Thursday, March 21, 2019

Raising the Debt Crisis Alarm

I have repeatedly discussed the debt-crisis problem, both on this blog and elsewhere:
  • My last two books discuss the origin of the structural debt crisis in modern welfare states; and
  • Last year I wrote a two-part paper for the Center for Freedom and Prosperity on the potential for a Greek-style crisis here in the United States.
I am far from alone raising the alarm about a U.S. debt crisis, but our voices do not seem to be able to penetrate the sound-proof walls of Congress.

At some point, hopefully, they will listen. Fortunately, Martin Feldstein of Harvard University has decided to lend a helping hand. His March 21 op-ed in the Wall Street Journal (p. A19, print edition or online with subscription) is as concise, pointed and blunt as always. His style, which I know irritates a lot of people, leaves no room for misunderstanding, and that is exactly what the debate over the debt needs.

There is, however, one aspect to the debt crisis problem that Feldstein does not mention. Let me get back to it in a little bit - first, a rundown of his main points.

After a quick review of the latest deficit numbers from the Congressional Budget Office (CBO), Feldstein reminds us that according to current projections, the federal debt will reach 100 percent of GDP by 2028. This is, we should note, the part of the debt that is held by the public; since debt is debt no matter who owns it, I prefer the broader definition that is already at 100 percent. Regardless, Feldstein's point about the trend in debt growth is what matters - as does his warning that these numbers are actually modest:
the CBO understates the problem. It has to base its projections on current law - in this case, the levels of spending and the future tax rules and rates that appear in law today.
This is a confinement that the CBO cannot do much about. This, however, makes it even more important to explore the debt problem beyond what the CBO can do. Doing so, Feldstein highlights an important reason for why this is a modest projection: the combination of growth in defense spending and the Democrat insistence on parity between Pentagon appropriations and the rest of the budget. 

According to the CBO, defense spending as share of GDP will decline - in short, military spending will not keep up with real growth plus inflation. In reality, Feldstein notes, it is unlikely that Congress will allow that. A more probable outlook is that defense funding will increase relative GDP. This, however, would cause non-defense spending to go up, as per Democrat demands. 

Feldstein also points out that the costs of Medicaid and Medicare are on a trajectory of growth relative GDP. In ten years these two programs are predicted to claim 7.2 percent of GDP, up from today's 5.5 percent.

There is a third cost driver, Feldstein explains. As the federal government's deficit continues to grow, and the mountain of debt grows, we are going to see higher interest rates and therefore a rise in the cost of the debt. 

Beyond Feldstein's three reasons for worrying about a debt crisis, there is the growing support for new entitlements in Congress. It is likely that Congress will pass some kind of paid family leave bill before next year's election. Republicans are trying to outdo Democrats in enthusiasm over this new budget boondoggle, with their latest idea marketed as the pun-intended CRADLE Act. This Pandora's box of new federal spending is tagged on to Social Security and would accelerate its bankruptcy. 

Far worse, though, is the prospect of exponential growth in paid-leave entitlements. My own estimates suggest that if the program reach standard European proportions - a desire that is not unheard of in Democrat circles - the total annual cost could run into the $370-500 billion range. That will not happen initially, but we also know that every new entitlement that has ever been added to the federal budget, has grown over time. Here, the potential for growth is almost unlimited.

Another fiscally explosive entitlement is "Medicare for all", a.k.a., single-payer health care. This is now a staple among Democrats, and we should expect Republicans to start warming up to it once paid family leave is in place. 

Somewhere in the shadows of this fiscal behemoth we can also find universal child care and free college.

Which brings us to the one aspect on the federal debt that Feldstein does not mention: the "growth switch". There is a fair amount of statistical evidence suggesting a "switch" like relationship between the size of government and GDP growth. As I reported in my book Industrial Poverty, when the spending of a welfare state grows past 40 percent of GDP, the growth rate of that economy slows down permanently. 

Very little has been added to the literature in terms of what actually causes this slowdown, although my own hypothesis is that the burden of government has a compounded effect that private businesses can no longer accommodate. Instead of continuing to grow, innovate and expand, private enterprises shift to some kind of "survival mode" where their focus is on keeping current operations profitable but not investing too much in growth and expansion.

Furthermore, it is likely that the combined barriers to new business entries reach a critical mass as part of government growth toward the 40-percent mark. These barriers vary from country to country, but can consist of any combination of taxes, fees, the regulatory landscape and union-biased legislation (common in the Scandinavian countries). When private businesses are increasingly squeezed by a growing government, they lobby for compensating legislation and regulations; raising the cost of entry to new competitors can allow businesses burdened by high taxes to maintain reasonable profit margins.

The downside, of course, is that industries grow stale, with negative consequences for productivity and innovation. Low-growth, mature industries prevail while new businesses with agility and high-growth potential lag behind or fail to emerge altogether. The lack of "silicon vallies" in Europe is an indication of this, as is the increased reliance of European welfare states on exports to keep whatever growth they have above freezing. 

All in all, Feldstein has produced another home run. Read his article online here. It is well worth your time.

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