November 25th, 2012
in Op Ed
By Marshall Auerback, New Economic Perspectives
Looking at the latest US data, business sentiment and capital spending have been eroding, and given the lagged impact of capex, that trend looks set to continue for the next few months. Against that, a number of consumer sentiment indicators remain upbeat and housing looks like it is in a firmly established uptrend, after a 5 year bear market. In fact, the existing home inventory to sales ratio is as low as it ever gets, and that is with still very depressed sales. If sales pick up further, given low inventories and with new housing starts still below the replacement rate, home prices could lurch forward.
That said, the markets have been fairly upbeat given the rising perception of a deal to avert the US falling off the ‘fiscal cliff’. But even a deal that drains, say, 1-1.5% of GDP will have negative consequences for the US economy. Bear in mind that the U.S. still has a very high ratio of private debt to GDP. Therefore any such fiscal restriction as contemplated by the two parties may result in a significantly lower economic growth rate than the average 3% rate of the last five quarters (which is what the revised economic data of the past few quarters will eventually show).
Of course, if there is no compromise, the impact could be calamitous. The IMF projects as much as a 4% decline in GDP if there is a full fiscal cliff. In 1936-37 there was a fiscal cliff of almost 6% of GDP. It was followed by a 36% non annualized decline in industrial production in a mere eight months in late 1937/early 1938. More recently, all of the European countries fiscal restriction has had a more negative impact on GDP than had initially been forecast.
So the range of likely outcomes ranges from slowdown to outright recession and the silly thing is that it is all so unnecessary. Social Security, Medicare and Medicaid impose no real burdens, even with a rising proportion of ageing baby boomers. In fact, one could plausibly make the case that an aging society could help to generate favorable conditions for achieving sustained high employment with high productivity growth. As the number of aged rises relative to the number of potential workers, what is required is to put unemployed labor to work to produce output needed by seniors. Providing social security benefits to retirees will generate the necessary effective demand to direct labor to producing this output. Just as rapid growth of effective demand during the Clinton boom allowed sustained growth of the employment rate, even as productivity growth rose nearer to United States long-term historical averages, tomorrow’s retirees can provide the necessary demand to allow the United States to operate near to full employment with rising labor productivity—a “virtuous combination” of the high productivity growth model followed by Europe and Japan from 1970–95 and the high employment model followed by the United States during the 1960s, as well as during the Clinton boom.
Here’s what most members of Congress (and, indeed, the media and the public) fail to appreciate: Policy formation must distinguish between financial provisioning and real provisioning for the future; only the latter can prepare society as a whole for coming challenges. While individuals can, and should, save financial assets for their individual retirements, society cannot prepare for waves of future retirees by accumulating financial trust funds. Rather, society prepares for aging by investing to increase future real productivity. Unfortunately, no such discussions are taking place, which is likely to lead to a bad to horrific policy outcome.
They are transfers in current time. They meet today’s commitments to seniors, survivors, dependents, the disabled and the ill – commitments they have earned through work – providing them with income and services at the expense of others also currently alive. This any community can always do, to the full extent of its will and resources.
The fiscal austerians are literally strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow. All of which exacerbates a problem of economies facing intense global headwinds from private sector deleveraging.
Viewed from that perspective, the terms of the debate have been truly twisted around. Granted, it is obviously more difficult to make the case for more government spending when legitimate distrust reasonably exists of dysfunctional financial and governmental systems. That said, what really matters is whether the economy will be able to produce a sufficient quantity of real goods and services to provide for both workers and dependents several generations down the road. The financial aspects of demographics per se should not play a role in policy formulation.
Any reforms which seek to address growth in the context of private sector debt deleveraging and demographics ought to be made with a focus on increasing the economy’s capacity to produce real goods and services today and in the future, rather than on ensuring positive actuarial balances through eternity. Unlike the case with individuals, social policy can provision for the future in real terms—by increasing productive capacity in the intervening years. For example, policies that might encourage long-lived public and private infrastructure investment could ease the future burden of providing for growing numbers of retirees by putting into place the infrastructure that will be needed in an aging society: nursing homes and other long-term care facilities, independent living communities, aged-friendly public transportation systems, and senior citizen centers.
Education and training could increase future productivity. Policies that maintain high employment and minimize unemployment (both officially measured unemployment, as well as those counted as out of the labor force) are critical to maintain a higher worker-to retiree ratio. Policy can also encourage seniors of today and tomorrow to continue to participate in the labor force. The private sector will play a role in all of this, but there is also an important role to be played by government.
On balance, if we were to focus on only one policy arena today that would best enhance our ability to deal with a higher aged dependency ratio tomorrow it would be to ensure full employment with rising skill levels. Such a policy would have immediate benefits, in addition to those to be realized in the future. This is a clear “win-win” policy, unlike the ugly trade-off promoted by both parties, who only differ in the degree to which today’s workers and future seniors are to pay for the mistakes of the banksters through misguided proposals to “reform” entitlements and put our future on a “fiscally sustainable” path.
About the Author
Marshall Auerback, a Director of Institutional Partnerships at the Institute for New Economic Thinking has 30 years’ experience in the investment management business, also serving as a global portfolio strategist for Pinetree Capital, a Canadian-based fund management group. He also acts as an economic consultant to PIMCO, the world’s largest bond fund management group, a Research Associate for the Levy Institute at Bard College, and a Research Fellow for the Economists for Peace and Security.