Thursday, July 16, 2009

The Crossroads

I was interviewed by our local paper last week, along with some other economists, about how to fix our budget mess. It was one of those usual things where they try to get the left and right points of view. I regret, upon reading that the unemployment rate in Michigan is a positively Spain-like 15.2%, that what I said sort of accepted the status quo, only substantially downsized – change Medicaid from a guaranteed-pay program to an individual insurance subsidy most importantly.

I should’ve aimed higher, because the welfare state has hit the wall. I have previously argued that social-welfare expenditures are going up all over the Western world, and that they are going to crowd out most other government functions:
But the rising burden of state pensions and health care in aging populations is going to result not just in rapidly growing tax burdens, but in a sharp narrowing of the political playing field. Options for spending money that would have been eminently debatable in the flush decades of yore are simply going to be fiscally impossible because of rapidly growing entitlement spending. This spending is going to crowd out not just private-sector economic activity but opportunities for public spending of all kind.

It has happened faster than I predicted. Below is a chart from BizzyBlog, via The Belmont Club:

This is a catastrophic decline in both individual and corporate income-tax revenues. Despite this, the Congress and President have already had the big stimulus party, much of which, it turns out, is being spent propping up state budgets rather than "shovel-ready" activities, with these budgets themselves exploding first and foremost due to expenditures on health, along with state pensions and education. In other words, future taxpayers are being shanghaied into paying for our current health care. Given that the projected deficit for next year, at about 12.5% of GDP, is higher than any country for which the World Bank has data for 2005 (the highest figure for that year was the Maldives at 12.1%), we now have the economic profile of a Third World basket-case country. And this is before the Congress has gotten around to destroying the health-care system.

The welfare state generates at least two lamentable dynamics. In the first, chronicled with characteristic skill by Charles Murray, the welfare state turns our minds away from the seeking of greatness and a life well-lived, and inward toward the emptiness of consumption. No one wants to take a big risk of scientific exploration if it cuts into the vacation time, and no one wants to go to Mars if it puts the state pension fund at risk.

The second dynamic is more directly economic. In it, once the welfare state hatches, benefits go ever higher. The electorate, having a very short time horizon, cares about gimme gimme now, and when the bill comes due it’s someone else’s problem. The resultant increased tax load drives business and high achievers out of the state – factories close, young people leave, etc. This is where states like Michigan have been for some time. Then, the people left tend to be poorer and unemployed, and require more expenditures under the existing entitlements scheme. This initially prompts the legislators to rummage through the state couch hoping a few billion dollars magically fall out. They legalize slot machines, they contemplate legalizing marijuana. None of this is done on the merits; all of it is done because of the need to feed the insatiable maw of the welfare state. (I predict that legalizing prostitution and illegal immigrants will ultimately be contemplated because of the desperate need for taxes.) Eventually, in Margaret Thatcher’s pithy phrase, the socialists run out of other people’s money, leaving only collapse or dramatic reform as futures.

That crossroads appears to have arrived. I wish I had told that newspaper reporter that my state should try something radical. It should brand itself as the one state in the Union that is serious about rewarding achievement. It should pull out of Medicaid, end all government spending not devoted to providing true public goods and significant externality control, and should then (because it now can) end the individual and corporate income taxes, repeal all protectionism for labor cartels, and sharply curtail anything that makes it difficult to open or expand business. It should then watch what happens. We must now choose a road, and the one we take will make all the difference.

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Anonymous Bill said...

Having had you as a professor in an MBA econ class (my favorite class of the program, btw), I know better than to try to spout econ theories as a rank ameteur because I'm confident I'd just come up short, but.....

It would seem if you go all the way back to the beginning, Grog figured out he was better at killing sabertooths than his neighbor Thor, but Thor could make a lean-to that kept the family dry while Grog's leaked like a seive, so they started working at trading things of value that they had skills in....expanded out over thousands of years and toss in a monetary system so we're not giving chickens to one another as payment, and our whole economy still rests on people trading one valuable thing or skill for another.

Even without the government entitlements that you speak about in your posting, the US demographics may sink us regardless of how market driven we are. Our company makes equipment, and in the past, most of it went to the auto industry. We started diversifying a few years ago, and of course, one of the hot commodities right now has become anything in the medical devices or pharmacy area. All good in the short term. It's technical work that requires skill and education and all those things that are good for a US workforce. But, take it to the logical conclusion that the sale of the vast majority of the goods in this segment will eventually go to the retired boomers who will be done trading things of value back into the system, and I'm not sure it's a sustainable model. I'm thinking that applies well beyond my company's little stake in the game.

Energy seems to be another area that's flawed. Except for nuclear, none of the current technologies are energy dense enough or refined enough to replace fossil fuels in a cost effective manner, but to ignore the research until we run out of fossil fuels doesn't work either, so there's an argument that government subsidy is the only bridge to get where we need to be.

So, now the biggest areas of the potential growth out of recession require government backing to make either work (life sciences because of demographics and energy because of current technology levels). That doesn't seem like too hot of a spot to be in!

I agree with the theme of pretty much all of your postings that government intervention into a free market economy almost never works out well, but even at the current ridiculous levels of meddling, their intervention seems more like rearranging the deck chairs on the Titanic.....our trade deficit, who owns our debt, who controls the energy situation, our loss of ability to create jobs by making things (ie, the move to a service based economy) all seem to stack up to point to a very tough coming decade for us even if the government stayed completely out of it. What's the answer?

2:52 PM  

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