Federal Investment and the Peace Dividend

The latter half of the 20th century has seen a major “peace dividend” through declining defense spending. But the fiscal advantages of that dividend have largely sidestepped investments in science, infrastructure, and education.

Policymakers on both sides of the aisle frequently call to boost investments in science, infrastructure, and education (including, reportedly, the White House next month). But beginning over forty years ago, legislators experienced an opportunity to do exactly that – and passed it up, effectively setting the groundwork for the current budget composition we have today. That they did so says something about the prospects for fiscal reform and investment today and in the future.

The chart below, which arrays categories of federal spending as a share of the total budget, tells the basic fiscal story using the Office of Management and Budget (OMB)’s historical data tables. The “Investments” category is compiled mostly from the OMB tables in section 9, and includes defense and nondefense R&D outlays; outlays for investments in nondefense physical capital like roads and airports,  pollution control facilities, construction by the Army Corps of Engineers, and other such items; and outlays for education and training programs. It excludes outlays for defense construction.

The “Payments to Individuals” category, which is primarily composed of mandatory spending, is taken from OMB table 11.2. It includes an array of transfer payment programs like unemployment insurance, the SNAP program, federal and veterans’ pensions, and supplemental security income, but the largest sources of outlays are Social Security, Medicare and Medicaid. In 2012, these three programs accounted for $1.6 trillion out of the $2.3 trillion in outlays for this category. Lastly, the “Defense” category is primarily Department of Defense outlays, though a small portion (typically three percent) is atomic defense spending in the Department of Energy. It also excludes defense R&D, which appears in the “Investments” category. Also note that there might be some minor overlap in these assorted categories, but it wouldn’t change the fundamental story.

Note the substantial decline in defense spending in the latter half of the 20th century, from over 40 percent in the late 1960s to less than 20 percent today. The largest decline, in the decade following Vietnam, represents an enormous postwar “peace dividend.” Such a savings would be the equivalent of well over $600 billion per year in today’s budget terms.  It also dwarfs the peace dividend at the end of the Cold War, relatively speaking.

Given the size of this defense savings in the 1970s, one policy option would have been to redirect some funding to further strengthen investment in R&D, job training, infrastructure, and the like. But according to OMB’s data, this didn’t happen. Instead, the “peace dividend” savings were mostly moved into transfer payments. Social Security was the largest recipient, accounting for close to half of these programs, while Medicare and Medicaid were much smaller then.

From an investment standpoint, this compositional shift looks something like a missed opportunity to bolster spending. It certainly helped to set in motion multiple trends that are still with us today. As a share of the total federal budget, OMB’s “Investment” outlays are now nearly half of their 1960s peak. Even in the 1980s, when the size of the total budget was elevated for an extended period, there is a notable step down in investments relative to everything else, due in part to nondefense spending cuts under President Reagan. Meanwhile, transfer payments – led by Medicare and Medicaid – have been allowed to grow and take up a much larger slice of the federal pie. As the Congressional Budget Office has pointed out, the above fiscal trends will continue barring policy change, making increases in the “investment” category that much harder to come by.

In hindsight, that these shifts occurred is not entirely surprising. For one thing, Great Society legislation establishing or expanding transfer payments regularly found favor in Congress and among the public, and many of these programs remain both popular and important. Many are also classified as mandatory spending, which means they’re outside the normal appropriations cycle and somewhat on autopilot. In the bigger picture, the political undertones of all this – including both the popularity of mandatory entitlement spending and the relative vulnerability of discretionary spending – contribute to our ongoing fiscal conflicts today.

In the present day, beyond more general concerns over the long-term sustainability of mandatory spending, deficits, and tax policy, it’s worth asking whether the current budget composition best positions the nation to meet the challenges of the 21st century. Is this still-ongoing shift a problem? Has Congress gotten it right? It’s exceedingly difficult to answer these questions. On the one hand, we don’t know the optimal level of investment spending. For instance, most economic evidence suggests R&D provides significant social returns, and thus more is desirable, but there isn’t a clear answer to how much more we should target. Further, industrial R&D is not a substitute for public research funding given differences in the kinds of research funded, but industry is nevertheless playing a growing role in the national R&D enterprise, which also has implications for the compositional question. And on the other hand, there are clear tradeoffs involved in shifting spending around. Even if one could precisely identify the advantages of increased investment, policy choices would still have to grapple with ideas of equity and fairness as much as good stewardship of the future.

Ultimately, budgeting is about choosing between competing priorities. It will be interesting to see whether the choices today and tomorrow echo the choices of the past.