Burden of Debt, Third Post (and last for now...)

 

Yesterday I stopped with a promise to show a more general, or maybe more realistic, version of the simple diagram I was using to illustrate Nick Rowe’s point about the burden we can place on future generations by borrowing today even if we never place a burden on future time periods.  I’ll do that here, but first I want to make quick point: this is not just an exercise.  The points do have relevance to current issues even if the diagrams looked simple.  For example, the last point I made yesterday was that economic growth can make the issue of inter-generational equity a lot muddier, and can make a current plan that imposes an extra tax on future generations look inter-generationally equitable.   This is the exact issue that Dean Baker was raising when he said this:

“However, the change in the projected growth of health care costs also has another much more important implication that went altogether unnoticed. It means that workers in the future will be considerably wealthier than we had previously believed. In other words, if healthcare reform will effectively contain cost growth without jeopardizing quality, then our children and grandchildren will be far wealthier than in a world without health care reform.

The 2010 projections show the average worker's wage will be 47.8 percent higher in 2040 than it is today. This is after adjusting for inflation, so the projections show that workers' purchasing power in 2040 will be 47.8 percent greater than it is now. The new projected annual wage for 2040 is 6.3 percent higher than figure projected for last year.

To understand the importance of this change in wage growth projections, suppose we told our children and grandchildren that the payroll tax would have to be raised by 3.0 percentage points to support Social Security (an extraordinarily large increase). They would have more money in their pockets with the tax increase under the current projections, than with no tax increase and the wage growth projected in the 2009 report.”  

So if we can make our simple diagram more realistic, and provide some more accurate data to fill it, we might be able to see something about our current decisions that matters.  I don’t plan to do all of that here, because it sounds like a career rather than a blog post.  But I’ll take one step in that direction.   Actually, this is an area where I haven’t done a lot of reading, so I’m sure there are better versions somewhere on the web of the graphs I will show here, but I haven’t been able to find them in what I admit was a fairly brief search.  Maybe someone who reads this can point me in the right direction.

An initial word of caution is in order: I grabbed the easiest real world data I could find to do this.  That turned out to be the median household income by age group, which I got from the Census Bureau in the Commerce Department historical data on incomes here.  I looked at table H-10, all races, to grab some numbers to fill a graph that showed the median of income by age of head of household by year, that is, by what I was calling an accounting period in my last post.  That may not be the best data to use for this---I mean, why the median instead of the mean, for example? And since the data I had showed things like “15 to 24, 25 to 34” and so on, I assigned the number for that category to the middle of that range---meaning I said that the number for “15 to 24” was what a 20 year old head of household made.  So that gave me data for ages 20, 30, 40 and so on. Finally, in order to make the data fill the graph I had to do a lot of interpolation to give me a data point for each year of life, which I did in the easiest and probably least justifiable possible way, which was straight lines between the points. Because of this, and knowing that once you put something on the web it can go anywhere and be used for anything, I’ve embedded nasty warnings at the tops of these graphs that they are not to be used for argument in favor of against any specific policy agenda.  A graph like this can be used, but first it has to be filled with trustworthy data that is appropriate to the task.

Here’s the result (below).  This is very like the simple two-age diagram from yesterday’s post, except I have ages from 20 to 70, and years 1967 to 2010.

I think this kind of diagram can be useful---I’m tempted to use the phrase “no matter how you slice it”, because that’s what I want to do.  The first slice direction is already there in the diagram: that’s the slice-by-year or slice-by-accounting-period that is shown as the various color slices in the picture.  The purple slice in the front is the data for distribution of income in 1967.  It has the shape you might expect: young heads of household have modest incomes, but that grows through life until they get to be about 50 when some of them begin to retire.  After that it falls off fairly rapidly, and the lowest lifetime income occurs at (or after) age 70.  In some ways, that might even be optimal: it’s in the middle of life, from 30 to 55, that many people have the heaviest responsibilities for supporting their children, or for helping their parents and their ne’er-do-well rapscallion siblings. 

A second slice direction would be to slice along the “year” axis.  You can see one of those slices by looking along the edge of the picture, at age 20.  But here’s a version that shows several such slices:

Interesting.  People who were seventy in 2010 were doing a lot better than people who were 70 in 1967.  The elderly have done fairly well over the last 40 years.  The rise in their incomes was not impacted much by the dismal economy of the late seventies and early eighties, but it was also not accelerated by the Volcker recovery from the Volcker recession through the mid-eighties.  Whether you think this is a good or a bad thing is a matter of personal vision. On the other hand, the thirty year olds have been buffeted by every recession, early eighties, early nineties, 2000, and the most recent one starting in 2007.  People who were 30 in 2010 were better off than those who were 30 in 1967, but not by much.   And so on.

Now let’s look at the cohort slices, the 45 degree slices I sketched on top of the diagram in colored lines.  Here’s what those look like when you slice in that direction:

This is a picture of the trip through life of particular groups, particular cohorts.  People who were 20 in 1967 are the blue line on the top.  The fact that they are on top, and that the lines nest underneath each other in age order, is evidence that things do get better; that in spite of everything each cohort so far is better off than the cohorts before them.  The blue light line at the bottom is the group that was 60 in 1967.  The teal line above that is the group that was 50 in 1967.  And so on.  The right side edge of the graph is the income---or their rough estimate within my massaged data set---of each of these cohorts at age 63, and each of the lines start in the year 1967, so that the ages of the cohorts depicted in these lines will line up.   One thing this means is that events in time, like the early-eighties recession, occur at different points along the different lines.  That event, for example, is the downward kink in the dark blue line at roughly age 32, and in the yellow line at roughly age 42, and so on.  You can see that the cohorts that were in their thirties or forties when that recession started had a reasonable recovery---but those that were in their fifties or older (the purple line at roughly age 52) basically never recovered from it.   I think that may be true in every recession.

One other thing that’s immediately evident from this picture is that life is not a smooth journey: all that bumpiness, the ups and downs of the lines, shows the turbulence of the times these cohorts lived through.  And this was a very easy time with limited economic turbulence!  This graph covers the time period that economists have been calling the “great moderation”!  I would guess that the life-lines of cohorts that lived through the world wars, or the great depressions, or the dust bowl, were vastly more turbulent than these.

You may have noticed that I haven’t talked about slicing the NICE graph along the vertical axis, that is, along income slices.  That’s partly because I don’t know what to do with that graph.  Economists use contour maps of mountains a lot (ask your local economist about isoutility curves or isoquants or iso anything else: they are all contour plots of mountains of utility or quantity or something.)  But I’m not sure it shows anything new or enables anything we haven’t already seen.  But it’s worth plunking a contour map down here just to be complete.  So here it is:

There is one thing that’s easier to see in this view than in any of the others.  If you were 20 years old in 1971, your cohort went right through a sweet spot in this graph, the highest median household income shown.  If you were 20 in 1988, you seem to be moving through a mountain pass: your cohort seems to be skirting that peak of incomes. 

Recessions hurt.   But they don’t hurt everyone equally.

 

So I’m back to where I started, in my opinions, in a way.  Does debt “burden” future generations?  It depends.  But failing to create sufficient stimulus is burdening our current generations, all of them that are around right now.  We have a lot of idle resources, and record low interest rates---actually negative real rates on Treasury bonds.  We can incur debt now and invest in infrastructure and education, and the end result will help us all get up off the floor of this mountain pass right now, and will lay the foundation of prosperity in the future. 

Krugman wrote a book with this title: End This Depression Now!   It’s a good book.  I recommend it.  We can, and in this case, under these conditions, that means we should.

More on Nick Rowe's Model

 

Nick Rowe’s model seems to be all over the internet once you start to look for it; there are quite a few people who are curious about it but not yet embracing it (possibly because it implies something on the “burden of national debt” question that they find discomfiting), and others who embrace it with exceptional glee (possibly because it provides them with another reason to believe what they had already believed before they ever saw it).  

Having had a day or two to think about what he was saying in the comments to my post, I think his model does capture something that matters, but I also think it may be answering a different question than the standard one about passing the burden of national debt on to “our grandchildren”, or at least a different question than the one I have always thought of when I heard that phrase.  I said that in our conversation in the comments, where I admitted that his original post had confused me a bit because I was stuck in a comparative-accounting-period frame of reference while he was looking at a process of linked cohorts.  Professor Rowe's linguistic criticism is right: I was talking about future times, not future generations.   Fortunately, the answer is still the same: whether we are asking whether current debt can burden future times or future generations, the answer is “it depends”.   But it may depend on different things.

A picture is worth…well, whatever a picture is worth.  But the distinction might be easier to understand in pictures, so I’m going to draw some. 

This first picture more or less depicts his example from the comments, but using my vision of the process, meaning looking at the world as a sequence of accounting periods (years or decades or something), rather than as a sequence of overlapping cohorts each of which happens to occupy some subset of those accounting periods.

And to keep the first picture simple, in each accounting period we will only look at two kinds of people: young and old.  The young are assumed to be working age, vigorous, and productive, and rewarded for that with a high income; the old are living by charity or savings or something, but their income is much smaller.  Here’s a picture of that simple model, with two policy changes that impact the distribution of apples (using Prof. Rowe’s example) between young and old.

In my model, what I would notice about this picture is that at every time period the economy produces exactly 4 apples (no economic growth, either positive or negative).  I would also notice that there are two distribution changes over the course of these 6 time periods: between times 2 and 3 for whatever reason the distribution became more equal between young and old, and between times 4 and 5 it changed back.  You can say that times 1, 2, 5 and 6 were more “fair” because everyone was receiving exactly what they earned, no more and no less, or you can say that times 4 and 5 were more “fair” because the old, whose health no longer allowed them to work, were not as poor as they had been.  In the chart above, maybe the young in time 3 instituted Social Security to maintain a reasonable old-age income for those who had created the world in which they, the young, worked.  In period 5 the young became resentful of the need to reduce their consumption to subsidize the idle old, and eliminated Social Security. 

But Prof. Rowe noticed something else about the chart.  Each generation, or cohort, is a group of people born in a particular time, who travel through their time in this world together and experience the same piece of history, and these cohorts are linked by policy decisions and other events that happen during the various periods in their lives.  Each cohort moves diagonally from the bottom to the top of the chart, young in one time period and old in the next.  So if we add up the apples provided over their lifetimes to the various cohorts in this chart, we see this: 

 

And now we can see that the changes represented by the blue lines, while they may provide each time period with a distribution of goods that seemed fair to them within that time period, are unfair between cohorts.  The second cohort got a windfall, and received 5 apples over their lifetimes instead of the standard 4, while the fourth experienced a clear burden, because they received only 3 apples over their lifetimes.   So if I understand Prof. Rowe’s model correctly, I think that at a simple level the difference in viewpoint between what I was saying in my post and what Prof. Rowe was saying is that I was looking at vertical (time period) slices of this picture, while he was looking at diagonal (cohort) slices.

It is possible that the differences between the time periods are created by debt: in periods 3 and 4, perhaps the young lend an apple to the old, and expect repayment when they themselves are old.  Actually, if the changes were created by debt, then period 5 above is not quite right: the old in period 5 would have a bond they could cash, so they would demand an extra apple---which would have to come from somewhere.  Since we’ve assumed there is no growth, and no stealing apples across time-segments, then that extra apple has to be extracted from the economy through some kind of tax, or through inflation, or something.  So it might be more reasonable to say the young and the old would each pay a ½ apple tax to pay the debt to the old in that case, so the distribution would really be 2.5 apples for the young, and 1.5 apples for the old.  But the result would be similar: one or more cohorts would get a benefit over their lifetimes from the initial application of the redistribution policy, and one or more would accept a loss to pay for that when the policy was reversed.

But notice three things:

First, the cohort that lost apples over their lifetime did not lose because of the first policy change but because of the second policy change.  There’s nothing strange about this: it is not creating debt that hurts, it’s paying debt back, and---if these changes were the result of borrowing and repaying apples---the second change is paying the debt back.   If we never pay the debt back (ie, if we are able to continually roll over the debt forever), then there will never be a cohort that loses, in this model. 

Second, the blue lines in this picture represent distributional change, not specifically debt or confiscation.  Debt is certainly one way to create an effect similar to this.   But this effect doesn’t have to result from an initial debt, or from paying off a debt at the end.  Any policy change that alters the distribution of income (or apples) between young and old will create a cost or a benefit for some cohort---if the change redistributes income toward older people, then those who were young before the change and become old after had the best of both policies: greater income from the initial policy when they were young, and greater income from the new policy when they are older.  And it works the other way too, of course: a policy change that redistributes income from the old to the young is costly for those who were young before the change, and older after the change.  What could cause a change like that?  The answer is: any of a billion things that can occur in history can do it.  Certainly, as Prof. Rowe has pointed out, debt or confiscation for the sake of redistributing income in a way that seems more “fair” to those who are around and voting in each time period can do it.   Other things that might impact the distribution of income between young and old---or between any two groups, for that matter---include changes in regulations, changes in tastes or technology, changes in education (ie, the young may be more or less educated, depending on whether we invest in maintaining and improving schools or not).  If we’re concerned with perfect intergenerational equity, history itself is our enemy: there is nothing fair about being a part of the generation that emerged into the economy just before the tsunami in Japan or the depression in Spain.   Or here, for that matter.   So even if we borrow, and if that does somehow create a kind of intergenerational inequity for some future cohort, that could still be the fairest thing for us to do if we borrow to reduce the intergenerational inequity created by a current depression. 

Third, things become a lot muddier if we include economic growth.   In the chart below, I used a 30% real growth over the roughly 30 years between the time a cohort is young and the time it is old, and for the two time periods between the blue lines I assumed that some change in conditions, perhaps a change in government policy that taxed the young and subsidized the old, transferred 20% from the young to the old.   

The end result, along the top, is that the total lifetime income of the sequence of cohorts shows a continuous rise.  The fourth cohort would have had more if the policy changes had never taken place, but is it reasonable to assert that life, or policy, has been unfair to them when they are able to consume more than any generation that preceded them?  Why, in general, is the result of generations of economic growth fair between cohorts?  If no redistribution had ever taken place cohort 2 (who initiated the change) would have consumed only 5.59  apples instead of 6.6, and cohort 4 would have consumed 9.45 apples over its lifetime, instead of 8.13.  But is it reasonable to say, in this case, that generation 2, consuming 6.6 apples, has placed an unfair burden on cohort 4, which consumes much more?  Why is that unfair? 

 

It becomes muddier still if young cohort 2 has worked and borrowed to create the economic growth that provided an improved life for young cohort 3 and young cohort 4. 

So inter-cohort equity is a difficult topic.  Intertemporal equity is much easier: for that, at least as far as current debt might impact it, read my post from last week.  But I think the topic Prof. Rowe raised, the topic of redistribution not just between young and old within a time slice, but between cohorts that cross time slices, can help us make choices.  And I think that a more general version of the simple diagram we’ve been using here will help us look at it. 

But I’ll put off a description of that for my next post, because this post is long enough.

 
 

Does the federal debt “burden” our grandchildren?

 

Every politician claims that we must find a solution to the federal deficit, we must find a way to balance the federal budget, because failing to do that simply passes our debts on to our children and their children, that we are stealing from the future when we increase the federal debt. 

Is that really true?

As you may have guessed from my last post, my answer to that question is “it depends”.  (If you didn’t read my last post and you respond to this by saying “that’s typical, economists can never give a straight answer”, go back and read it now and stop whining.)

When I thought about writing on this topic I started by looking on the web for other comments, figuring I would find a few rants about it on political web sites that would provide some quotes I could use.  But I found a sizable discussion in the econoblogosphere, much of which seemed to me to miss the point---or at least to miss the point as I see it.  I’m hesitant to make too strong a denunciation of any participant in that discussion, because a lot of very impressive economists contributed to it, starting with Paul Krugman, here and here.  An economist named Nick Rowe in Canada was next with a response to Krugman, in which he claimed that Krugman “did not get the memo” telling us all to switch to the view that debt has to burden future generations.  I like Nick Rowe’s blog, I respect it and him enormously and read him often, but I didn’t get that memo either.  And his blog post surprised me.  Even when he says something I don’t completely agree with he generally says it with exceptional clarity and eloquence, but this post seemed confused and drifting to me.  But Simon Wren-Lewis at the Mainly Macro blog was eventually convinced by Nick Rowe’s argument.  And Steve Roth at Angry Bear discussed the Rowe argument without being completely convinced, but without overtly opposing it either, as far as I can tell.   (None of these blog posts are impenetrable or inaccessible to non-economists; any reasonably intelligent person can follow them.)

There was a lot of other discussion in the econoblogosphere as well, and substance in the comments in all of those posts, so if you are interested in this issue there’s plenty of good discussion.  If you are not interested in this issue, I have to assume that you won’t complain about the debt burden in the coming election or after.

Let me lay this out as I understand it, and if you’re not convince by my argument then you can read all those other blog posts to find one that suits you better.  I’m going to do things that look like I’m developing an economic model, and I guess I am.  But it’s such a simple model that I don’t really think it deserves the title.  Let’s call it an organized fiction with a purpose, or a parable,  or something.  But this is a complex topic, so I have to start very simple and then gradually relax simplifying assumptions to get to greater realism.  This step-by-step takes some space so this will be an even longer post than usual.  But if you’re distressed by our current debt it’s worth reading.  It may let you sleep better.  (Or not…it depends.) 

First lets look at two points in time (present and future), as Nick Rowe and many others did, and look at what happens if we borrow money in the present time and repay it completely in the future time by taxing the general population then.  Let’s start with a crazy assumption, just to build from the simple to the slightly less simple: let’s assume that there is no economic growth at all, positive or negative, so that the sheer quantity of stuff that is available for consumption or investment in the future time is the same as the sheer quantity of stuff available in the present.  Let’s also assume that there is no population growth.  See how easy economic modeling is?  Let’s also assume that there is really no good way to preserve stuff for that future time (it’s too far away).  In this model, the people alive now will consume whatever we produce now that is consumable, and the people who are alive in that distant future will consume whatever is produced then.  There is no way we can sneak into the future and steal the carrots from their garden, or buy the cars that are rolling off their assembly lines.   So what we do today, even if it’s running up a lot of debt, doesn’t (by our assumption of a constant quantity of production) have any effect on the sheer quantity of stuff they have to consume.  We have not harmed them materially as a generation by creating debt.   (Nick Rowe claimed in his post that he wasn’t using a time machine, but with the current assumptions, the absence of any growth or deterioration of productive capacity, how else can we take anything material from the future?  I know, this is insanely simplistic, but bear with me for a while.  It gets more realistic later.)

Even in this model, where we can’t change the amount that is available for consumption in the future, that doesn’t mean that current debt has no impact in the future.  As Nick Rowe pointed out, if we borrow money now from some sub-group of the present generation for distribution to some other sub-group (borrow from A to finance consumption by B), then we have created a debt to A in the present that we must (by our assumption) repay in the future.  In the future in our model we tax the general population to pay A back.  So A can consume more in the future, but all the rest of the population must consume a bit less to make that work. 

Now, if A is a different country, China for example, then we might actually harm the people who live in the borrowing country by creating an external debt: in that kind of future, people in China would consume more, and people here in the United States would have to consume less to pay for that.  We would work just as hard, but some of our product would leave the country as exports purchased with our debt repayment.  But as Krugman pointed out in his posts, for the most part the debt we owe externally is still a small part of our total debt; for the most part we still do owe most of the federal debt (and total debt) to people or institutions inside this country.   Krugman has some graphs looking at total debt (not just Treasury debt) as a percent of GDP, and net foreign debt.  But just looking at federal debt, it’s still true that we owe most of it to ourselves, in spite of all the alarm you hear about the Treasury’s debt to China.  Here’s a graph that I generated in Excel from the “Treasury Direct” bulletin using data for December 2011 showing who owns the federal debt:

There are a couple of things here that I want to emphasize.  See the dark blue slice of pie at the top, at the far north north-east?  That is the amount of Treasury debt that is owned by the Federal Reserve system.    This is what the Fed has bought on the open market to drive interest rates down.  It’s a significant chunk of the Treasury’s total debt, and it’s not a chunk we really owe to anyone identifiable within the country or outside the country: the Federal Reserve owns it.   That means, in a way, that either that we all own it or no one owns it, and if we as a country chose to do this we could simply vaporize that debt without harming anyone.  (I’m not suggesting that---the Fed can use those Treasury bonds when it thinks it needs to; they are a tool the Fed can use later.  But the point is that as they are now, they don’t provide any private person or institution the ability to demand future consumption.) The next chunk, the red chunk to the east, is the Treasury debt owned by the United States government in one trust fund or another.  The government quite literally owes that to itself, or more correctly one part of the government, the Treasury, owes it to other parts of the government.  That cluster of small slices to the south is a bunch of things like private or state pension plans, insurance companies, state and local governments, mutual funds, and so on. 

Still, there is that big, kind of dusty purple slice to the north-west labeled “foreign and international”.  China is part of that.   In the model I have so far, that means that in the future time period people or firms from China could demand some of the stuff we make here, and they could consume or invest the future product of our work. 

But of course my model is pretty simplistic, isn’t it?  No growth?  Really?  Ok, so let’s accept the possibility of growth at a fixed rate, but leave everything else as it was.  If we assume that our current borrowing has no impact on growth, then the outcome of our simple model still holds: nothing we do with our finances, by (very simplistic and unrealistic) assumption, can have any impact on the sheer quantity of stuff we produce in the future, so the only thing it impacts is the distribution of that stuff.  So the only way current borrowing can change the outcome is by having an impact the rate of growth, and on our ability to produce in the future. To make a model that enables current debt to burden or benefit future generations, we have to dispense with not just a no-growth assumption, but also with a fixed growth assumption.  We have to assume that current debt somehow impacts economic growth.

There are two competing visions on this, and you’ll hear both of them repeatedly over the next couple of months. 

First vision: if we borrow money to invest in things, like infrastructure improvements, that can create higher economic growth, then we actually make the people in the future as a whole better off!  Note that this does not require us to do any tiresome calculations about the rate of growth enabled by our investments, or the rate of interest we pay on the debt.  Those things, still in this simplistic model, will change the distribution of claims on the production in the future, but they won’t change the sheer quantity: if we are growing faster, we will have more stuff in the future, and all of it will be consumed then.  We can’t consume future product now by the act of borrowing, no matter what the interest rate is.

So why do we care about the interest rate we pay and the growth it enables?  Well, if we pay too high an interest rate then the people who lend us money now will have an excessive claim to product in the future, so that while our borrowing may change not how much we produce, it may change what we produce: we may produce more grand yachts and less corn, because that is what will be in demand then. 

But we can go a bit farther if we relax another of our initial assumptions: the assumption that we repay the debt in the future time by taxing the public.  Let’s assume now that we roll over the initial debt in the future, but not the interest on that debt; that is, if we borrow $100 in the present time, then we borrow $100 (and only $100) in the future time to pay that principal back.  Under this assumption if we borrow now, and with the money we create a rate of growth greater than the interest rate we pay, then in the future everyone is better off.  Everyone!    Our grandchildren can pay off the interest on the loan, roll over the principal, and still have something left over to distribute among themselves.  And as a bonus, the $100 our grandchildren borrow to roll over the principal is a smaller fraction of their (larger) GDP than it is of ours---so that debt turns into a shrinking fraction of GDP as well.

Second vision: we borrow money now to finance consumption.   But where does that “extra” consumption come from?  Still in our simple model with the assumptions that remain, either the people who lend the money consume less in the present to provide consumption goods to the people we help to support with the money, or it comes out of some other kind of production.  Typically, the argument is that when the government borrows now, it “crowds out” investment, which creates economic growth.  So when we borrow now, and crowd out investment, then we are actually reducing the quantity of physical stuff that could otherwise have been created in the future: in this case, we truly would be consuming today by reducing consumption in the future, not by digging up future carrot patches, but by reducing the present investments needed to create those carrot patches in the first place. 

But this argument depends a great deal on one of the last simplifying assumptions we started with.  It depends on the assumption that the total quantity of stuff we can produce now is fixed.  In other words, it depends on the assumption that we can’t produce more than we are producing.  This amounts to an assumption that we are at full employment of everything, of labor and of factories and of land and of everything.  Does that sound like the situation we are in now?

We finally have eliminated enough of our starting assumptions that the model looks a lot more realistic.  In the future we will be able to produce more than we can now (GDP grows over time); we will roll over some part of our debts in the future; what we borrow now can, under some conditions, reduce what future generations can produce, and therefore how much they can consume, but under others conditions it can expand how much they can produce.  So I’m back to my start: can debt we create now burden our grandchildren?  It depends.  If we are at less than full employment, so that we can borrow money and use it to increase our current production, debt is ok, we will be materially better off in the present and will not materially burden the future.  If we borrow now and invest in projects that increase economic growth by more than the interest we pay, then debt is ok, and will not burden the future.  Both of those conditions hold at the moment: interest rates paid by the treasury are currently less than zero!  So if we invest in infrastructure that has any positive impact on economic growth at all, it’s a good investment.  And we are now well under full employment of our resources, so we can borrow and hire the unemployed (both unemployed people and unemployed industrial capacity) without crowding out other uses of those same resources.  (I’ll write post about crowding out in the financial sense---but that’s another topic for another day.

So as a general answer to the question “can current debt burden future generations”,  my answer is “it depends”.  But in the current situation, all the things it depends on are resolved, and the answer is no.   We have a lot of resource that are unemployed, and there are plenty of infrastructure tasks that would enhance our rate of economic growth in the future.  We can borrow to put people to work producing consumption goods, and we will be materially better off in the present with no harm to the future.  Or we can borrow to invest in infrastructure, be better off in the present and benefit the future.  Let’s borrow now: the cost is low, there’s a lot to do, and we can benefit the unemployed in the present, and benefit (benefit, not burden!) everyone in the future.

After we truly recover, so that employment and borrowing costs are both higher, those things will not be nearly as true.  So we should grab this chance while we have it.

Beware the One-Handed Economist

I started out thinking that I wanted to write about whether the federal debt “burdens” future generations, as almost every politician from every party says it will.   But first I have to take a detour. 

The title of this blog is taken from a pained lament from President Harry Truman, or at least that’s the story.  His economists, when asked about the impact of some policy, would tell him “well, on the one hand it will have this effect, but on the other it will have this (opposite) effect.  So it all depends.” Finally he exploded, wanting a straight answer: “I want a one-handed economist!”

But if you ever find a one-handed economist in that sense, an economist that can only see one possible answer to any real question, run hard the other direction, and count the spoons.  Because economics isn’t that easy.  There’s almost never an answer that doesn’t come with lots of conditions.  One of the first phrases you are introduced to in econ 101 is “ceteris paribus”, Latin for “with all other things the same”.  It’s used as the universal condition on simplified models.  Here’s a simple model, or a simple assertion that is elevated in econ-speak into a law: the quantity demanded of a good will decrease as the price rises, ceteris paribus.  What other things could change in a model as simple as that?  Well, the quality could change---the demand for cars decreases as the price rises, but if the low priced car is an old Edsel, and the higher priced car is a new Mercedes, that could change the result.  The environment could change: the lower priced car could be in a very dangerous part of town, or could be stolen, or could be offered by a less trustworthy dealer, or it could be an obvious lemon.  A thousand things could change. But ceteris paribus, if nothing changes but price, then this simple model says that the dealer will sell more of them at a lower price than at a higher price.  Is this simple model true?  Well, it depends…most of the time it is, but there are situations where even this simple model, this economic "law", is not true.

This dithering from economists seems to frustrate people, who claim that other disciplines are able to come to firm principles, so economics should too.  How can it be called a science if it is so fuzzy in its results?  So let me defend indecision a little bit, before we get on to the main topic.  Let’s look at an example from physics, about as no-nonsense and decisive a discipline as there  is:  how fast does an object fall toward the earth?  “Ha”, you are exclaiming, “that’s a trick question, because the speed of an object changes as it falls”.  Well, yes, falling objects accelerate; my high school physics teacher told us that an object accelerates at 32 feet per second per second.  So right up front all of us physics students had to ask a few questions before we could answer that question if it popped up on a quiz: how long has it been falling?  Did it start at zero speed toward the earth?  Of course my teacher was lying, anyway.  That’s really just an approximation.  Wikipedia refines it by one more decimal place: their entry says that the acceleration of a falling object is 32.2 feet per second per second.  But with that aside, the assertion is that if an object starting at rest is free to fall, it will accelerate from zero speed at that rate. But…what if the object is a bird, or a hot air balloon?  Oh…you thought I meant an object that did not counter gravity with its own means of propulsion in the opposite direction.  Or: you meant that objects fall at that rate in a vacuum.  But I didn’t say either of those things in my original question; if you fell into line in this pop-quiz you assumed it. 

Ok, let’s accept that the object is adrift in a near-vacuum.  What if the object is a rock in near vacuum somewhere in the vicinity of Jupiter?   Ah, another assumption: the object accelerates at 32.2 ft/s² if it is near the earth’s surface.  Or what if the object is Jupiter itself?  Are the rock and the planet accelerating toward the earth?  Well, they’re trying, but other things keep getting in the way.  The rock is more powerfully accelerating toward Jupiter than it is toward Earth, so on the whole it may be accelerating away from earth.  And Jupiter is more powerfully accelerating toward the sun than toward earth. 

Ok, so let’s assume that it’s an object in a vacuum near the surface of the earth. Another quick pop-quiz: does it accelerate at the same rate at the equator as it does at the North pole?  From another Wikipedia entry: “At different points on Earth, objects fall with an acceleration between 9.78 and 9.82 m/s² depending on latitude, with a conventional standard value of exactly 9.80665 m/s² (approx. 32.174 ft/s²).”

Drat.   32.174 ft/s² ???  Approximately??? And it changes across the surface of the earth?  Is nothing easy anywhere??

The point is that there is no simple answer even to that simple question: if you are told that objects accelerate toward the earth at a fixed rate, and then you blame physics when a hot air balloon released in the atmosphere of Gliese 581 G fails to behave in exactly that fashion, you have misunderstood physics.  Because the right answer to how fast an object will accelerate toward the earth is “it depends”.   On the one hand, the gravitational attraction between the object and the earth will cause it to accelerate toward the earth.  On the other, things like wind resistance, buoyancy, distance from the earth, and even latitude on the earth’s surface, and a thousand other things, will change the rate of acceleration. 

Even physicists have two hands when they are providing simplified answers to people who need answers in a hurry.

Now on to the federal debt question in the next post.

The first and third threat...

 

On Saturday I cited Robert Samuelson’s op-ed piece in the Washington Post last week,  and I quoted from that piece as follows:

“The young (and I draw the line at 40 and under) face two threats to their living standards. The first is the adverse effect of the Great Recession on jobs and wages. Even if this fades with time, there’s the second threat: the costs of an aging America. It’s not just Social Security, Medicare and Medicaid — huge transfers from the young to the old — but also deferred maintenance on roads, bridges, water systems and power grids.”

I pointed out that this is really three threats, not two (the long run impact of our current recession, social support programs for the elderly, and crumbling infrastructure), and I discussed the middle of them and left the first and last for today.

It’s not clear that Samuelson had the long run impact of today’s unemployment in mind when he raised the first of his three threats.  Maybe he meant that the discouraging job market is only a threat while unemployment is high.  In fact, in today’s column praising Romney’s choice of Paul Ryan as a running mate, he continues his obsession with the threat to the future posed by old people, and does not mention any longer term threat from current recession.  He also does not mention the threat posed by crumbling infrastructure.  So his first and third threats are not his top phobia: it’s the aging population that really worries him.

But there is a long run impact to extended high unemployment.  If we act quickly, we can limit the damage, but the longer we delay the harder that becomes.  Simply speaking, long run unemployment gradually becomes permanent; skills erode, self-confidence erodes, personal expectations erode, plans erode, a sense of hope and purpose erodes.    The graphs in this blog post by Brad DeLong make it fairly clear.  Over the last few years, civilian participation in the labor force has declined, year by year.  So what started as a general decline in demand rather than a structural issue can slowly, over time, become structural, with the long-term unemployed gradually becoming both unemployable and withdrawn.   The unemployment number may decline, but it declines because eventually, after long struggle, people drop out of the labor force.  That means that the potential GDP declines too.

Samuelson’s third threat also has some sting in it, as I’ve said several times in this blog, and as many many others have said too.  This isn’t complex, and it isn’t obscure.  If we fail to maintain our national investment in infrastructure, in highways and bridges, railroads, dams, power grids, water for life and for irrigation, sewage treatment plants, and all of it, then we are failing to maintain our ability to produce.  If we fail to increase our infrastructure, then we are failing to increase our ability to produce.  Much of that investment is done by private industry, but much is not.  

But---again, as I’ve said here before, and as many others are screaming in their blogs too---we can go a long way toward defending against both of these threats at the same time, by spending federal dollars on investment in maintained and improved infrastructure, and on increased research; in other words, if we hire people (thus reducing unemployment in the short run) to perform tasks that can increase our economic growth in the future.   We could end this recession in fairly short order, within a year or two, if we had the political will to do it, and we could lay the foundation of future prosperity at the same time.  Our failure to do these things may have a very high cost, and for a very long time.

Don’t Panic! At least not about that…

In last week’s column by Robert Samuelson set me off a little.  Not because he’s entirely wrong; he does identify some issues we need to work on.   But he seems excessively exercised about issues that really aren’t that threatening, and not nearly exercised enough about those that are.  He’s ridiculously obsessed with Social Security, for example, and continues to confuse Social Security with Medicare.  For the record: Social Security may need some tweaks or supplements, but it’s not our primary economic problem in either the short run or the long run.  Medicare and Medicaid, which he also cites, is a bigger long run problem---but not because they are government programs, or because we pay for them through taxes.   No matter how we pay, with public funds or private, the problem is that the fraction of our national income we use to pay for health care is rising exponentially, and unless we change that fact those costs will eventually overcome our ability to pay them.   

But Samuelson’s panic is not that health care costs are rising, it’s that too high a fraction of the population will be old in the near future, and that it’s not fair to the younger generation to have to support them.  Here are his words:

“The young (and I draw the line at 40 and under) face two threats to their living standards. The first is the adverse effect of the Great Recession on jobs and wages. Even if this fades with time, there’s the second threat: the costs of an aging America. It’s not just Social Security, Medicare and Medicaid — huge transfers from the young to the old — but also deferred maintenance on roads, bridges, water systems and power grids.”  

So right up front we see that Samuelson can’t count: that’s really three threats (the long run impact of our current recession, social support programs for the elderly, and crumbling infrastructure).  On the last and first of these, yes, and I’ll expand a bit below, or tomorrow.  But let’s deal with the middle “threat” first, with Samuelson’s special obsession with the unbearable burden that the elderly will place on the young in the future.   

Frankly, I see his point; it’s true that the ratio of the population that is working age will shrink somewhat in the next few decades.  My difference with him is that I think it’s a waste of time to get all sweaty with fear or depressed about that.  After all, what, exactly, are we supposed to do about it?  Is Samuelson’s column a plea for mass extermination of anyone over forty?  Or does he think we should throw the elderly out of their houses to live in post-apocalyptic tent villages by the sides of the country’s deteriorating freeways, foraging for grubs and weeds to eat?  What is his suggestion here?  Yes, the population is aging, and yes, that means that we who are still working---and even though I’m a baby boomer I expect to be healthy and working for quite some time yet---will have to support them with at least a minimum level of medical care and a minimum level of dignity in their lives. I don’t regard that as a calamity, or as an unendurable burden either.  I regard it as a fairly ordinary and unexciting fact.  We can manage it.  These are the people who worked their whole lives to leave us with the America we have now; people who fought wars for us, built businesses for us, built dams and highways and sewage plants for us.  I have no complaint about paying a little more in taxes to keep them out of poverty at the end of their lives.  And the bargain, for me and for all those youthful under-forty types, is that when at last we are declining into old age, those who are healthy enough to work then will provide us with what we need to stay out of poverty.  There’s nothing new about this.  It’s been the custom of families and tribes since long before history began.  The only difference now is that we do it as a nation. 

And I’d like to remind Samuelson, and all the others who are currently obsessing over this, that the issue of how the nation’s product is distributed is not brand new.  We all live in our own bit of history. The bit I lived through as a young working adult started in the seventies, just as the supply-side anti-tax, anti-regulation view became economic orthodoxy and government policy.   As a result those at the very top of the income scale have absorbed much of the economic expansion over the last thirty years.  Follow the link in the last sentence for more on this, but I’ll reproduce one graph from that link here.  It shows the change in income since the nineteen-fifties for the 20th percentile, the 50th percentile, and the 95^th percentile.  It shows that through the fifties and the sixties, and well into the seventies, incomes at all levels grew with the economy.  Since then incomes at the top have grown much faster than the economy, and incomes below the top have lagged far behind.  And look at what has happened to the top 5% in this century! They too have finally started to stagnate---but the top 1% are still thriving. 

Samuelson fears that the workers of the coming generation will experience less robust income expansion than they might in an ideal world; that their incomes may stagnate a bit because they will have to give up part of the value they create to support the elderly.  And so they may, to some extent.  They may have to share what they produce just as those below the top in my generation have “shared”, and experienced slower income growth than we might have, because we have had to support the wealthy.   But we have not stood still.  Even with the stagnation implied in the graph above most of us are still better off than we were in the fifties, or the sixties, or the seventies.  The incomes of the 50^th percentile rose more slowly than it had in prior years, but it did rise, and so will the average income in the next generation.

But there is this to ponder: we helped support the wealthy for the last few decades, and we will have to help support the elderly in the next few decades.  But is it reasonable to ask us to help support both?   And if not, which would you rather support?

“The man at the bottom who, left to himself, would starve in his hopeless ineptitude, contributes nothing to those above him, but receives the bonus of all their brains.”

 

A couple of posts back I used the Ayn Rand quote from the title.  It's from Atlas Shrugged, a work of fiction, but it's not a bad description of the social vision we sometimes hear, where all affluence seeps down from the top, where the people at the economic pinnacle deserve their place, and provide more social good than they receive in compensation, and the people at the bottom of the economic ladder  deserve their lowly place, and in fact that they live on unearned charity from those above them.  

Here is a link to a TED talk by an educator named Sugata Mitra about his experiments with providing to children in very poor areas of India an environment in which there was something to learn.  I mean exactly what that sentence said: he provides an environment, nothing else.  No teacher, no guidance.  He provides a computer with some content, and leaves for months at a time.  In some cases the content on the computer was complex, and in a language the children did not speak. 

These are the children of the people at the bottom, who Rand thinks are so intellectually inept that they cannot survive on their own. 

Fascinating.

Romney, Klein, and the Tax Policy Center

 

            This week the skin came off the Romney tax plan, and by extension the entire Republican economic agenda, and the grizzly gore under it was sickening.  It would shift the burden of taxes away from the rich and toward the middle class, and it would devastate the budget for many years to come.  I’m being blunt, of course, where journalists like Ezra Klein have been polite.   Mr. Klein and I are both looking at a document produced by the Tax Policy Center, which you can download here, that looked closely at the Romney tax plans and concluded that the only possible way they can work is to raise taxes on the middle classes by a substantial amount, and even that analysis bends over backward to give the plan the benefit of every theoretical doubt. 

Oh, I know, the Romney campaign will find ways to present it all in a better light.  They are already claiming that their plan will create a massive bloom of growth that will improve revenues, and enable it all to work.   We have not the slightest reason in theory or data to believe them.  And they will be astonished to hear that Klein’s piece can be called polite.   But it was: Kein could have been much, much more scathing.   He should have been, and so should the whole of the journalistic world.   But journalists are careful to maintain their image as impartial, non-partisan reporters, and in the cold grip of that constraint they end by failing to report anything like a true image of the world as it is, or even as they see it, but instead report the image of the world that will make the fewest people angry and create the fewest complaints from right or left.  There’s no doubt that in recent years the right has spent more hours and more decibels than the left has in complaining about partisan bias in the “lame-stream media”.  Telling the unvarnished and compelling truth about the Romney plan as it has been stated would enrage the right even further, so journalists avoid doing it.

The problem with the Romney plan is the same as the problem with a lot of so-called plans: the Romney team has put forward a list of policies that fulfill their personal desires, and promised to pay for them with wishful thinking.  Romney promised to cut taxes across the board by 20%, and to make up the losses from that by a combination of “base broadening” and a magical blossoming of the economy.  "Base broadening" is a way of saying that he will try to raise revenues by eliminating some tax exemptions and tax deductions.  But he has also said he will not raise taxes on capital gains or dividends, or on inheritance, and will reduce the corporate income tax as well.  So what exemptions and deductions are left on the table?  He won’t say---and that reluctance is a massive red flag wherever you find it.    Because the exemptions and deductions that remain mostly benefit the middle class.  See here for the Forbes list of the 10 biggest individual tax expenditures and here for an excellent discussion of them.  They include deductions for employer paid health insurance and contribution to employer paid pensions, mortgage interest deductions, deductions, the earned income tax credit, deductions for state and local taxes, for defined contribution (401K) plans, and so on. 

The basics are clear.  The plan Romney has outlined will benefit only the wealthy if it benefits anyone at all.  And it may not benefit anyone, because it will both dramatically increase the deficit, and very probably, through quick and large austerity measures, will induce a second dip into a recession in which even the wealthy will suffer losses. 

I’m not in love with all of Obama’s economic policies over the last few years either.  They’ve been tentative and distracted.  But the issue here is not so much that Romney’s plan is wildly unrealistic, and that the arithmetic doesn’t work.  I think the issue is that Romney knows that his plan wildly unrealistic, he knows the arithmetic doesn’t work, and he thinks that he’ll be able to develop and adopt a more realistic plan after he wins office.  I think the real, underlying game that he and his advisors are still playing, the final plan, is the “etch-a-sketch” plan where he can play one character during the primaries, erase that and “pivot” to a new character during the general election, and then erase that character and everything it said to “pivot” to still a different character when he wins. 

But he’s having trouble erasing that etch-a-sketch character from the primaries: the Republican base won’t let him do it.  And I think he’ll face the same problem if he is elected in the fall.  The Norquistians are already salivating at the prospect of an all-Republican government, with Republicans in control of the House, the Senate and the White House.  Their glee is not just from some partisan pride of conquest, but because they think they can finally adopt a pure Ayn Rand budget plan, a plan even more wildly unrealistic than the one Romney is promoting as a campaign theme on his etch-a-sketch: they want to pass the Ryan plan, or something like it.  It’s not Romney’s plan specifically, but Romney has repeatedly praised it over the course of this long campaign.  If Romney tries to avoid implementing it he will face full rebellion in the Republican held House (and if Romney wins both the House and the Senate will surely also go to the Republican party).  That body will pass the Ryan plan, as it has before, and sometime in January or February the newly Republican Senate will pass it too, by reconciliation (meaning there can be no filibusters from those pesky Democrats).

Does Romney really think that he can get away with vetoing the plan he has repeatedly praised during the campaign?  How will he erase his etch-a-sketch and “pivot” to a more realistic plan when Congress presents him with the Ryan budget a month after he takes office?