fed is tightening. Many economists, including this reviewer, believe the large Treasury demand for credit this far along in the expansion must produce an upward tilt to interest rates.

Heilbroner and Bernstein make the valid point that the usual crowding-out arguments consider only the possible drain on private capital spending and ignore the potential benefits from the government's investing all that money it's borrowing. In their view, the trouble is that the government has to spend so much on entitlements and other current demands that it's investing little. They attribute a huge chunk of the decline in America's productivity growth to the squeeze on government investment since the early Eighties. Yes, there's a close correlation between net private capital stock and productivity, but it has led few economists to feel capital spending explains all the sluggishness in productivity. Curtailed government spending on infrastructure may explain more of the productivity problem, but not as much as the authors suggest. Heilbroner and Bernstein are so distressed by the shortfall in growth- promoting government spending (which they broaden to include research, development, education, and training), they recommend slicing the federal budget into capital and operating segments. Decisions on balancing the operating budget would depend on how much stimulus or restraint the economy needed. But the government wouldn't worry about balancing the all-important capital budget because, in the authors' world, it would be financed completely by borrowing. It would have to be since, as they argue with a tinge of elitism, the public hates taxes so much that it would never pay up for sufficient capital spending. The authors also endorse the position (advocated mainly by Northwestern University professor Robert Eisner) that the deficit should be restated to account for lenders' loss of principal due to inflation -- it reduces the real ( value of what the government owes and the wealth of government bondholders -- on the ground that this shrinkage has a restraining effect on the economy that is not now counted. This argument leaves me cold. It says the higher inflation, the more restraint exerted by the budget -- without any policy change. Further, when growth is slow and inflation high, it would appear that the budget was too tight and should become more stimulative. In general, the wrong prescription. FOREIGN INVESTORS' reaction to the U.S. deficit is another nonworry, say the authors. In an unsatisfactory two sentences they as much as say ''Nonsense!'' to the proposition that failure to cut the deficit will make foreign investors fearful that U.S. policy is out of control. But that proposition isn't crazy. The resulting rush to try to get out of dollars could indeed cause a surge in interest rates and perhaps a recession, as the occasional spikes in interest rates when the dollar has weakened in recent years tend to show. The Debt and the Deficit is so fetchingly written that it practically forces the thinking reader into the exercise of refuting it. The odd effect: One realizes freshly how worthy of worry the budget deficit is.

BOX: EXCERPT: By no stretch of the imagination can ''reducing the deficit'' be considered as America's No. 1 problem, as it is considered by 44% of the population and probably by a larger percent of economists. If it were America's No. 1 problem, we would be very well off indeed.