2010 November 20 Saturday
Economic Growth Essential For Balanced Budgets

Since the rate of economic growth has a huge impact in the sizes of government deficits I am expecting big deficits until either sovereign default or stealth default by inflation.

If the economy grew one half of a percentage point faster than forecast each year over the next two decades — no easy feat, to be fair — the country would have to do roughly 40 to 50 percent less deficit-cutting than it now appears, based on my reading of budget data from the economists Alan Auerbach and William Gale.

To get a concrete sense for what this would mean, you can play around with the The Times’s online deficit puzzle. It asks you to find almost $1.4 trillion in annual spending cuts and tax increases by the year 2030. If growth were a half point faster than expected, the needed savings would instead drop to less than $700 billion. That would mean many fewer painful choices, be they tax increases or Medicare cuts.

These results illustrate the US government's desperate need for economic growth. The economists assume economic growth and within that Business As Usual framework they examine the effects of different rates of economic growth. But what happens if the expected growth does not happen?

Suppose growth is 0.5% less than mainstream economists expect. Likely the deficit would grow about $700 billion bigger by 2030. That's just from lower growth. Imagine instead what sustained economic stagnation - same total GDP from one year to the next - would do to US government finances (to say nothing of states and localities). The rising costs of a larger retired population combined with a rising segment of poor people would necessitate severe cuts in retirement benefits, raised retirement ages, cuts in defense, cuts in spending on poor people, education, road maintenance, and in many other government programs.

But I expect something far worse. Starting some time in the next 5 years imagine that that the US economy (along with most of the rest of the world) starts shrinking every year for at least 10 years. Tax revenues would decline even more rapidly than the economy (especially since revenues from taxing profits would plummet is profits evaporated and many corporations filed for bankruptcy). At the same time, the number of poor people asking for government help would soar, large numbers of banks would fail with huge deposit insurance costs on national governments, and returns on government and private pension plans would go negative, forcing benefits cuts. Either the US government and other Western governments would default or they would jack up inflation to do a stealth default via inflation.

So why will the US economy shrink? Primarily the peak in world oil production. See The Impending World Energy Mess by Robert L. Hirsch, Roger H. Bezdek, and Robert M. Wendling and Hubbert's Peak: The Impending World Oil Shortage by Kenneth Deffeyes. Even before the peak production is growing so slowly that oil prices are staying high even during a recession with about 10% unemployment. World oil production is about where it was in 2005 or 2006 but with more demand from India and China displacing oil consumption by Americans and other Western developed populations.

My expectation is that once governments give up hope in the resumption of normal economic growth the threat of inflation will become very real. It is not QE 2 (the recent Quantitative Easing round 2 by the Federal Reserve) that will cause inflation. It will be the money supply expansion that the Fed will be pressured into doing once a sovereign debt crisis grips the US (and the UK and assorted Euro countries) with no relief in sight. Central banks could buy sovereign debt once the markets become unwilling to do so and deficits soar even higher than they are today. Since the highest levels of US national security circles show every indication of being Peak Oil aware my guess is they've already thought about inflation as a tool for dealing with it. I'd really like to know what they have concluded.

John Dickerson points out that the US population is very uneager to cut the size of government. They want lower taxes but higher spending. This is a recipe for continued profligacy. The American people are not responsible citizens as a group.

People aren't desperate to go on a diet, so they're not willing to embrace any plans to shrink the buffet. According to a recent NBC poll, 70 percent of Americans say they would rather not cut programs like Medicare, Social Security, and defense. Fifty-seven percent said they were uncomfortable with increasing the Social Security retirement age to 69 over the next 60 years. A recent CNN poll showed that people are extremely reluctant to cut any big areas of the federal budget. Faced with the choice of cutting a program to reduce the deficit or protecting the program from cuts, 79 percent opposed cuts to Medicare, and 69 percent wanted to protect Medicaid. On Social Security, the equivalent figure was 78 percent. Sixty percent or more favored protecting aid to farmers, college loans, and unemployment assistance. The country is split evenly on cutting defense spending. What do people want to cut? Government salaries, "welfare," and the arts, which, depending on how you figure it, represent around 10 percent of the budget.

A site called defeatthedebt.com has a page with visitor votes on how to cut the US federal debt. What's most notable about it: people are overwhelmingly opposed to higher taxes or higher age for Medicare eligibility. Any policy that would substantially cut spending or increase taxes has weak support or strong opposition. So it is unrealistic to expect the 2 major US political parties to tackle this problem until the US national debt has gotten so large that it precipitates an international financial crisis.

On a related note, Ferdinand Bardamu argues that the Tea Party is all about reserving spending for old people. There is some truth in that argument. I expect to see sharpening inter-generational and also inter-racial disagreements about taxes and government spending. It will no longer be possible for the government to buy off all major interest groups. Will divisions between generations, occupations, income levels, races, cultural groups, and religions become deeper and more bitter and angry as a result?

Share |      By Randall Parker at 2010 November 20 11:06 AM  Economics Sovereign Crises


Comments
James Bowery said at November 20, 2010 1:16 PM:

With an NPV of US citizenship of approximately $225k, 40 years of immigration liberalization against the will of the majority diluting that value with 48M immigrants to date and Reagan tax cuts approximately $300G/year for the last 30 years and a risk free interest rate of about 3%, there has been a total value of $35T transferred from the middle and upper middle class to the wealthy during the years of boomer fertility.

Now, let me ask you one question:

If that much wealth has been stolen by the upper class, why should we expect the economy to have a consumer base at all?

The principle victims of this were the mid to late boomers, as early boomers (Bush, Gore, Clinton, etc.) got to ride the demographic wave providing them real estate appreciation and managerial upward mobility. There are also the children of the boomers who were victims. Assuming a 1.6 total fertility rate among the boomer females, we have approximately 125M citizen creditors due that $35T for the breach of the social contract commencing with the Immigration and Nationality Act of 1965. If paid down over a period about as long as it took to run up that social debt, each citizen creditor is due an annuity of $13,000 or about $1100/month.

That wouldn't restore the entire consumer base immediately but it would allow for trickle up to start creating wealth in the quantity required to finance the government.

Its pretty obvious to me that the energy, environment and productivity problems could be solved except for the maldistribution of capital -- and that the de facto goal of continuing this situation is a die off that preserves the managerial elite that benefitted most from the breach of the social contract against those born subsequent to 1950.

The primary question before us is: How can the death burden be shifted to be more equitable?

Randall Parker said at November 20, 2010 1:29 PM:

James Bowery,

We can not solve productivity problems when demographic changes are making the population less skilled and less productive unless we reverse the demographic changes.

We can not solve the energy problems without going thru a long stretch of declining living standards. We need both new technology and the accumulation of more efficient capital that uses that new technology. That all takes a substantial amount of time and money.

You are right that there's a difference between the early and late boomers. Someone born in 1960 isn't going to get squat. By the 2020s the US government will be cutting retiree benefits like mad.

A.Prole said at November 20, 2010 1:50 PM:

Of course, if China and India had their economic growth stymied 30 years ago - by a deliberate mercantilist policy of 'trade blocs' or 'co-prosperity spheres', and were left as pastoral economies, then they wouldn't be burning oil the USA could have been using, and as we know oil is the basis of economic growth.
Just one example of why Ricardian trade theory is just a load of garbage that shouldn't be taken seriously.
On second thoughts, the nation that really develops nuclear energy first will prevail, and that nation is China.If we take as our base assumption that abundant energy is the main constraining factor, then we must realise the urgency of the development of nuclear.

James Bowery said at November 20, 2010 2:42 PM:

Randall, I submit that you don't need a large population with high intelligence and skills to have explosive productivity. You need just a few Wright Brothers' bike shops updated to the modern era. We've destroyed those Yeomen during the 20th century but it would be relatively easy to get them back were it not for the maldistribution of capital.

As to late boomers vs mid boomers, you're missing the point:

The question isn't who will get Social Security, but who got, during their years of fertility, the resources to form families rather than expending their social and financial capital on the instabilities of families resulting from the explosion in the expense of family formation so well documented by Elizabeth Warren.

James Bowery said at November 20, 2010 4:31 PM:

I should qualify the $35T figure as only $25T going to the wealthy and the other $10T going to special interests (immigrants, captured political organs, etc.) providing services to the wealthy and their managerial elite.

Mike said at November 20, 2010 7:36 PM:

The fact that we are entering a modest growth environment makes it all the more essential to cut immigration. A growing population requires a lot more economic growth to sustain it than a stable one.

TangoMan said at November 21, 2010 1:28 AM:

total value of $35T transferred from the middle and upper middle class to the wealthy during the years of boomer fertility.

This hypothesis reminds me of the Gnomes Underpants Grand Strategy:

Phase 1: Collect Underpants
Phase 2: ?
Phase 3: Profit

Phase 1: Transfer wealth from middle class to upper class.
Phase 2: ?
Phase 3: Success

The key point here is how the wealth was transferred. I'll grant you resource misallocation via rentseeking. Use the power of government to actually distribute wealth to upper class (bank bailouts) and use the power of government to restrict market entry (physician pricing models for instance) but I'm not convinced that rentseeking is solely responsible for growing income inequality nor am I convinced that it has played a significant role. Looking at the changing composition of the most wealthy I see a lot of people who are self-made via success in fields that have little to do with government procurement. What I see is a growing return to skills or position and a lessening of value for more ordinary skills or physical labor. If you can get people to trust you to manage a billion dollars based on your performance of managing smaller capital pools then you stand to make a lot more for your skill than someone who is a programmer because the market is freely making the distinction. People are freely willing to pay the management fees which so richly reward some people and they're not willing to pay more for programming skills. There is no nefarious plot afoot to "transfer" wealth across class.

John Dickerson points out that the US population is very uneager to cut the size of government. They want lower taxes but higher spending. This is a recipe for continued profligacy.

There is an information asymmetry at work. Dickerson knows the real scope of the problem and most citizens don't. He's reaching a conclusion that has little predictive value. Yes, today citizens are not eager to cut the size of government. They're not eager because they think that there is plenty of low hanging fruit which can be cut and once cut that would solve the deficit problem. What they think while they labor under a false impression doesn't tell us anything about what they would think when their impression is shown to be false. The solution here is simple - don't work to create a comprehensive solution which solves the problem and educates people at the same time, rather do as the people suggest, cut the low hanging fruit first and then allow the new normal to manifest. When the deficit problem is still present then ask the people what should be done now that welfare, foreign aid, arts funding, etc has already been eliminated.

Randall Parker said at November 21, 2010 9:11 PM:

TangoMan,

The information asymmetry will continue regardless of what cuts get made. There's no way to get a well-informed citizenry. They are dumb, lazy, uninterested, or just out for themselves or some combination thereof.

TangoMan said at November 21, 2010 9:35 PM:

The information asymmetry will continue regardless of what cuts get made. There's no way to get a well-informed citizenry. They are dumb, lazy, uninterested, or just out for themselves or some combination thereof.

My point is that the asymmetry can be narrowed. Fixing the budget crisis will not be done in one fell swoop. It'll likely be running series of iterative actions. Therefore, we might as well design the sequence so as to close the information asymmetry gap. If the public thinks that the budget can be balanced by cutting foreign aid and arts funding, or whatever, then oblige them by doing so and making it very well known that this has now been accomplished. Then ask them what to do next. The easy answer is now gone. Now you have a better test of whether the public will accept cuts or taxes. The next likely target would likely be to cut non-entitlement and non-defense spending. OK, cut that. No more money for parks, for air traffic control, for the FDA. Now the government's spending consists almost entirely of SS, Medicare and Defense. The information asymmetry has been further reduced. Many of us know that the budget can't be balanced without reforming how SS & Medicare work and as we accede to the public's demands that cuts come from other parts of the budget they too, more and more of them, will see that there will have to be decisions made on entitlement reform because the cuts that have already been undertaken haven't done the job of reducing the deficit to manageable levels or reducing it entirely.

When people labor under a false hypothesis, more often than not it's a futile job to try to explain to them the errors inherent in their view. It's far better to actually put their hypothesis to the test. This process is seen in teaching - when explaining doesn't work then show the student, when showing the student doesn't work then get the student to get hands-on with the problem or principle.

Now, to tie into the theme of your comment, I'd invoke the parable of leading a horse to water but not being able to make him drink. Yes, plenty of people are stupid and lazy and we can parse these people away from those who were merely misinformed. When the misinformed have their ignorance corrected, the information asymmetry is closed and they can make a politically informed decision. When the lazy and stupid have the information asymmetry closed, they just stick their heads in the sand and ignore the problem or cling to some illogical conspiracy. The $64,000 question is how to predict the size of both groups.

Randall Parker said at November 21, 2010 9:55 PM:

TangoMan,

I live in California where the state constitution requires the legislature to at least pretend to balance the budget. Pretend they do. They still haven't shut all the state parks in spite of a severe crisis with a deficit that is approximately a quarter of the total budget. Trying to cut at the federal level runs into the same problem but worse because the feds can run a big deficit.

If Congress enacts cuts in parks then park visitors will raise a howl. FDA cuts would provoke even louder and more vigorous opposition. Think you are going to get federal education spending when the Blank Slate faithful claim that dumb kids could go to college and come out with great earning power?

I do not expect Congress reps to see the political calculus as favoring big cuts. They'll lose more votes in reelection than they'll gain from cutting spending. The people whose programs get cut will remember at reelection time. The people who want to see spending cuts won't remember. There's an asymmetry of motivation.

TangoMan said at November 21, 2010 10:31 PM:

Randall,

I think we're talking past each other. I'm not disagreeing with your last two comments. I was disagreeing with Dickerson's conclusion, specifically that it was unsupportable, or in other words, conjecture. My rebuttal focused on process so that we could understand how to split the responsible from the stupid.

To your points in your last comment, I think that processes which are unsustainable will eventually hit a point where they can't be sustained. There is slack in every system. Eventually the slack runs out. With difficult situations the easiest answer is to punt it forward so that you don't have to deal with it today. Eventually you can't punt anymore.

Damn right people will be screaming bloody murder as non-entitlement spending is cut. My POV is that this whole process will be iterative. "Well, you told us not to cut SS and Medicare and you told us to cut other parts of government. We did. Now you want those cuts rescinded. OK, if we restore the FDA what should we cut in its stead?" This process will be tepid because it must be instituted by elected politicians whose primary concern is managing the affairs of today and who don't give a damn about the affairs of tomorrow. This is where Hoppe's comment about politicians not having a vested interest in long term issues leads them to maximize short term value comes at disastrous cost to long term value. So, after cursory attempts to address the problem it will be punted forward until, finally, the shit hits the fan. Alternative measures to spending cuts will be undertaken, such as tax increases and planned inflation, but we can't really tax our way out of the problem and inflation would be quite traumatic as well.

We've seen more homogeneous societies tackle this problem (Sweden, Canada, Asian crisis) but I don't hold much hope for a heterogeneous US. Social peace has been bought with redistribution. You know Chua's work as well as me.

As for asymmetry of motivation. Yes, you're right. That's the problem with big government - everyone has a vested interest in protecting their favorite parts. By closing doors on various spending cuts the alternative may look to be one of tax increases but that'll simply stagnate the economy and job creation, which when coupled with a growing population which needs new jobs created every month and with a retiring population which continues to expand the entitlement system, won't provide even a holding pattern on deficit size. See Hauser's Law.


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