The Holy Grail and Mis-Trust Funds for Social Security and Medicare

I was recently part of an interesting discussion about government debt and current debates about how to control it. One side says that we cannot touch Social Security and Medicare spending. Those programs are too politically sensitive. Another side says that it is nearly impossible to control US federal debt without cutting these two important social programs. There are, of course, many other debates about the debt but I thought I would focus on this one today: Can or should we cut future spending on Social Security or Medicare?

First a little story. Then I will get to some data.

Nolan gets a part-time job and finds it impossible to spend all the money he earns each month so he lends the residual to Jason who promises to pay him back in 14 years. Jason spends the money each month. Fourteen years later, when Nolan asks for the money back and shows Jason his spreadsheet of past contributions, Jason agrees that the spreadsheet is impressive and that in fact he now owes Nolan enough money to go to college at Georgia Tech. Unfortunately, since Jason did not invest the money or any other money, he explains to Nolan that he is out of luck. Judge Judy saw otherwise and ordered Jason to find a second job so as to pay Nolan back what he owes him.

You might expect by now that Jason is going to shoot me. But this is not about Jason or Nolan – it is about the United States of America. Despite receiving very large sums of dollars for about 80 years from people paying into the Social Security system and other so-called trust funds, the US has nothing to show for it. Our government has done nothing but spend more each year than it receives in Social Security taxes and all other taxes. As such, instead of a shovel-ready-saving account the government now has a gigantic debt. Worse yet, all the annual balances of the major trust funds are either already in the red or are headed that way (see table below). Despite some funny accounting that shows trust funds with positive balances, there is no lock box and there is no money. It's like Nolan's spreadsheet.  

The USA now has to get a second job – or find a clever way to raise our taxes to keep the parade going.

Now to the data. Source is the Congressional Budget Office

https://www.cbo.gov/about/products/budget-economic-data#3

The bottom of the table below shows projections of annual flows into and out of major US government trust funds. These projections are based on existing legislation. Notice that in four short years (2021) they will begin spending more than they take in each year. In 10 years, they will have combined deficits of almost half a trillion dollars each year hence. Notice that Social Security and Medicare explain all of the problem with trust funds -- with Social Security going into deficit by 2019. Medicare is already showing annual deficits. And yes, these deficits must be paid out of the general budget each year. That means more debt.  

The table also shows that the national debt held by the public (the gross debt is even larger) is going to increase by $3.5 trillion or 25% in the next five years. The annual rate of federal government spending will also increase by 25% or by close to $1 trillion per year in those five years. 

Notice that if spending control is to be used to slow or reduce the nation's debt, the choices are limited to make a noticeable impact. Nine of the 10 spending categories listed below will increase between 2016 and 2021. But the expenditure increases are small for all of those except for three. The increase in defense spending is expected to be $58 billion; for income security the rise is $19 billion. Compare those amounts to the much bigger increases for Social Security ($281 billion), Medicare ($220 billion), and Net Interest ($194 billion). Since the latter is unavoidable, we are left with only two real opportunities to make a dent in spending and the debt. 

No one wants to push old people over cliffs. But if one is sincere about managing the country's debt load, the choices are pretty limited. And notice again, we are not talking about cuts in any program. The annual amounts of spending for Social Security and Medicare combined will increase by half a trillion dollars per year by 2021. That's a whopping per year 31% increase in Social Security spending and 32% per year for Medicare. Don't tell me there isn't room to cut before it starts to hurt grandpa. 

10 Year Budget Projections
(in billions of dollars)	2016	2021	Change	% of Total
Social Security	910	1191	281	30
Medicare	692	912	220	23
Medicaid	368	474	106	11
Healthcare Subsidies	42	85	43	5
CHIP*	14	6	-8	-1
Income Security	304	323	19	2
Defense	584	642	58	6
Net Interest	241	435	194	20
NonDefense Discretionary	600	641	41	4
Total	3755	4709	954	100
Government Debt	14.2	17.7	3.5
Held by the Public
(in trillions of dollars)
Trust Fund Annual
Deficits and Surpluses
In billions of dollars
	2016	2019	2021	2027
Social Security	30	-23	-96	-366
Medicare	-6	3	-8	-90
Mass Transit	57	-16	-18	-25
All Trust Funds	314	72	-20	-454

*Children's Health Insurance Program

Lesson 0. Why Study Macroeconomics

Recently a friend who reads this blog blurted, "I like the blog and all that, but what am I supposed to get out of all your words?" Apparently I have been putting the proverbial cart before the horse. So I am creating one more lesson-style post and numbering it zero to communicate the idea that this is supposed to be the beginning of one’s journey with macro. This is supposed to be the equivalent of those first paragraphs of a first book on macro. And, of course, it is the hardest one to write. But I do have a full glass in front of me. 

One place to start is with the phrase forest from the trees. Macro has a lot of parts, or trees, but macro is bigger than the sum of its trees. Wikipedia defines macro as “the part of economics concerned with large-scale or general economic factors, such as interest rates and national productivity.” I read that and almost fainted. It breaks every rule of definitions. About the only words I understand in that definition are large and scale – and even those words are misleading. There are lots of large things (e.g. the Goodyear blimp and Refrigerator Perry) but not all of them are macro.

So let’s start over. First, macro is a science. Macro is a science because its main goal is to explain stuff and thus improve our lives. Physics is a helpful science because it tells you that after you throw a sharp dart up into the air, you should move or it might land on your head. Astronomy helps us to understand why the sun “comes up” each morning. Biology explains why eating too many extra-large Big Macs might not be a good idea. Science is our friend.

Macro is our friend too. It takes the economy of the country as its focus. While biology might focus on the whole body, macro asks questions like: How is the German economy doing? What’s up with Greece’s economy? While the concept of a body is very specific, the idea of the economic system of a whole country is less tangible. And thus macro is already in trouble. The doctor can touch your arm but the economist cannot touch the national economy. It is a figment of our imaginations. It exists only in our minds. And some of us have some pretty whacked-out minds. 

That sounds pretty bad. But the truth is that we use such counterfactuals for much good. You read fictional stories to your children hoping they will learn important lessons about life. Scientists stick millions of thingies on semiconductors that are so small that you can’t see them, and yet we are able to do amazing things with cellular phones and their apps. In biology class we experiment on fetal pigs, and despite the fact that they are not human beings, we learn a lot about human biological systems.

With macro, we can learn how the economy impacts our lives. The economy is like a train with many cars. Each car might be very different but when the train goes forward all the cars go forward. We might not be able to touch the national economy but we can try to improve its outcomes. At the heart of macro is something called GDP. GDP is not a tangible thing. It is an idea. It is defined as the nation’s output of goods and services. Think of a huge pile of goods and services and that is what GDP measures for given quarter or year. 

Every nation produces tangible goods like autos and JD. Every nation produces services that disappear the second you consume them, like when the Uber pulls away or the bartender moves on to serve another customer. Your drive in an Uber's Prius is over the second you step out. Okay, you might have a nice memory. In the bartender case you do have a lovely Old Fashioned but that drink is a good. The act of the bartender delivering it was the service.

In 2016 the US produced about $18.6 trillion dollars of goods and services. That's quite a pile! Can you touch that $18.6 trillion? No! You personally bought parts of that amount but the “whole enchilada” is the macro concept. GDP is like a basketball team. We cheer for it. Go GDP! Sure we have favorite players, but it is the team that we focus on year after year. In that sense, a basketball team is definitely not a tangible you can touch. It is a concept (and to many people, a very important one).

When GDP falls in a year, we call that a recession. We frown during a recession because we get less goods and services – and we dislike the fact that many people lose jobs as part of the contraction in output. We smile when GDP rises, and we clap when it rises faster than normal. Just as a basketball coach is expected to produce good results for the team, we expect our government leaders to create the right policies for growth of GDP. And like basketball coaches, even the best leaders win some and lose some. No one is a winner all the time.

  

I am just about down to the ice cubes. But I think I am almost finished. Macro is a science and as such is supposed to help us improve our lives. Macro uses concepts that are not always tangible but which are developed to help us think more productively about how to improve the nation’s economy. Macro devises policies and sometimes they succeed and sometimes they don’t. But like the meteorologist who missed the exact speed and location of a hurricane that came on land near Sanibel Island, the macroeconomist is constantly evaluating our macroeconomic science and policies with an eye toward learning from one’s mistakes.

Finally – since macro is about a whole nation – it is not about you or me specifically. Macro is not about Hoosiers versus Coloradans. Macro is not about workers versus owners. Macro is not about girls versus boys. Macro is not about JD or corn or oak barrels. Macro is not really about the rich versus the poor. The field of economics has categories to investigate each of those things, but macro tries to focus on the whole economy of a nation. When macro policy starts trying to be everything to everyone, it always fails at doing the one thing it is intended for – helping the economy to grow more so we all have jobs and more goods and services to play with!

Fumbling Around in the Dark

Fumbling around in the dark is a scary thing. You awaken at 2am in a very dark hotel room to find that you are relieving yourself in the closet. Or maybe you are trying to find the glass with one ounce of JD left in it, and you accidently knock your wife’s mobile phone into the toilet. Regardless, fumbling around in the dark can be pretty destructive.

Such fumbling is simple to explain. You are used to having light to guide your eyesight. Take away the light or the eyesight and you find yourself in a treacherous environment. Decision making becomes a totally new thing. You can do it but it necessitates new rules. It might require that you memorize the layout of your hotel room. It might mean groping with hands or buying a cane. How you operate depends very much on the expected time period of the darkness. A temporary situation would be dealt with differently than a permanent one.

It seems to me that the Fed is operating in the dark today. With Congressional economic policy in the potty, we rely on the Fed to guide the economy. Unfortunately, the lights went out in 2008 and the Fed has been groping around for ways to assist the economy ever since. In the beginning, most of us thought that the darkness would be temporary. Now I am not so sure. 

By darkness I mean that we have been dealing with economic problems and performance that are new. Our economic indicators are misbehaving. GDP contracted far more than during our experience of the last 75 years. US inflation bordered on the negative during those years. The Fed was correct to assume its role of lender of last resort. Economic darkness called for rare policies right after 2007.

But the great recession ended in 2009 and, according to my JD calendar, it has been eight years since we started an economic recovery. And yet in those eight years the Fed saw the same thing – economic weakness. And thus the Fed keeps its interest rate target at less than 1% and it leaves trillions of dollars in bank excess reserves. Why is the Fed so afraid to return to a normal monetary policy? Note I haven’t asked why they didn’t raise interest rates to 3-4%. I simply asked, why didn’t they start to return us to a more normal policy?

The latest answer is that they have already attained a normal policy. That is, the economists at the Fed looked into the darkness and drew a conclusion. Normal has changed! In particular, they resurrected a concept called the neutral or natural rate of interest. Aha – the neutral rate of interest has declined and therefore the current rate of less than 1% looks a lot more normal. 

What is the neutral rate and why is the Fed so confident that it dropped like a rock? Tuna – the neutral rate is not the neutered rate. To the rest if you – the neutral rate is an interest rate at which monetary policy is just right. As in Goldilocks, the Fed wants a monetary policy that is neither too cold nor too hot – they want it just right. If for example, the current policy interest rate (the Fed’s main policy target is an interest rate called the Federal Funds Rate) is 0.6% and the neutral rate is 4%, then we would conclude that the Fed’s policy rate is too low. It would also imply that the Fed is stoking the fires of the economy too much. But if the policy rate and the neutral rate are both around 1%, then Goldilocks kissed the charming prince and she and the frog live happily ever after.

As you can imagine, the Fed is relieved that it found economists who would explain why the neutral rate is low – and why it might stay that way until Nolan applies for Social Security. Not to contradict economists who work for the Fed, I will say that if they are wrong about this, then the Fed will continue providing stimulus to the economy long after it should have stopped, and the consequences could and probably will be a Fed-engineered bout of stagflation.

Could they be wrong about the size of the neutral rate? I think so. To conclude that the neutral rate is low, the Fed focuses on recent data that shows among other things a slowly growing economy. Such data includes declining labor force participation, a slowdown in productivity, and a discovery of new planets that might have doppelgangers for Barbara Streisand and Sara Palin. But can we believe all this?

I recall a very widely held concept called Secular Stagnation advanced by leading economists that explained why, after World War II, the US economy would slip back into the Great Depression. It never happened. Similarly, economists today look at data from a spoiled batch of milk. Whatever caused the great recession of 2008-09 and whatever unprecedented policies followed that decline appear to remain with us today. But just as turning off a light switch causes confusion for a while, the impacts of the last eight years will dissipate and then disappear. In the meantime our usual data are going to be very suspect, and thus our conclusions from such data will be equally suspect.

This darkness meant that the Fed had an excellent excuse to use emergency policies in the beginning of the recession. But it does not mean it should make up excuses to continue that policy forever. While the Fed is supposed to support full employment with stable prices, nowhere does it say they should engage in a binary policy of spigots open followed abruptly by closed spigots. The Fed does not know the value of the neutral rate. Erring on the side of a low rate to support its current aggressive policy means risking a future burst of inflation and an eventual Fed-induced recession. To mix metaphors – it is time to take the foot off the accelerator. 

Currency Manipulation Fairy Tales

More and more is being written about exchange rates. The US is accusing other countries of illegally manipulating their currencies and gaining unfair advantage in trade. Could this be another deflate-gate? Or is it just another attempt to deflect and persuade? In truth, most of us know little about exchange rates and wouldn’t know a manipulation if it twerked right in front of us.

So let’s begin at the beginning. The Lord created man and then the exchange rate. ... OK, not really. The modern exchange rate became useful after countries moved from barter to currencies, and people starting trading across borders. As you can imagine, Germans preferred being paid in dm (note: dm stands for deutsche mark. And yes, I know there are no longer dms or French francs or French fries). If Pierre wanted to buy a beer in Berlin, then he needed to swap some of his francs for dm. The exchange rate would determine how many dms Pierre could get in return for one franc. 

Let’s suppose a beer cost 10 dm in Berlin. If the exchange rate was 1.0, then that would mean Pierre would need 10 francs to acquire 10 dm, and therefore buy one beer in Berlin. Let’s now move forward and think of a hypothetical time after the French government flooded the country with francs. Now each individual franc is worth less. Now it takes, say, 20, francs to buy a beer in Berlin. If it took way too many francs to buy dm, then Pierre might not buy that beer in Germany, save his francs, and buy a Fischer's back home.

The above example illustrates the following. First, currency exchange is a common everyday practice relating to trade across borders. Second, the exchange rate is impacted by markets and governments. Third, in the above example a surplus of francs relative to the demand for francs can cause the franc to depreciate in value against the dm. Fourth, I can’t remember the fourth one. Oh yes. The depreciated franc makes foreign goods more expensive to Frenchies.

The exchange rate can be impacted by many events. For example, let’s suppose French people decide that French goods are inferior to German ones, and they shift their buying preferences toward German goods. If they are going to buy more German goods, then they will need to exchange more francs for dms. Thus the market value of the franc falls and the value of the dm rises.  

The above applies simple ideas about supply and demand to exchanges of currencies. If demand goes up for a currency then its value rises. We say it appreciates. Supply of a currency goes up and its value falls. That's called a depreciation.

WAKE UP. This is not over yet. The fun is about to begin. Let’s suppose you are a German and the value of the dm rises. You might have one of two reactions. If you love to buy French wine, you are very happy because a stronger dm buys more francs and therefore more French wine. If Juergen sells machinery to French buyers, he is very sad because now his goods cost more to French persons and he worries they will stop buying his equipment. Every time the exchange rate changes, some people are benefited while others are hurt.

That means that the value of a country’s exchange rate is always and everywhere a policy/political indicator. Since those who are hurt by exchange rate swings always yell louder than those cheering, we have an opportunity for politicians to ride in and save the damsel in distress.

So what can a good politician do? Ha ha – a good politician! I'll drink to that! Anyway, there are two typical ways a country can address an exchange rate problem. First, the country can intervene in exchange markets. If their currency is too strong and muscular, they print up lots of bright shiny notes and sell them in the market. Thus they acquire foreign currencies as they reduce the luster and price of their own. If their currency is instead weak and puny, they can sell the foreign exchange and buy their own currency from the markets, thus raising the value of their currency.

The second way to manipulate the value of a currency is through the use of monetary or interest rate policy. Compared to the first way described above, this approach is less direct yet just as effective. When the Fed engaged in all manner of monetary increase after the great recession of 2008/2009, the result was to reduce US interest rates, cause world investors to invest elsewhere, reduce the demand for dollars, and viola!, reduce the value of the US dollar. The Fed said this policy was necessary to stimulate the US economy by the usual domestic policy means. But the larger truth is that it was also aimed at reducing the value of the dollar so that US exports would be better priced in world markets. There is no question that the Europeans, Japanese, and others have caught on to this gambit and are now imitating the Fed. 

Let’s face it. If a country is facing a very weak economy or a recession, it is going to use one or both of these methods to stimulate its economy. The more important are exports to that country the more the temptation. Thus currency manipulation is like the last JD of the evening. You swear you will not do it and decry its worth, but once the party gets going and the Stones are on the Victrola, you are the first to pour one last nip.

It is truly ironic that the US is making such a fuss over currency manipulation when our own actions are so responsible for the vagaries of the high dollar today. It was us who used monetary policy to cause the dollar to swoon faster than a pelican above a catfish farm. It is again us today with our stronger economy and rising interest rates that now makes the dollar rise. To be sure, other weaker economies are contributing to the rising dollar with their own manipulations, but pointing a finger of blame at them is like getting mad at your children for raiding your unlocked JD cabinet while you are at open mic night at George and Wendy's. 

Repeal and Replace

Repeal & replace or repair. While there is importance to these words, they can be misleading. Sleight-of-hand is the tool of the magician ... and the politician and the subway thief. A band of entertainers enters your subway car and does magic tricks as their buddies relieve you of your wallet and other valuables. Those skilled at sleight-of-hand are never easy to anticipate and generate a lot of fun before they do their harm.

Repeal and replace gets the political base all fired up. Some people prefer to say repair but even that word elicits a political war cry. My eyes grow weary reading the endless minutiae. The Democrats will fight to the end over either repeal or replace. Republicans will argue the timing of the repeal and replace as if they were deciding which sit-com to watch first.

But stop sniffing a minute and realize that these words are there to inflame while the real issue is the improvement of the national healthcare system. D or R, we all believe that the system can be improved. Before Obama radically altered the system, most of us would have agreed that the system could be improved. And today, I think we know that healthcare isn’t perfect.

So why blab repeal and replace when what we all really want is improvement. Of course, we don’t agree on exactly what needs to be improved just as many of us held different opinions about Meathead in All in the Family. We are a nation of free thinkers. We love to disagree. Most bars would go out of business if we all agreed on everything.  

As we go about improving healthcare, it wouldn’t hurt to start out with some shared goals. We might not agree on the ways to reach those goals but let’s at least find some common ground. For example, most of us would agree that hospital gowns should have backs to them. No one likes a butt sticking out. And then there is the total avoidance of JD as a painkiller. That seems silly.

So now we have a place to start. Let’s move on. Another shared goal is access to healthcare. Let’s vote. Should we advocate limited access or wide access to healthcare? Everything else the same, let’s try to have a system that is available to most of us.

Second, let’s have a system that is affordable. Again it is easy to agree. Do we want a system that no one can afford, or do we want most people to be able to buy healthcare without selling the family's glug glug collection?

Third, to attain these goals we know there must be a mixture of market provision and government assistance. This is our tradition and is nothing new. We buy cars and cabbages in the free market yet we also have an extensive income supplement program for those with less capacity to purchase. We liberals and conservatives argue about the balance of market versus supplement but we pretty much agree that both are necessary.

Fourth, it doesn’t take Albert Einstein to understand that society must be able to afford this balance of market and supplement. Our hearts cannot rule our heads. Too much supplement doesn’t automatically make us Greeks but it could weaken our overall economic strength. 

Fifth, if the market is to provide healthcare then attention must be paid to the purveyors of healthcare – doctors, nurses, hospitals, insurance companies, pharmaceutical and medical device makers. There is no market without supply. Suppliers must want to provide their goods and services. At the same time, since parts of their earnings come from government supplements to the system, some supervision over their participation and prices is necessary.

Insurance will likely continue to be the basis of the healthcare system in the USA. Insurance markets exist in other venues – houses, automobiles, life and other financial products, and so on. Insurance has well-known principles. A major one is that many people pay into the system while others receive benefits. For example, good drivers pay for auto insurance each year and get nothing but piece of mind in return. But after some maniac who tries to change lanes with a margin of three feet going 90 miles per hour rams into you, then State Farm pays you to have your wrecked Lada replaced with a lovely Ford Edsel.

That’s the way insurance works. Some folks pay and some folks receive. If there are too few of the former and too many of the latter, then you have a problem. It makes absolutely no sense to let people enroll in insurance after they have a wreck. So any plan for health insurance in the USA will have to address ways to make people want to participate in the system when they are not ill. It seems to work for autos. I am not sure why we can’t find a way for healthcare.

It also seems related that people who find themselves out of a healthcare plan would be allowed to transition to another one. If someone has very serious conditions there should be an affordable way for them to find and keep insurance. Kids on parents' plans similarly need to be covered.

The above does not seem far out to me. Replace? Repeal? Keep your eye on the ball. We need a better healthcare system. Period. Healthcare reform always starts with something. Then you improve it. Now is no different from the past. Except for maybe the fact that people in both parties seem to have more fun screaming like banshees than actually doing something good for the country. 

Big Bang

Jimmy went in for his annual physical with Dr. Nolan. The doc shook his head and explained to Jimmy that he was going to have to change a lot of his habits: "Jimmy, you have a lot of things wrong with you. You are vastly overweight, anemic, diabetic, you smoke and drink too much, and your knees are about to go out under all the stress." Dr. Nolan suggested that Jimmy solve all those problems in one big bang. He would have to cut down on his visits to the Varsity, quit eating Key Lime pie, eliminate his 5 pm JD, quit smoking, and most important, eat more spinach, do more burpees, and have two knee replacements.

Jimmy was stunned. While he was willing to change his lifestyle over time, moving quickly on these fronts seemed impossible. How can one eat more spinach and not follow it with at least a tiny mouthful of luscious pie? And how can a human being cut out a daily ration of chili dogs without at least one puff on a cig or washing it down with a little JD? Worse, how does one do burpees without fully operational knees?

Dr. Nolan was insistent. "Jimmy, all these vices are connected. If you make headway on one, then you will just fall backwards on another unless you attack them simultaneously. Sure it will be rough for a while. But once you get past the first days, you will begin to feel like Melissa McCarthy on steroids." Jimmy replied, "Yes, Doc, but trying all that stuff at once might just demoralize me, and I might not even make it to my next appointment. And by the way, Melissa McCarthy is a woman."

Enough foolishness? I don’t think so. The idea of big bang versus gradualism is worth discussing in light of our new government’s volley of shots aimed at our country’s problems. I don’t have to repeat it all here but we have seen and heard policy announcements in many areas – healthcare, bank regulation, environmental regulation, tax reform, infrastructure, and so on. The rationale is that we have deep problems that are worsening. The explanation is that we cannot wait to attack these problems. Since many of these problems are related, it makes no sense to prioritize, because failure to move in one area means new policies in other areas will not succeed.

Is policy in 2017 like building a house wherein one must start with the foundation before erecting the walls? Or is policy more like making an omelet where you throw in all the fillings more or less simultaneously?  

Much was said about a big bang after the Soviet Union fell. Many countries were freed from Soviet policies and decided to move away from a socialist economic framework to one that was more capitalist. Some, like Poland, wanted to move quickly on many fronts. Hungary took a more gradual approach. (Hungary and Poland were not in the Soviet Union but were under its influence.) Others went even slower. I just read some of the economic analysis of these programs and policies and now have a headache. As you might expect there is no silver bullet to transformation. How one approached economic transformation depended on a lot of things including the nature of each country’s specific problems, its culture, and its history with socialism.

Countries that moved quickly and forcefully experienced very negative short-run effects including large recessions and high unemployment. Some that took gradual approaches avoided some short-term pains but followed a slower path to eventual stronger growth. It has been a quarter century since all that started, and the truth is that transformation goes on in most of the former Soviet sphere. The Baltic countries (Latvia, Lithuania, and Estonia) and Russia are the only countries to have annual real per capita GDPs of close to $20,000 per year. The rest are much lower.

The radical changes necessary to move from Soviet to market economies dwarf the changes going on today. Nevertheless, the experience of big bang is helpful. First, while there is some precedent for moving quickly on many fronts, there is also the recognition that gain may follow considerable pain. So one question is whether or not America in 2017 can tolerate a step backward. Second, much depends on the severity of the problems. Severe problems may be more entrenched and difficult to dislodge. A second question, then, is how bad are today’s problems in the USA? Third, results depend on history and culture. A past with experience in competitive markets helped places like the Baltic countries once they were freed from the Soviet Union. A third question: do US voters want to return to less government and more reliance on markets?

Are our economic problems in the USA today bad enough that people are willing to take a step backward to move the economy forward? Or do we even think these new policies are on the right track? It looks like a new big bang is about to start. The dust is about to fly. 

Trade

You don’t grow bananas or manufacture your own shirts, and Bill Gates doesn’t do his own typing. That’s called the benefits of trade. There was a day when people were mostly self-sufficient. Families grew their own crops, chopped wood, made their own clothing, and so on. But we don’t do that anymore. True, we are all getting fatter as a result. But we are also getting richer too.

The change from self-sufficiency to trade came gradually, and now we don’t think about it. Today is an age of specialization and trade. Most of us are plumbers or accountants or bartenders. We earn incomes at our specializations and use our incomes to buy whatever we need or want. In Tuna’s case, that would mean luxurious vacations for Pat. We don’t think of it this way but what we are doing is benefiting from the activity called trade.

We benefit from trade mostly because of what some whacked out economists call comparative advantage. Bill Gates is really good at what he does for a living. Suppose he is worth $1 million dollars a day in the marketplace. Should he do his own typing? I think not. If he spends a day typing, he loses $1 million and gains the average wage of an administrative assistant. It wouldn’t make sense. And of course, trade doesn’t just help Gates. Some people cannot make business decisions and are not valued at $1 million a day. Some people are really good at being an administrative assistant. Those people are delighted that Mr. Gates needs their services. They happily trade with Bill Gates.

It is true that the administrative assistant might earn $30,000 per year. But that person cannot pawn himself off to a company for more. That person is probably quite happy to find employment for what he is good at. In trade, people willingly enter into agreements, and both parties are advantaged by it. This goes on every day. 

We live at a wonderful time when all we have to do is want something and someone else is there to make it or sell it to us. Of course, we have to uphold our end of the bargain and make sure people value what we do, so we can earn the money to buy all those other things.

That’s pretty simple. But it all goes haywire when we go from talking about Nathan and Christina to similar trade between the US and Mexico. You see, trade is trade, whether it goes across a national boundary or not. The same principles apply. Nations have always traded. Even dinosaurs traded. Trade works because a nation can produce and sell things in which it has an advantage and buy things in which it has no advantage. In doing so, all countries benefit.

Back to benefit. Recall Bill Gates and his administrative assistant. Both of them enter into an agreement willingly and gain from it despite the fact that one is a lot richer than the other. Some people believe that some countries are always harmed by trade. These countries are poor and get taken advantage of. That may sometimes be true but what is also true is a country’s poorness often gives it great advantages in trade. Think of why we richer nations buy things from places like Vietnam. We buy because they have learned production techniques and combined that mastery with employees who are used to living on very low incomes and wages. It might not seem fair to some of us, but if you are from such a country and a new trade deal makes you MORE valuable, you are less inclined to envy the rich and more inclined to take advantage of a higher income and standard of living and perhaps better job security.

Trade is good and makes both parties better off even if it doesn’t make them equal. The problems come when one or more of the parties to trade receive actual benefits that are less than expected. Unintended effects of trade can occur for many reasons. Some reasons are real and can be addressed. Other problems are made up or simply contrived for political purposes.

For example, Bill Gates might suffer business losses because of a new competitor. He might blame his administrative assistant despite the fact that the assistant was not the real problem. So he reduces the wage of his assistant or fires him. Clearly, if the real problem is a new business competitor, firing the assistant accomplishes nothing and sooner or later we find out the truth of the matter.

In the US today, we are rethinking trade. We have trade deficits with the world and with specific countries. We are about to say “You are fired!” to these trading partners. How much of these trade deficits are in fact the direct results of freer or unfair trade? How much are caused by ourselves, or at least things out of control of our biggest trading partners?

I don’t have all the answers but I can offer a few. One answer comes from macroeconomics. We in the US love to spend. We love to buy goods and services. Apparently we can’t make enough to satisfy our love of buying, so we have to import. Maybe if we saved more that would help. Furthermore, we find ourselves in a time when the US economy, despite a lumbering pace, looks stronger than many of our trading partners. We have more ability to buy from them than they from us. None of this has to do with cheating, and none of this argument can be solved by US protectionism.

Another answer has to do with a realistic assessment of economic transformation in developing countries. When we made trade agreements with these countries, we made them with the full knowledge that they were transforming. Transformation is neither easy nor quick. When the Soviet Union collapsed, I recall economists saying that it would take 30-40 years for countries like Poland (not in the Soviet Union) and Latvia to approach rich country status.

What’s the hang-up? The problem is that subjecting a country that was centrally planned for decades to the rigors of competition is rough. You can’t wave a magic wand and privatize very inefficient companies that have little experience with competitive markets. Likewise you can’t overnight liberalize prices of all goods and services when many prices were kept at a very non-economic low.

Rapid privatization of companies can lead to large-scale unemployment and liberalization of prices can cause drastic increases in prices. Any country engaged in these and many other transition policies understands the social/economic upheavals associated with change. Nevertheless, they do it because of the eventual benefits transformation promises.

Richer countries know this, and trade agreements were made with the understanding that many of our important trading partners have government-owned companies and government control over prices, wages, and many other things. To say today that country X unfairly subsidizes its industry Y makes no sense. The word subsidize makes no sense in the context of a transforming nation.

Are we all wrong and are they all right? No. Maybe we do need to reopen some trade agreements. After all, some of them are old, and times have changed. But in doing this we need to remember a few things. First, some of these problems we bring on ourselves because we probably won’t ever produce enough to satisfy our appetite for goods and services. Second, some of the problems will go away when economic growth in other countries returns to something more normal. Third, developing countries are still developing. They have very low incomes. They are in transition. 

Putting unrealistic pressures on them only weakens them. We don’t gain by weakening the people who we want to buy our goods.

Trade is good. Trade agreements can be reopened. But there are clear limits to what can be accomplished without changes in our own domestic policies. 

Misinformation about Tax Cuts

Note -- On 2/10/17 I realized that the table below has an error. The error does not impact my points but it does attribute the largest tax rate to Bush 1 when it was really Clinton 2. The order of the names at the end of the table should be Bush 1, Clinton 1, Clinton 2. The order of the numbers in the column is correct.

There are two things in life that are certain: taxes and JD. Or something like that. There is a lot of buzz about coming tax changes. Most of us like tax rate cuts. They make us richer. Some of us want bigger cuts for the poor. Others want bigger cuts for corporations and the rich. Others want bigger cuts for farmers who export agricultural products. I don’t want to get into all that because it gives me a headache.

In fact, what I want to do here is to take one baby step. That step has to do with the idea of tax cuts and tax revenues. Tax revenues are important. Everything else the same (economists love to say that), a reduction in tax revenues causes the government to have a larger deficit and debt. Since our national debt is larger than a 2X T shirt at Walmart, we don’t want new policy changes that make it even larger. So policies have to be careful not to reduce government’s tax revenue.

We awaken from our slumbers when we hear politicians speak about large tax rate reductions. One proposal would reduce our corporate income tax rate to chicken feed. Another reduces rates for the average worker. Other proposals would undo tax penalties recently put onto the richest of us. This is tax rate reduction season.

But cranky old men and a few of their lady friends say, wait a minute, buddy. Tax rate cuts are going to reduce tax revenue, increase the national debt, and probably lead to higher weed consumption. And those armed with more vim than vigor point to that nasty Ronnie Reagan and his tax cuts and those tragic government deficits he caused. Never mind that Reagan was President before the Great War and no one (except Fuzzy) can actually remember 1981 – the proof is in the Key Lime Pie (with graham cracker crust).

Or is it? I decided to take out my Janis Joplin album, pour a nice JD over rocks, and look into this issue with my usual astute analysis of the data. That didn’t work since I was bowled over at how complicated it becomes to pour JD and type numbers at the same time. And I also realized that the issue has way too many dimensions. For example, tax revenues depend on how strong the economy is. And Reagan had two terms in which the composition of Congress changed. And then there is the nagging issue of how decisions about national government spending affect government deficits and debt.

So after nearly fainting I decided to limit the scope of my project. Whatever I say here, therefore, is subject to lots of ifs, ands, and buts. Nevertheless, the story is useful and perhaps adds to our discussion about tax cuts and government deficits.

One would think that if the Reagan tax cuts significantly bent tax revenues downward despite a subsequently growing economy, then we would have some good evidence against tax rate cuts. So I decided to look at historical changes in one number – tax revenues as a percent of GDP. The table below contains what I found. The table shows federal government tax revenue as a percent of GDP from 1969 to 2000. The average tax revenues as a percent of GDP during that 32-year period was 17.8%. In 2015 the number was 18.2%. The numbers in the table refer to averages over four-year presidential terms.

Table: US Government Revenues

as a Percent of GDP

Nixon            17.8

Nixon/Ford   17.4

Carter            18.0

Reagan 1       18.0

Reagan 2       17.5

Clinton 1       17.4

Clinton 2       17.7

Bush 1           19.0

Interestingly Reagan’s average for his two terms was 17.8% or exactly the average from 1969 to 2000 and was a smidge less than Obama’s rate in 2015 (not in the table). And Reagan’s tax numbers do not significantly look different from the other Presidents. Nixon/Ford and Clinton 1 managed to get tax revenues down to 17.4% of GDP while Bush 1, Carter, and Reagan 1 increased tax revenues to 18% or more.

So if Reagan cannot be identified in a mug shot of past tax rate offenders, then why were his budget deficit numbers so creepy? Why has Reagan become the poster child for tax cuts, larger deficits, and poor B-grade movies? The answer, of course, has to do with the other side of government – disco dancing. Ha! I meant to say expenditures or spending. If government deficits were larger under Ronnie R, then you need to dig out the data on spending. But why dig it out? If Batman didn’t do it, then it must have been Robin.

So if you want to be mad at Ronald Reagan for government deficits, then you need to discuss spending. During Reagan’s presidency, Congress was split. The entire eight years Reagan worked with a Democratic-controlled House and during his last two years the Democrats controlled both houses. Not to blame the Ds or the Rs, the fact remains that government with a big G let deficits swell. It was not Reagan and it was not Reagan tax policy. It was spending.

It might be fun to think about all this as we head into the next months. Many politicians have already sworn an oath on their Mickey Mantle baseball cards to not push Grandma over the cliff – that is, they are not going to reduce spending on one program by one cent. No matter how fast these programs are growing and no matter that Grandma has a rocket-propelled wheelchair with an iPhone and tablet. And don’t get me started on all this infrastructure nonsense that both parties are trying to foist on us.

Argue about tax cuts versus government spending all you want. That’s fun. But don’t for a minute think it is a slam dunk. Tax cuts are not your enemy, and if they have a way of creating more economic growth, they might be worth the risk. More government spending, however, is going to send all of us to an early grave. Cheers. 

It's the Economy, Stupid

What joins us all together is the reality of the economy. If the economy tanks tomorrow, Democrats and Republicans will lose jobs or find their incomes rising less than hoped. If inflation roars back, we will all complain about the higher prices we have to pay.

While Ds and Rs have their preferred recommendations for economic policy, what will matter most is not who is right but whether or not we attend to real economic problems and make improvements in our lives.

So rather than dwell on policies and policy debates, I thought it wouldn’t hurt to lay out where the health of the economy sits right now. This amounts to a description of economic challenges, or you might say for those of you on post-New Year diets, this amounts to the before-diet picture.

Dieters want the post-diet photo to show major beautiful changes relative to the before-diet photo. So where you begin is very important. But even where you begin is not completely objective when it comes to the economy. And some people might think that any description of the economy right now is tainted with politics. An Obama supporter might disagree with any remarks that show a weak economy. The Republican would bristle at the idea that the economy might look strong right now.

Furthermore the economy is pretty complicated and dynamic. Anyone who attempts to describe the current economy might be leaving something out – or might be too focused on the latest data rather than more enduring trends. I readily admit that this is no easy task. And no matter how hard I try it won’t be perfect.

But it ought to be done and those who disagree with some of the conclusions below are free to ignore them or to add their own comments.

The place to start is with the growth of national output – or what we call real GDP. Most people would agree that it is not growing as fast as it used to. While there have been some quarters of decent growth in the past eight years, the overall trend is modest. We grew at a faster pace during most of the 1990s and right before the great recession of 2008-09.

Associated with that growth has been enough employment growth to push the unemployment rate down to levels close to what we describe as “full employment.”

Despite this increase in employed persons, we also have high levels of people who have been unemployed for more than 15 weeks, high levels of people who want full-time jobs, many folks who took jobs beneath their skills, and finally a lot of people who simply quit looking for jobs.

Despite an increase in the demand by employers, many workers lack the specific skills being demanded and thus shortages of workers exist side-by-side with surpluses of workers. The net result is that wage gains are lacking, and we talk about labor market mismatches.

Looking deeper at the modest real GDP growth we find one sector particularly lacking. Consumers are pulling their own weight through spending on housing and autos purchases. But the spending by firms on plant, equipment, and software has been in the doldrums. This has two key impacts. First, near-term growth lacks punch and second, new investments by firms have not raised productivity of workers and have harmed international competitiveness of companies. This means we get slower growth today and tomorrow, and we threaten future wage growth and our ability to compete with foreign companies.

Exports of goods and services have slowed for many reasons but primarily because many of our trading partners have not recovered or remain in recessions after the global recession. These foreign purchasers are not buying goods and services at home – and they are not buying from us.  

Interest rates and the value of the dollar have been rising. This is no surprise mostly because of the relative strength of the US economy. If interest rates rise appreciably more this could dampen investment spending further; if the dollar continues strengthening this might jeopardize exports.

Lackluster economic growth has also impacted poverty. The official US poverty rate in 2015 fell to 13.5% of the population – down from 14.8% in 2014 but is still higher than in 2007 (12.5%) and 2000 (11.3%).

Debt is also of concern. The Federal government’s debt threatens to reach more than 100% of the economy. Student debt has reached new peaks with little sign of abatement or payment. Similarly, mortgage debt is getting bigger and riskier.

This “photo” of the US economy today is where we have come to in early 2017. Is it complete? I doubt it. Does it foretell a disastrous future? I don’t think so. Is it where we want it to be? I don’t think so.

But I do think it wouldn’t hurt to have this story in the back of our minds as we contemplate and debate remedial actions in the days ahead. No matter what other issues we try to solve, we should at least not make these economic trends worse. I don’t care to place blame or praise for today’s economy. I just want us to make it better. 

Truth, Lies, and Misrepresentations

We are learning a lot lately about how people purposely lie and mislead on social media. Especially sad is how people fabricate news stories to the delight of friends who they know will spread the lies multiple times. The term urban legend has been around a long time. I understand it to mean a fictional account that has been circulated enough so that many people believe it to be true.

It worries people that soon we won’t know the difference between fact and fiction. Information will exist but its validity will be suspect. Whether it is evidence about global warming or about the color of the skin of a murderer, most of us will just shake our heads and wonder if the latest story has any truth to it. Information will (already has) become entertainment and persuasion.

We have been dealing with fact and fancy for a long time. In physics, we learn that the very fact of observing a phenomenon can bend its result. Does a tree that falls in the woods make a sound if we are not there to hear it? These ideas titillate the mind. Complicated phenomena (like poverty, economic growth) must be observed and interpreted, and there is room for two different observers to come away with two very different observations and conclusions.

Thus it is reasonable to think of truth as being subjective. And therefore it is possible that you might think one person is lying despite his or her very ardent attempts to be truthful. But when it comes to most things, this element of subjectivity is pretty minor. Many things are very clear. What goes up usually comes down. One final JD has predictable effects. A person high on crack may commit horrible crimes. Too much pollution makes for illness and discomfort. It it other more complicated phenomena that cause the consternation about truth or fiction.

I want to split a hair about these complicated issues. Yes, there is more than one interpretation. There is more than one intelligent view of the truth. But that does not give one license to intentionally lie and mislead. I am often critical of economists who intentionally distort issues by leaving out critical facts that they know to be true. They probably do not admit to their families that they tell whoppers, but surely they appreciate the back slaps, promotions, and high-paid speech opportunities that come with wowing their followers.

Sadly, misrepresentations are hitting new levels. Let me list below some of the ones that have been spouted in the last week by very prominent people.

Federal Reserve interest rate increases will lead to the next recession.

Any attempt to reform Obamacare will be tantamount to pushing grandma over the cliff.

Because Boomers are retiring, it is impossible to have strong employment growth in the US.

Consumer finance deregulation will lead to predatory lending and hurt loan customers.

Tax rate reductions that are part of tax reform will worsen poverty.

Deregulation of the financial sector will lead to excessive leveraging and lead to another financial disaster.

Any attempt to regulate abortions will cause irreparable harm to women’s health.

Infrastructure proposals with strong private sector participation/ownership will lead to rampant corruption.

No, I am not going to take each of these and bore you with a complete analysis. But be honest. The people who are now saying these things (and more) are misrepresenting truth. The people who say these things get wealth, power, and popularity by misleading you or providing ideological fodder for your predilections.

Could any of the above statements be true? Of course they could. But they might also never happen because they are each based on excluding things we know to be true. We know that regulations introduced in the last eight years were not all perfect. We know they have had severe unintended effects. We know that today we have major economic and social policy challenges. 

Policies and regulations can easily be represented by a meter or a dial. In some years the needle moves to the left. In other years it moves back to the right. Arguing about these shifts and changes is normal. Screaming bloody murder when the next team gets power is normal too. But making up stories is not and should not be tolerated. 

Let’s decide a position for the needle in the coming years based on honest and open discussion of the fullest possible set of facts. It might not amount to absolute truth but it will get us a lot further than a bunch of sad distortions. 

Show Me the Money

It is January 10, and you are finally getting over the unintended effects of your New Year’s Eve celebration. You also read my last two blog posts and are ready to drop your subscription.

So I thought I would begin 2017 by really spouting off. Hopefully, this spout will antagonize many of you – at least those of you who cling to the old politics.

I title this one “Show Me the Money” because that’s what people in Missouri say. 

When you say this phrase, it means you want some evidence that something is valuable and that it is worth paying for. Robbers sometimes say the same thing but I am not dealing with those robbers today.

"Show Me the Money" is what I hope we collectively say to our politicians this year. Let’s face it: the Blue team is out of office now and they are not happy that the Red team is going to try to undo everything now Blue or Blue-er. We can be sure that even though the Republicans have majorities in Congress, they will be tested over and over. Supreme Court justices, energy policy, health care, tax policy, you name it – the screaming will be loud and colorful.

That’s where “Show Me the Money” comes in. Wouldn’t it be refreshing if instead of name-calling our fully paid and pensioned representatives of the people decided to have real discussions and debates about policy effectiveness? Maybe they could throw out a theory or two? Maybe they could argue over some real data? Maybe they could look at goals relative to results of their policies?

I am a macroeconomist, and therefore I would like to stick to what I know. I have opinions about lots of policies but one important one concerns income inequality. It turns out that despite me being the best professor ever on the planet, there were other professors teaching silly things like finance and nuclear physics who made more money than me. And similarly, I made more money than most high school teachers and a few plumbers.

So it is pretty clear just looking at my boring life that incomes are not equal. But if we look even farther, most of us who have any heart at all realize that there is a very wide gulf between the rich and the poor in America.

That bothers a lot of people. Many people believe that this gulf should be made smaller. Some want it to vanish altogether but probably most people just want it smaller. So it might seem reasonable that we have a debate about what to do to accomplish that. But try as I might, I don’t see anyone in Washington DC approaching this topic from a rational vantage point. Often the level of the argument does not exceed the intuitive but thoughtless idea that if we just take a dollar from a rich person and give that dollar to a poor person, then the problem would be solved.

In my perfect world, we might make some headway by doing the following. First, define the problem warts and all. Second, think about policies that might effectively improve the situation. Third, identify unintended consequences of the policy and deal with those too.

In the case of income distribution, problem identification is critical. Those who seem to worry the loudest about income distribution have in mind a comparison between the very rich and the very poor. But let's suppose, for example, the numbers tell us that much of the income gap is between the upper 1% and the upper 5%. We might not classify that as a big problem. Instead, maybe the income gap mostly impacts those who make $20k per year versus those who make $30k. Maybe you see that as a big enough problem. But clearly the remedy for that specific challenge is different than the usual perception about the richest and poorest. Maybe when we get done measuring, we find that there is no big distribution problem. Perhaps, instead, the problem is that economic growth lifted most boats but didn’t lift them enough. That’s not a problem of the distribution of income. That is a problem of not enough income for those at the bottom. But we won't know what the problem is until we stop lobbing F-bombs and start looking seriously at some data.

Once we have isolated a real distribution of income problem, then we need to find a matching solution. To do that, we might need to examine other country’s experiences with similar problems. And that is made tricky because, unlike white mice, countries can be very dissimilar. So doing thought experiments on policy among various countries is not as easy as picking out the best singing voice in Europe. For example, I took a quick look at the rankings of country income distributions done by the United Nations and the US Central Intelligence Agency (https://en.wikipedia.org/wiki/List_of_countries_by_income_equality ).  

Here are some of the countries with much more equal income distributions than the USA: Ukraine, Norway, Kyrgyzstan, Afghanistan, Denmark, Iraq, Sudan, India – can I stop now? Clearly the US does not want to follow the economic policies of all these countries.

How can we make permanent improvements in income equality across the citizens of the USA? Since we have never explicitly considered income distribution to be among our country's policy goals, we don’t have a lot of experience answering this question. It would nice if we trusted our elected representatives to do this in the same way that Eli Lilly scientists and executives try to solve Alzheimer’s disease.

Finally, there is the issue of unintended consequences. In our zeal to solve social and economic problems, we often forget that things don’t always work out as planned. I am sure that Lyndon B. Johnson would be quite shocked to learn that his great war on poverty created many more poor people than existed in the 1960s. An earnest examination of poverty programs or any other programs designed to improve income distribution should commence. What has worked? What hasn’t worked. Come on dudes – be honest!

What is the real problem today and in the future? What policies have been used to eradicate or mitigate these problems? How can we learn from the past about approaches that work? What are the risks arising from these policies? How can we parcel out the citizen’s money in ways that we would all be proud of? Under Trump, we don’t know what to expect. Maybe he and his new advisers can forget partisan bickering and approach our problems like real scientists and executives? Or maybe I need another JD? 

Happy New Year: macronotesmba.com and other Blog Facts Updates

New for 2017 --  http://macronotesmba.com/

My followers include people with and without much education or experience with macroeconomics. I have heard from many of you that you like to read parts of my postings but often you get lost in the vocabulary and the details. 

So I decided to adapt a reader I use in courses for blog purposes. It is called MacroNotesMBA and can be found at the above address. 

Once you find the location you will see four main blocks: Home, About, Blog, and Contact. Below all that are the main topics for international macro. Place your cursor over any of those topics and you will see a number of sub-topics. Cool! 

If you find it useful please use it for background to the blog. Feel free to share it. 

MacroNotes was developed for my past MBA courses -- it attempts to be a very practical and useful guide to the main topics of international macroeconomics. 

Other Stuff

Because I have been traveling and partying excessively (code words for an extra JD or two), I didn’t have enough grey matter or energy to begin the year with a power-packed analysis of the President-elect’s policies or potty habits.

But I did decide to share some blog facts with you.

·       I mounted this pony in 2010 and since then, I have more or less posted each week for a total 390 posts. As a result the A and the S on my keyboard are worn off.

·       I am especially pleased that nearly all posts have comments from colleagues and friends. They are often the best part of the blog.

·       I am told you must have a Gmail account to post comments but I have been told more than one thing about that. Sometimes people send me their comments and I post them. Blogspot help is absolutely no help for anything. They seem to ignore all my requests.

·       If you look on the right-hand-side of the blog homepage, you will see two different listings of all the posts – one by date and one by topic (Label). Click on a label and you will see all the posts about that topic. Look for the label Kardashian under K.

·       I have posted 22 times on Economic Growth, for example, and only one time on Bernie Sanders.

·       Blogspot shows me some facts about the readers. Each week I send an email to approximately 500 old friends, neighbors, and creditors. I also post on Facebook, Linked-In, and Twitter.

·       Until about three months ago, readership had grown from about 1,000 page views to about 2,000 per month. But strangely, in the last few months I am getting more like 8,000 page views per month. I don’t know how or why – but for the last three months the numbers have gotten high and stayed there.

·       I am shown information about page views by country. In the last month, the great majority of page views were from the USA (8,000). Behind the USA was Russia (1,100), Germany (50), France (40), followed by China, Ukraine, Canada, South Korea and India. Since the blog began it has had about 130,000 page views.

·       I have thought about getting a sponsor and making money from the blog but I also thought about being a pole dancer in Budapest.