WASHINGTON – America is facing death by garrote-like, slow fiscal strangulation. Overtime, Washington piled up debt levels that beat any historic comparison, except for WWII. We have heard that this is very dangerous; that this level of debt overtime will undermine the very stability of America as a functioning society, while making it impossible for America to be a world leader. Huge levels of debt will progressively crowd out discretionary spending, (already vastly reduced as a percentage of total spending), up to the point that the US Government will cease to have any investment capability or spending flexibility. With the pressing need to pay interest on a larger and larger national debt, there will be less and less money for national defense, for the management of foreign affairs, for building new infrastructure, for medical research, for science and technology, for NASA, for education, let alone foreign aid.
Sky not falling
And yet, optimists observe that with all this debt piling up, and piling up fast, so far at least the sky has not fallen. The US continues to run huge yearly federal budget deficits and to issue new debt to finance the shortfall. But there are buyers for US Treasuries, (China, of course and Japan and many others). We still get the credit –at that, we are also getting extremely good deals, as the interest that we pay on new debt these days is very low. So, entirely reversing the perspective, one might even think that being in debt is not so bad, after all.
And so the average observer may be tempted to conclude that all this doom and gloom talk about the debt is just hype, political scaremongering. Don’t we always hear that the country is going to hell and that disaster is just around the corner? Besides, hey, everybody –Japan, Europe– is in debt, some in much worse shape than we are. And they are surviving. So, may be this is not such a big deal. And, somehow we shall find a simple way to get out of this.
…No, our debt is structural
True enough, maybe the debt is not such a big deal today. For the moment, we are not having troubles financing it. But, if we look at unprecedented federal debt, much of it structural, that is built into the normal operating cost of the US Government and not tied to specific economic contingencies, plus intractable states debt, and municipal debt, (even though they cannot be lumped together in one single account), it defies credibility that this can and will go on indefinitely and that we shall be able to borrow more and more –essentially forever. At some point there will be insolvency, somewhere. At some point we can have some kind of crisis due to a fiscal breakdown in a large state, (look at perennially challenged California), that will get no more credit and will have to go bankrupt. And thus Washington may be called to the rescue. But rescue with what, as Washington is totally strapped?
When will the sky fall?
And here we enter the unknown territory of perception and fears. At what point will the good credit of the USA be no longer good? At what point will investors run away from US Treasury Bonds? Or, more likely, at what point will they demand, unlike today, a huge interest premium to buy them, (think of Greece or Ireland), making thus the whole debt financing operation a lot more costly and eventually crippling? Who knows when this might happen. But piling up more and more debt is a sure way to find out where the breaking point is.
Old debt v. new debt
Sure enough, we should distinguish between debt increases due to the higher cost of current operations, mostly entitlement programs and the recent, (2008-2009), jump in spending and thus debt due to the extraordinary circumstances caused by this unprecedented economic recession. The extraordinary spending due to the crisis will come to an end. But the ongoing shortfalls due to the built-in increased cost of federal transfer payments will not. So, overall, our national debt is not a temporary problem. This is systemic. The current contingency, with all the additional spending aimed at containing the damage of the financial/housing crisis, has only made a bad situation much worse.
Our problem: unaffordable entitlement spending
Unaffordable entitlement programs constitute the bulk of our debt and thus they are the real threat to long term fiscal health. If we keep in mind the higher spending trend due to our gigantic obligations towards seniors as currently framed, to think that there will be a fix other than cutting down spending for current operations –and this means mostly reducing the cost of all welfare programs– is total madness. Likewise, the hope that we can simply grow the economy so that more revenue deriving from an expanded base will get the Federal Government out of debt is wishful thinking.
We cannot “grow out” of this debt
Surely we can and should accelerate growth. This is good anyway. But there is no way that a mature economy like the US will be able to grow at a China-like 10 per cent a year thus generating the additional revenue that will allow Washington to progressively repay all its debt. So, even though we may not feel it yet, we are in a bad fix. Again, this is not temporary. On top of various needed spending cuts here and there, unless we reformulate our entitlement programs so that they will cost a lot less, there is no way out of this. And so, precisely because as bad as things are today the sky is not falling, this is the time to put together a credible plan for debt reduction.
We can debate the timing of a debt reduction strategy, not the need to have one
Sure enough, assuming that we have agreement on a real debt reduction plan, there are legitimate arguments –given the delicate, indeed fragile economic situation of the country—for implementing it more slowly rather than more aggressively. In this, however, we may have a thing or two to learn from England. After years of profligate spending, the UK, now under new Conservative/Liberal-Democratic management, has just embarked in a truly drastic deficit and debt reduction plan. Some say that this is crazy. Hasty, draconian cuts will simply kill the country’s economy. Indeed, the plan to cut public employment by huge numbers may backfire, as it may just add to total unemployment in a time of weakness, thus depressing aggregate demand and slowing down the economy.
England has a “Plan”
Is Prime Minister David Cameron reckless in all this? Who knows. We should revisit the UK plan a year from now. But one thing is clear. While one may debate and disagree with the timing of the strategy, at least England has a “Plan”, and for now a decent national political consensus around it. Here in the US we do not have any national consensus around any “Plan”. And we are supposed to be the world leader?
Others have had a “Plan” imposed on them
In other cases of deficit and large debt affliction, an unpleasant cure has been imposed on otherwise reluctant countries. We have seen what happened to Greece earlier this year. And we have seen that in the wake of Greece’s near death, Ireland, Portugal and Spain had to take actions aimed at deflecting international concerns that they were in equally bad shape. Now, of course, we can argue that the US is not close to these countries’ conditions. True. But the difference is one of degree. The nature of the affliction is the same: overspending. In our case it is not as acute. But, left untreated, the disease will only get worse.
America: no “Plan”
And yet, here in America, even though we know what happened elsewhere, and much debate notwithstanding, there is no structural debt reduction policy in place. In fact there is not even an embryo of a “Plan”. (We shall have this embryo, once an ad hoc bipartisan Commission nominated to study the issue will come up with its recommendations, sometime after the mid-term elections. But its plan, whatever it will be, will not be mandatory. It may or may not be seriously discussed, let alone implemented. Eventually it will be up to the elected representative to take responsibility for any binding decision). And this, lack of any plan, may indeed be the worst part.
It is inconceivable for the largest industrial democracy and largest world economy, in many ways trend setter, not to have any strategy to get back to fiscal stability. You cannot be a perennially semi-broke world leader. You can be semi-broke alright; or may be just broke a la Greece; but not a world leader at the same time.
We may indeed argue about timing and fine tuning of any debt reduction plan. But, we must have one, and it better be for real. The notion that you may be able to deal with this level of debt through half mesaures such as eliminating congressional earmarks or by abolishing this or that agency is ludicrous. We may eliminate the entire Department of Defense, unlikely as this is, and the substantial savings will still not be enough to get us out of debt.
Rise above politics, forge a national consensus
Our twisted politics aside, it would be almost suicidal not to forge immediately, whatever the political environment after the mid-term elections, the equivalent of a “National Fiscal Pact” that will outline the basic steps of a deficit reduction and ultimately debt reduction strategy that most Americans can buy into. I know that this sounds improbable, given our poisoned political climate. But, if this is so, if our politics do not allow an agreement on this vital issue, then we can kiss good bye to America as a world power. As I said, you cannot be broke and a world leader at the same time. Are we really so shortsighted not to see what is at stake here?
Why are we in debt?
With all that, once again, why are we in such debt? Because Uncle Sam spends much more than what Washington drain from the public via taxation. Once again, most of the overspending is not about this or that pork barrel project. It is due to payments to seniors.
Sure enough, not all debt is bad. For Government as in other instances, one could and should distinguish between “good debt” and “bad debt”. Good debt is what you get into if you want to start a business or finance a large equipment purchase that will benefit your business operations. You get into debt, all right. But there is a credible plan there that the money will be used to grow the business. Your business plan calculates that through your new equipment financed with borrowed money you will make more money and you will be able to pay back your debt, the interest charged and at the same time improve your profits. This is the kind of “good debt” that growing businesses routinely get into. Granted, sometimes this does not work. The business plan was not good. The new equipment purchase does not increase profits, etc. etc. And the business may have to retrench or it may go under. We all know that. But at the very least there is a decent expectation, vetted by your bankers, that getting into debt is a way to grow. You invest borrowed resources in order to grow the business.
Borrowing to invest, borrowing to finance current operations
In the case of a Government, we may argue that there is also a distinction between getting into debt to finance capital projects such as new infrastructure that provides lasting economic benefits to the nation and debt incurred to finance transfer payments: such as pensions or veteran benefits.
In the first case you borrow to improve the capital endowment of the nation. A new airport, an upgraded container terminal or improved rail connections usually will have a positive impact on the pace of economic activities, while reducing costs of all businesses using them. So, this would be an investment.
In the second case –transfer payments– you borrow to finance a life style that the nation could not otherwise afford. You can do this for a while; but not forever. This is now America’s predicament. This is indeed unsustainable.
America borrows to finance an unaffordable life style
Washington is on this unsustainable path. Indeed, in the case of the US, as well as other mature industrial democracies, most of the money borrowed goes indeed to finance the growing cost of current operations and transfer payments. And this is unsustainable. In other words we have costly IOUs in the form of transfer payments, mostly to seniors, that have become unaffordable. It is as simple as that.
The welfare state was built at a time in which nobody could fathom how expensive it would become over many decades. At the time when Social Security and later on Medicare were introduced nobody could fathom that today the growing costs associated with them would end up absorbing most of the federal revenue. But this is the issue. Not even a growing economy can generate the additional revenue required to fund progressively more expensive entitlement programs.
Welfare state: more expensive than initially thought
The welfare state as originally designed and later on modified is simply no longer affordable. This does not mean eliminating it. But it surely means restructuring it. The most obvious consideration is that we have to respond to changed demographics. While the problem is huge, it is also very simple.
We have fewer babies. There are fewer working adults paying into the system. At the same time entitlement recipients, the retirees, live much longer. So we have totally altered ratios, due to transformed demographics. Instead of having many young workers paying into the fund that goes to relatively few retirees, now we have fewer active persons paying into the system that finances checks for more numerous seniors who, due to improved health care, live much longer and thus collect for a much longer period of time.
Fixing Social Security
A very simple solution is to postpone retirement age and certainly to postpone the age at which one can collect full benefits. Of course, one can also jack up the federal tax that goes into the Social Security pot. And this will increase solvency. But by far the simplest remedy is to change the age of eligibility. And this can be done without jeopardizing payments to current recipients or to those already close to retirement.
You give a fair warning to those just entering the work force or who are sufficiently removed from retirement. You tell them that they will be eligible to receive their minimum Social Security checks at 64 or 65 and not at 62, for example, or whatever we want to decide, based on actuarial calculations about projected numbers of recipients and life expectancy. Of course, if the demographics change, you have to revisit the payment schedule.
Medicare is the real issue
The really hard part is a drastic reduction of medical payments to seniors, via Medicare. And this is a lot more complicated than Social Security because we are not talking about a fixed, predictable payment. Here we are talking about an out of control system, with awful incentives to overspend. Fixing Medicare would require a serious health care reform, unlike the one that we just had. This is really complicated stuff. This has to do with forging a real national consensus on what is appropriate health care and what is not. What is needed and what is unnecessary and who can legitimately decide on which is which.
On top of that, a huge chunck of the current Medicare cost is due to care at the very end of life. At what point can we say that giving expensive treatments to a person near death is superfluous? I do not even pretend to have the answers to any of this. But if we do not even begin this conversation, we shall not have any solutions. The current Medicare system, if unchanged, will mathematically bankrupt the nation, as Medicare costs increase at a much faster pace than even the most optimistic rate of economic growth. There is no question about that. So, better start talking now about reasonable alternatives that will provide care to seniors without destroying the country’s finances. Other developed countries manage to provide health care at a lower cost. What is an acceptable compromise that Americans can live with?
We know the problems
As I said, the problems that we are facing are huge but not mysterious. They become complicated, indeed intractable, only if they become political. To the extent that recipients have become accustomed to think of entitlements as “natural rights”, sacrosanct and untouchable, we have a problem, as the public is incapable of viewing what they get in the broader context of national solvency.
The notion that people can continue to get what they get, irrespective of the conditions of national finances, is crazy. Of course, when we get into any belt tightening conversation, then inevitably we get into “fairness”. “Why should I get less than so and so”? And this is why the issues are politically poisonous and thus carefully avoided. There are no good choices, because someone will be hurt by any cuts.
Action or no action?
Nonetheless, we are staring into the abyss. We are not in it yet, but close. If, for lack of political courage, we may conclude that falling into it is better than forging alternatives, then we shall deserve the inevitably bad consequences of our choices.