Posner lays out clearly many of the present and future solvency and default risks to the United States federal government. He bases some of the analysis on a valuable recent Morgan Stanley report with the provocative title “Ask Not Whether Governments Will Default, but How”. Default on some of their debt by countries like Greece and Italy are real possibilities, and default by leading countries like the US and Germany is surely possible. But I do not believe their default is at all inevitable.
The report first presents the usual measure of default risk- the ratio of government debt (not held by other government agencies) to GDP in 2009- for the federal government of the US and for eight European nations: France, Germany, Greece, Ireland, Italy, Portugal, Spain and the United Kingdom. On this criterion, Greece and Italy look in trouble, with ratios of about 1.15, and the US looks in reasonable good shape, with a ratio of about ½, which is much lower than that for most of the other nations in their comparison set. For example, Germany’s debt/GDP ratio is 0.73, while the United Kingdom’s ratio is 0. 68.
Morgan Stanley’s report argues debt/GDP is not a good measure of default risk, and suggests instead the ratio of debt to government revenues. On this measure, the US looks terrible, with a ratio of 3.58. This ratio is much higher than that of the eight European nations because they tax a much larger fraction of GDP than the federal government of the US does. Yet it is not obvious to me that using tax revenue rather than GDP in the denominator is a better measure of solvency risk. Countries that already collect a sizeable fraction of GDP as tax revenue have less room to raise taxes than do countries like the US that tax a much smaller fraction. This argument suggests that the high GDP/tax revenue ratio for the US makes its solvency risk lower rather than higher compared to Europe. On the other hand, that the American federal government raises so much less may be a sign of greater resistance to higher taxes in the United States than in Europe.
On balance I believe it is better to use the debt/GDP measure, although the discussion that follows would be the same with either measure. Two main factors will determine the size of the default risk for the US as well as Europe. As both Posner and the report emphasize, a frightening prospect is the expected growth in entitlements over time, especially the growth in medical care spending. This is partly due to the continuing aging of populations in developed countries since older persons take a greatly disproportionate share of spending on medical care. Even more important than aging itself is that spending on each older age group has risen at a fast rate over time with the development of expensive new drugs and surgeries.
In the Affordable Care Act that became law in March of 2010, Congress and the president tried to address the high and growing spending by the US on healthcare. The US ratio of spending to GDP is approaching 17%, which is essentially the highest ratio in the world. Unfortunately, in many ways this law worsens America’s approach to health care rather than improves it. One main defect is the failure of this Act to increase the quite small ratio of out of pocket spending by older sick individuals on their own healthcare compared to their spending out of tax dollars. Obviously, individuals have much less incentive to economize on unnecessary health spending, such as the removal of the prostate for 85 year old men with prostate cancer, when the great majority of their spending comes from tax dollars rather than from their own income and wealth. Another serious defect of the law is that it extends rather than contracts the American reliance on employer provided health care. My post on the new law on March 28th discusses other defects.
The Morgan Stanley report does not give much weight to the potential of faster economic growth to reduce the likelihood of sovereign default risk. If the rate of growth in GDP were speeded up, the debt/GDP ratio might be kept under control even without governments collecting a much larger share of GDP in tax revenue, as long as the growth in government spending did not adjust upward to the faster growth in the economy. For example, if the economy grew in the long run by 2% per capita per year rather than 1.5% per capita per year, GDP per capita would double in about 36 years rather than in 48 years. This difference in the level of GDP achieved over time would greatly improve the ability of governments to handle their debt.
In recent months I have argued in several posts on this blog that governments should be concentrating on trying to speed up longer-term economic growth rather than promoting further stimulus packages and other short run palliatives. Faster long term growth in per capita incomes and real reform in the looming health and retirement entitlement are the only truly effective and efficient ways to greatly reduce the risk of eventual default on sovereign debt by the US, Europe, and other nations.
Debts in Europe and the US are the tip of the iceberg. The Iceberg itself is how are the 0.7 billion Western European and American citizens hoping to maintain their enviable and unique Western prosperity levels when individual incentives to produce in the West are declining, while incentives to produce for at lest 3 billion people in the rest of the world are increasing (relative to current levels).
J.Moreau
Posted by: J.Moreau | 08/29/2010 at 06:05 PM
The 400 pound gorilla of healthcare’s effect on deficits and economic performance is not the law’s effect on medical costs, but primarily its effect on productivity and thus economic growth:
When you tell people:
A) If you make less than $88,000 per year then someone else will pay for your healthcare,
while
B) If you make more than $88,000 you will not only pay for your healthcare but for someone else’s too (i.e. must earn after tax income to pay your medical insurance premiums).
Then what do you think will happen to medical expenditures and, more importantly, to incentives to produce and thus economic growth, which, as you point out is essentially the only effective antidote to satisfying the naturally greater and greater appetite for medical services?
Posted by: IntuitiveEconomics | 08/29/2010 at 06:29 PM
Becker gets this one right. Policies that promote investments in total factor productivity growth produce long-term economic growth.
JAS
Posted by: Joseph Swanson | 08/29/2010 at 07:37 PM
On a positive note, hopefully creditors will take note of 3.58 to 1 ratios and stop lending money to various government entities, thus putting pressure on government spending even if it results to “too little too late”.
The FED on the other hand, with its loose monetary policy is essentially forcing savers (those fools who did not spend their money and of which fools we do not seem to have enough) to accept returns that in no way reflect the real risks they are taking by lending, especially when lending directly to the sovereign(*). So active monetary policy becomes yet another form of the indirect redistribution of wealth that the government mandates through Keynesian manipulation of the economy. You can expect to fool some savers all the time and all savers some of the time. But you cannot fool all savers all of the time, forever.
The dynamics may be gaining enough critical mass to explode in a “mother of all crises”, resulting in a sudden rather than gradual end to the Western Welfare State (dis)incentives to produce.
(*) BTW, if there is a way to short overall mid-term US economic performance, please post.
Posted by: Elze | 08/29/2010 at 08:29 PM
The Iceberg itself is how are the 0.7 billion Western European.Then what do you think will happen to medical expenditures and, more importantly, to incentives to produce and thus economic growth.
Posted by: ffxiv gil | 08/29/2010 at 08:38 PM
I remember when my father, already under duress in his business, told the family that if Wallace won the election it would simply be smarter for him not to work. It was just too hard to run a business at the time. Whether or not he really would have joined the great society, I dont really know. But his feelings were certainly expressed with honesty.
Right now small business people all over the country are saying a modern version of the same sentiment. They cannot get credit. But they know the welfare state isn't viable support for them. And they see the state as either incompetent or predatory. So they really have few choices.
I build medium sized companies. Seven so far in my career. And I am beginning to feel like there isn't any point in trying any longer. If the government hates me, and demonizes me. Then why should I work so hard, and take so many risks, to create companies and jobs?
Posted by: Curt Doolittle | 08/29/2010 at 10:52 PM
Using the CPI brought forward from a 1950 baseline, I am clearly "middle class". My taxes, consisting of federal income tax, state income tax, state county and city sales tax, telephone tax, gasoline tax, natural gas tax, sewage and water tax, automobile taxes, airline taxes, taxi taxes,capital gains taxes,and pass-through product taxes are in excess of 65% of my gross income. Since I live on fixed income and my house is worth 30% less than a year or two ago. There is no investment gain in stocks, bonds, savings. Well, I am not all that excited about paying more taxes to help the feds out. More likely I will be looking for lower costs to live and that doesn't include going back to work or continuing to live in a high tax state, city, county.
Posted by: Jim | 08/30/2010 at 09:19 AM
" Debts in Europe and the US are the tip of the iceberg. The Iceberg itself is how are the 0.7 billion Western European and American citizens hoping to maintain their enviable and unique Western prosperity levels when individual incentives to produce in the West are declining, while incentives to produce for at lest 3 billion people in the rest of the world are increasing (relative to current levels).
J.Moreau"
J Moreau there is variable that was overlooked in your post. The variable is that America's politician are the ones who control spending policy and they have a strong bias to spend taxpayer money. Another thing you need to take into consideration is the 50 year program of unlimited immigration, which has created demand for the various spending programs of the government.
Posted by: Joshua Norman | 08/30/2010 at 09:20 AM
The Laffer Curve and Debt to Government Revenues as a Metric for Judging Insolvency Risk
As Becker suggests, debt to tax revenue may not be a superior meausre of insolvency risk. The Laffer Curve implies that having low tax collection as a percent of GDP would be very beneficial: a government would need a smaller marginal increase in the tax rate to raise as much tax revenues as a government that has already has a higher tax rate.
Posted by: Matt | 08/30/2010 at 11:19 PM
To further the Laffer point, the solvency risk is really: the resistance of citizens to further tax increases relative to the amount of additional required tax revenues to remain solvent and the required increase in tax rates. For example, Europeans may be less opposed to Americans on raising tax rates, but because Europe is closer to the maximum point of the Laffer Curve, they would have to raise tax rates by a larger amount than the U.S. to remain solvent. This could actually result in greater opposition than in the US where a smaller increase in marginal tax would be required although the US on a whole is more resistant to tax increases.
Posted by: Matt | 08/30/2010 at 11:24 PM
Going from once dismal, to now moderate incentives to produce:
http://online.wsj.com/article/SB10001424052748703369704575462770053958664.html?mod=WSJ_hps_LEFTWhatsNews
Going from once good incentives to produce to now ever more moderate incentives to produce (i.e. Welfare State incentives):
http://www.washingtonpost.com/wp-dyn/content/article/2010/07/30/AR2010073000806.html
American convergence to worldwide average per capita income may come sooner than most Americans think.
Posted by: J.Moreau | 08/31/2010 at 02:47 AM
So how are Americans going to face the challenge posed by the fact that 3 billon people who once faced dismal incentives to produce have now enough freedom to at least partially catch up to the West and are thus growing at 10+% annualy?
http://money.cnn.com/2010/07/14/news/international/china_gdp/index.htm
…By transitioning America to European style Welfare State incentives to produce, of course. The proposition is almost ridiculous.
Posted by: J.Moreau | 08/31/2010 at 02:57 AM
All of this babble is pointless. The dollar is backed by nothing but the full force and terror of the US government, as the late Saddam Hussein should have recognized. Take the trading of your oil off the dollar and you will pay a price. Since it has no intrinsic value, to discuss potential "default" in "payment" is nonsensical. The dollar is not a commodity but mere digits in computers which can be increased without limit. Taxation is merely a means of controlling the supply of this fiat money in the hands of consumers since government could simply create the "money" to pay its "debts." What should be the relative value of the dollar? This depends upon the "value" of other currencies used in foreign trade." The discussion in these blogs only leads to one conclusion: the bloggers are Ivy League Idiots who are indoctrinated to believe the American "dollar" is something of real intrinsic value rather than merely a tool used by the globe's principal fascists to manipulate the exploitation of natural resources. At some point as the Mideast and Eastern world become independent and the US and Britain become less relevant, it will be impossible to enforce the use of the dollar as the primary reserve currency by force and it will drop rapidly and mercilessly. We will be a more humble but a better nation, less dangerous to the remainder of the world and no longer able to threaten other human beings with our arrogant claimed hegemony. Leader of the free world? Hardly. Fascist bullies for certain. The US will simply follow in the usual pattern of empires similar to the collapse of Britain after WWII. As their foreign debt increased to finance their senseless wars, their tentacles were excised and millions of human beings were freed. Hopefully our collapse will also lead to similar benefits in those parts of the world in which people now find it necessary to arm themselves against the vampires of the West with our ravenous and incessant need for the resources of the remainder of the world. Now go out and enjoy driving your SUV and pickup truck while you still can. Send your moronic kids off to war. Bitch and moan about taxes. Demand government give you everything. Be Americans!
Posted by: M Hoffman | 09/12/2010 at 09:46 AM
To further the Laffer point, the solvency risk is really: the resistance of citizens to further tax increases relative to the amount of additional required tax revenues to remain solvent and the required increase in tax rates. For example, Europeans may be less opposed to Americans on raising tax rates, but because Europe is closer to the maximum point of the Laffer Curve, they would have to raise tax rates by a larger amount than the U.S. to remain solvent. This could actually result in greater opposition than in the US where a smaller increase in marginal tax would be required although the US on a whole is more resistant to tax increases.
http://www.homadynamic.com/
http://homadynamic.com/hid-xenon-lamp-c-1.html
http://homadynamic.com/hid-ballast-c-2.html
http://homadynamic.com/hid-xenon-kit-c-3.html
http://homadynamic.com/
Posted by: Alex | 09/22/2010 at 11:07 PM
The uproar and concern over debt is largely missing the central point that it is not wages driving jobs overseas, it is the total alienation of investment by regulation.
A good example is how we seem to have forgotten how the EPA rules and the strangle hold of the pristine Super Fund laws changed the business climate in the USA forever. There are millions of dollars of land and assets that now are untradable in the US, much of it in abandoned inner cities.
Similar EPA rules kept foreign skimmers out of the Gulf. We all want less pollution. But we have went overboard. We have become a nation hostile to business while we struggle with government monopolies in education, health care, and energy that are driving costs up and the economy into bankruptcy.
No monopoly can innovate or drive costs down. Bureaucracy alone precludes it. Why are the economists not screaming this from the rooftops, since they surely know this to be true?
Posted by: WhiskeyJim | 09/24/2010 at 02:38 AM
"The US ratio of spending to GDP is approaching 17%, which is essentially the highest ratio in the world."
... and ...
"One main defect is the failure of this Act to increase the quite small ratio of out of pocket spending by older sick individuals on their own healthcare compared to their spending out of tax dollars."
--
You point out to inefficiencies in the US health-care system by comparing its spending ratio to GDP to other countries. Then you argue that less insurance, and more out of pocket spending, would lead to more efficiency. You fail to mention that other developed nations have a lot of insurance and close to zero out of pocket spending in healthcare. So how do you square this observation with your observation that the US healthcare system is inefficient? Maybe insurance is not so bad after all.
Posted by: jst | 09/29/2010 at 12:20 PM