Year: 2012

Every intro econ class points out that the total aggregate demand economy is the sum of consumption plus investment plus government plus exports minus imports. It also points out that the \”government\” category for \”government demand\” in this equation isn\’t the total government budget, but rather government spending on purchasing goods and services and paying employees. Parts of the government budget that involve a transfer of funds to consumers are not treated as part of demand by government , but instead are treated as demand by consumers. Daniel Carroll gives the facts behind this distinction in \”The Shrinking Government Sector,\” published in the April 2012 issue of Economic Trends from the Cleveland Fed.

First, here\’s a figure showing government demand or the \”government sector\” as a share of GDP. Total budgets for federal, state, and local government have been over one-third of GDP. But total government demand for goods and services has actually been falling. Here\’s Carroll\’s exposition:

\”While it is true that the ratio of government expenditures—including federal, state, and local government—to GDP increased precipitously during the crisis (reaching 21.1 percent in 2009), it has been trending down sharply since. At 19.7 percent as of the fourth quarter of 2011, it has given back 70 percent of its post-crisis increase.

This downward trend is the result of decreasing shares at all levels of government; however, the most significant factor has been cuts at the state and local level. Unlike the federal government share, which currently sits at 15.7 percent, state and local government spending is now nearly 3 percent below its first-quarter 2007 level. Because state and local government accounts for about 60 percent of total government spending, the trend in this component has more weight than the federal component on the overall government share.\” 

Carroll also provides a graphs of income transfers by government: again, in the breakdown of GDP into components of aggregate demand, these are allocated to the \”consumption\”category. Note that this graph isn\’t directly comparable to the one above, because it starts in 1997 rather than in 1970.

 Several intriguing patterns emerge from these graphs:

1) I hadn\’t known that government spending on goods and services was actually higher in the much of the 1970s than it is today, nor that government demand for goods and services had such a big decline in the 1990s. For those who have a vision of government doing things like building roads, providing education and national defense, enforcing laws, and paying for research and development, government is doing less of those things as a share of the economy now than it was a few decades ago.

2) The recent rise in government transfer payments is extraordinarily large 4%: nearly 4% of GDP during the recent recession, or more than 5% of GDP if one compares from the peak of the business cycle in 2000 to the trough in 2009 and 2010. For comparison, total defense spending in 2011 was 4.7% of GDP. Thus, just rise in government transfer payments has been roughly comparable to total defense spending.

3) One way to look at the government budgets is that tax and other revenues pay for transfers, and borrowing pays for all government demand for goods and services. Carroll writes: \”\”[G]overnment as a component of GDP does not include transfers; however, transfers greatly exceed tax revenue and nearly exhaust total revenues. This leaves little funding to pay for government consumption and investment, and so the difference must be borrowed.\”

Michael Lipton and C. Peter Timmer won the 2012 Leontief Prize for Advancing the Frontiers of Economic Thought from the Global Development And Environment Institute at Tufts University. Lipton gave his acceptance talk on \”Income from Work: The Food-Population-Resource Crisis in the \’Short Africa.\”\’ Here is a sampling of his remarks (footnotes excluded):

What is the \”Short Africa\”?
\”\’Africa\’ in this talk is \’the short Africa\’: excluding N Africa, Madagascar, Mauritius and South Africa. All these are sharply distinct from the rest of Africa environmentally, agriculturally and economically, and generally well ahead in mean income; poverty reduction; growth; farming (irrigation, fertilizer, seeds); and demographic transition. The short Africa is itself highly diverse, but no more so than is India or China.\”

What\’s the demographic and economic  challenge for this region?
\”Between 1950 and 2012, population in the \’short Africa\’ rose fivefold. It will more than double again in 2012-50 to 11.3 times its 1950 level. Workforces – people aged 15-65 – are rising faster still, thanks to better child survival and some fall in fertility. In 1985 sub-Saharan Africa had 106 people of prime working age for every 100 dependents. By 2012 there were 120; in 2050 there will be 196. That\’s a 63% rise in workers-per-dependent from now to 2050 – and a 3.5% rise each year in the number of people aged 15-64. In South and East Asia, a similar rise in workers-per-dependent proved a demographic window of opportunity, contributing about a third of the \’miracle\’ of growth and poverty reduction – because those extra workers found productive employment: first, in smallholdings, gaining from a green revolution and usually land redistribution; later, in industry and services, as farm transformation released workers. In \’the short Africa\’, will the swelling ranks of young workers produce Asian miracles – or worsening poverty, unemployment and violent unrest?\”

Why smallholder farmers are of central importance. 
\”Farming will decide in Africa, as it did in Asia. Farms remain the most important income and work source for over 2/3 of the short Africa\’s economically active – more among the young and the poor. This will change, but not fast.\”

More land under cultivation isn\’t the answer.
\”Farmers\’ strategy of feeding themselves by land expansion – forced on them by insufficient public atten-tion to irrigation, fertilizer access and seed improvement – not only failed to maintain living standards: it has run out of steam and is, or is fast becoming, unsustainable in most of Africa. That is, farmland ex-pansion is inducing, or soon will induce, soil depletion that means net farmland loss.\”

Improvements in irrigation, fertilizer and seeds are a possible answer.
 In \’the short Africa\’, below 1% of cropland is irrigated (20-25% in S/E/SE Asia in 1965; 35-40% now). Below 2 kg/ha of main plant nutrients – nitrogen, phosphorus, potash – are applied (>150kg/ha
in S/E/SE Asia). …  [F]ast yield growth without fertilizers and water-control is bricks without straw.\”

Summing up.
\”\’Scientific smallholder intensification\’ in Africa is no easy path to development. From global evidence, we know it\’s possible. Is it necessary? Initially, yes. Farm development is only the start of modernization away from agriculture; I\’m no agricultural or smallholder fundamentalist. But I\’m an income-from-work fundamentalist. \’The short Africa\’ by 2050 will have 2.3 times today\’s population – but 3.7 times today\’s 15-64-year-olds. They need an affordable initial path to workplaces giving income and respect. Other-wise, potential demographic dividend will become demographic disaster. But, with half the people still in severe poverty and States cash-strapped too, what initial path is \’affordable\’? One, trodden elsewhere, is scientific intensification of smallholder farms. If there\’s an alternative, what is it?\”

The U.S. Treasury has published \”The Financial Crisis Response In Charts.\” The labels on the charts largely tell the following four-part story: 1) There was a deep financial crisis; 2) The government did things; 3) The crisis did not continue; 4) Therefore, what the government did was beneficial and useful and responsible for the recovery. Even those of us who are generally supportive of many of the steps taken during the worst of the financial crisis late in 2008 and early 2009 can spot some logical flaws in that syllogism.

But two of the charts in particular, about the U.S. banking system, caught my eye. The first one is titled: \”The financial industry is less vulnerable to shocks than before the crisis. The panels show two lessons. \”Banks have added nearly $400 billion in fresh capital as a cushion against unexpected losses and financial shocks. Banks are also less reliant on short-term funding, which can disappear in a crisis and leave them more vulnerable to panics.\”

The second panel of interest shows that, relative to the U.S. economy, \”The U.S. banking system is proportionally smaller than that of other advanced economies.\” The horizontal axis shows total assets of banks as a share of the economy of their home country. The four largest U.S. banks by assets are JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo. The vertical axis shows total assets of all commercial banks as a share of GDP. By either measure, U.S. banks are relatively small in international terms.

Of course, this comparison is somewhat misleading.  U.S. banks are being compared to the huge U.S. economy, while banks in Belgium and Sweden and Switzerland are being compared to their much smaller national economies, not to overall economy of the European Union.  However, the figure still makes a useful point that while the biggest U.S. banks are enormous, by some standards they aren\’t so large.

Along similar lines, I blogged on December 7, 2011, about \”The Rise of Global Banks in Emerging Markets,\” where I quoted Neeltje van Horen: \”In fact, the world’s biggest bank in market value is China’s ICBC. The global top 25 includes eight emerging-market banks. Among these, three other Chinese banks (China Construction Bank, Agricultural Bank of China, and Bank of China), three Brazilian banks (Itaú Unibanco, Banco do Brasil, and Banco Bradesco) and one Russian bank (Sberbank). While excess optimism might have inflated these market values, these banks are large with respect to other measures as well. In terms of assets all these banks are in the top 75 worldwide, with all four Chinese banks in the top 20.\”

My broader point is that in thinking about the financial system, it\’s important not to overemphasize just the large U.S. banks. The U.S. financial system is much larger than the banking system, and includes all the ways of borrowing funds like asset-banked securities, commercial paper, and bonds. In addition, there are enormous banks in other countries as well. In addition, U.S. banks have largely returned to health in terms of holding more assets and being less reliant on short-term financing. Looking ahead, the big issues about stability of the financial system go well beyond the big U.S. banks–although they pose too-big-to-fail issues of their own–and require looking more broadly at international banks and global finance.

I admit to a bias against Trade Adjustment Assistance, because I fear that it plays to an untrue but common stereotype that if only the U.S. economy didn\’t have to deal with imports, workers would be far more secure. In reality, many factors across the vast U.S. market can cause some workers to lose their jobs: tough domestic competitors, a firm that doesn\’t keep up with shifts of production processes, shifts in popular tastes for goods and services, poor management decisions, and others. I\’ve never seen a serious argument that most of the workers who lose their jobs in the continual churn of the U.S. labor market do so because of import competition. In my mind, the entire category of unemployed workers–especially in the Long Slump following the Great Recession–can use greater assistance from active labor market policies in moving to new jobs. I don\’t see why such assistance should be limited to those who can get the U.S. Department of Labor to certify their claim that their jobs were lost specifically  because of import competition

Trade Adjustment Assistance began with the Trade Expansion Act of 1962, although no one was actually ruled eligible for benefits for the first seven years. It has been repeatedly updated and amended over time, especially in recessions and at times when new trade agreements are being discussed, including in 2002, 2009, and again in 2011. It\’s not a large program. In 2011, TAA included a total of 196,000 participants, about half of whom participated in training programs. The U.S. Department of Labor page describing what kinds of services are provided is here. It\’s a mixed bag of job search assistance, support for retraining, support for costs of relocation, assistance in paying for transitional health insurance while out of work, and wage subsidies for older workers who end up taking another job at a much reduced wage. The key goal is to help dislocated workers find new jobs.
Training and cash benefits under the TAA will be $826 million in 2012, according to the Congressional Budget Office baseline forecast.

Although I\’m not a fan of how Trade Adjustment Assistance is focused on such a limited group, it does offer a testing ground for how these sorts of policies might work. However, results do need to be interpreted with care. Those who are ruled eligible for this program are not a cross-section of American workers across all industries: tend to be heavily in manufacturing jobs, like steel or textiles or autos, where it is more straightforward to make the argument under the law that their jobs were lost due to foreign competition. But these workers also tend to be older and to have lower education levels compared either with other displaced workers in the U.S. economy or with the U.S. workforce as a whole. They may also be more likely to be in communities that depended on a big manufacturing plant, and that have a limited number of alternative job options. For evidence on these points, a useful starting point is \”Does Trade Adjustment Assistance Make a Difference?\” by Kara M. Reynolds and John S. Palatucci, in the January 2012 issue of Contemporary Economic Policy. For an earlier look at the subject,Katherine Baicker and M. Marit Rehavi wrote on \”Policy Watch: Trade Adjustment Assistance,\” for the Spring 2004 issue of my own Journal of Economic Perspectives. 

The Reynolds and Palatucci paper looks at the 150,000 beneficiaries of Trade Adjustment Assistance in 2007, who on average received benefits worth $5,700 from TAA. They compare \”dislocated\” workers who lost their jobs and were eligible for TAA benefits to other dislocated workers. Here are their two main findings:

\”Unfortunately, we find no statistical evidence that the TAA program improves the average employment outcome of beneficiaries over a comparison group of nonbeneficiary displaced workers with characteristics similar to those workers in the TAA program. Our results imply that while the TAA program may provide an income safety net, it does not help the average displaced worker who is enrolled in the program find new, well-paying employment opportunities. …

\”Upon further examination, however, we find strong evidence that those workers who participate in a TAA-funded training opportunity are more likely to obtain reemployment, and at higher wages, when compared to the TAA beneficiaries who do not participate in training. Specifically, participating in the training component of the TAA program increases the likelihood that the average TAA beneficiary will find new employment by 10–12 percentage points, and reduces the earnings losses of the average worker by 8–10 percentage points, when compared to a group of similar TAA beneficiaries who do not participate in the training component. Although the income support, job and relocation payments, and other TAA benefits may not help workers find new, well-paying
employment, training seems to improve employment outcomes for these workers.\”

Again, it could be hazardous to generalize too broadly from these findings, because those eligible for assistance under the Trade Adjustment Act are not a randomly selected group. For example, it may be that this group is less well-situated to take advantage of job search and placement assistance, and but better-situated to benefit from training. But with the unemployment rate above 8% since February 2009, and the Congressional Budget Office forecasting that it won\’t drop much before 2014, there should be a heightened urgency in figuring out how to help the unemployed find job slots. 

How much would raising marginal tax rates on those with high incomes cause their level of income to fall? Emmanuel Saez, Joel Slemrod, and Seth H. Giertz tackle this question in the March 2012 issue of the Journal of Economic Literature in \”The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review.\” The JEL paper isn\’t freely available on-line, although many academics will have access through their libraries, but a 2010 working paper version is available at Saez\’s website here.

The short answer to the question is .25. That is, a plausible mid-range estimate based on the economics research literature is that raising the marginal tax rate by 10% (not 10 percentage points, but 10% above the previous rate) would lead over the long-term to a reduction in taxable income of 2.5%. The longer answer is that understanding the implications of the question is difficult. The article itself is on the technical side, but here are some of the key issues.

When marginal tax rates rise, people will seek to avoid paying at least some of the increase. But how they seek to avoid the higher taxes matters. For example, one possibility is that people react to the marginal tax rate by working fewer hours or by making less entrepreneurial effort. Another possibility is that they find ways to shift taxable income to future years, in which case a decrease in tax revenue now might be offset by an increase in tax revenue later. Yet another possibility is that they find a way to shift the form of income, perhaps by receiving more income in the form of untaxed fringe benefits or in lower-taxed capital gains. People may also react to higher marginal tax rates by taking greater advantage of tax deductions: for example, they may give more to charity.

Economic studies that consider how revenues changes in response to past tax changes tend to pick up short term effects of these changes, and the most common short-term effects are probably changes in timing of taxable income or shifting it to less taxable income. From society\’s overall point of view, these changes are not of central importance. In fact, if the problem with higher marginal tax rates is that people are finding ways to avoid paying those higher rates legally, then an obvious answer is to combine the higher marginal tax rates with rules and enforcement to make such legal tax avoidance more difficult. The long-term responses are potentially more worrisome, but also in the nature of things much harder to measure with confidence. Consider the difficulties, for example, of figuring out how a change in higher marginal tax rates might (or might not!) affect incentives to get an additional graduate degree or to start a company. Here\’s Saez, Slemrod, and Giertz:

\”One might expect short-term tax responses to be larger than longer-term responses because people may be able to easily shift income between adjacent years without altering real behavior. However, adjusting to a tax change might take time (as individuals might decide to change their career or educational choices or businesses might change their long-term investment decisions) and thus the relative magnitude of the two responses is theoretically ambiguous. The long-term response is of most interest for policy making although, as we discuss below, the long-term response is more difficult to identify empirically. The empirical literature has primarily focused on short-term (one year) and medium-term (up to five year) responses, and is not able to convincingly identify very long-term responses.\” 

It also seems likely that the economic reaction to higher marginal tax rates is not a single constant number, but may vary for different taxpayers, and under different tax regimes (like what is being taxed, and how many opportunities the tax code offers for legally minimizing one\’s tax burden). For example, it\’s plausible that higher-income taxpayers have greater incentives and resources to search for legal ways to minimize their tax burden. For example, it seems clear that after the 1986 tax return, which broadened the tax base and reduced top personal income tax rates, there was a large shift in reported income from corporations to the personal income tax, and a vast reduction in personal tax shelters.

The very top incomes were about 60 percent from dividend payments in the early 1960s, and faced top marginal tax rates of about 80%, which suggest that these investors had little control over the form in which their payments were received. But there has been a huge shift and now top incomes are much more likely to be from partnerships and wage income, which suggests much greater potential for control of the form and timing in which income is received. As they write (citations omitted): 

\”The difficult question to resolve is to what extent the secular growth in top wage incomes was due to the dramatic decline in top marginal tax rates since the 1960s. This question cannot be resolved solely looking at U.S. evidence. Evidence from other countries on the pattern of top incomes and top tax rates suggests that reducing top tax rates to levels below 50 percent is a necessary—but not sufficient—condition to produce a surge in top incomes. Countries such as the United States or the United Kingdom have experienced both a dramatic reduction in top tax rates and a surge in top incomes, while other countries such as Japan have also experienced significant declines in top
tax rates, but no comparable surge in top incomes over recent decades …\”

 Among the goals that they suggest for future research are a greater effort to disentangle the different responses to higher tax rates:

\”[F]uture research that attempts to quantify the welfare cost of higher tax rates should attempt to measure the components of behavioral responses as well as their sum. It needs to be more attentive to the extent to which the behavioral response reflects shifting to other bases and the extent to which the behavioral response comes from margins with substantial externalities. …  [R]esearchers should be sensitive to the possibility that nonstandard aspects of tax systems and the behavioral response to them—such as salience, information, popular support, and asymmetric response to increases versus decreases—might affect the size of behavioral response.\”

As I said at the start, the short answer from economic research to the question of how higher marginal tax rates reduce tax income is .25: a 10% rise in marginal tax rates will tend to reduce taxable income by 2.5%.  But given the current state of research, that answer includes considerable uncertainty over its size and its underlying economic meaning. 

Rising life expectancy is a good thing; indeed, Kevin Murphy and Robert Topel estimated in a 2006 paper in the Journal of Political Economy (\”The Value of Health and Longevity,\” 114:5, pp. 871-904) that the 30 years of additional life expectancy gained by an average American during the 20th century was $1.3 million per person. But growing life expectancies also put pressure on public and private retirement programs. What if those programs are underestimating how much longevity is likely to rise? The April 2012 Global Financial Stability report from the IMF tackles this question in Chapter 4: \”The Financial Impact of Longevity Risk.\”

The first step in their argument is to make plausible the claim that government and private retirement plans may well be understating how much longevity is likely to rise (citations and references to exhibits omitted): \”The main source of longevity risk is therefore the discrepancy between actual and expected lifespans, which has been large and one-sided: forecasters, regardless of the techniques they use, have consistently underestimated how long people will live. These forecast errors have been systematic over time and across populations. … In fact, underestimation is widespread across countries: 20-year forecasts of longevity made in recent decades in Australia, Canada, Japan, New Zealand, and the United States have been too low by an average of 3 years. The systematic errors appear to arise from the assumption that currently observed rates of longevity improvement would slow down in the future. In reality, they have not slowed down, partly because medical advances, such as better treatments for cancer and HIV-AIDS, have continued to raise life expectancy …\”

Here are a couple of illustrative figures. The first shows projected life expectancies for the United Kingdom.  Starting at the bottom left, the lines show the projected rise in life expectancies at that time. Notice that the projected increases consistently underestimate the actual rise, which is the black line on top.

The table below shows the typical life expectancy at age 65 used for pension funds  in a number of countries in the first column. The second columns shows the currently estimates of life expectancy at age 65. Notice that in each case, the number used for future life expectancy in the first column is above the current estimates of life expectancy, which is wise. But also notice that for a number of countries, including the United States, the actual increase in life expectancy since 1990 is substantially larger than the difference between columns 1 and 2.

The IMF asks what would happen if life expectancy by 2050 turns out to be three years longer than current projected in government and private retirement plans: \”[I]f individuals live three years longer than expected–in line with underestimations in the past–the already large costs of aging could increase by another 50 percent, representing an additional cost of 50 percent of 2010 GDP in advanced economies and 25 percent of 2010 GDP in emerging economies. … [F]or private pension plans in the United States, such an increase in longevity could add 9 percent to their pension liabilities.  Because the stock of pension liabilities is large, corporate pension sponsors would need to make many multiples of typical annual pension contributions to match these extra liabilities.\”

What\’s to be done? One step could be to build into the benefit formal for public pensions, like Social Security, provisions for an automatic decline in expected benefit levels for future retirees as life expectancy rises. The enormous change that has taken place in private retirement plans, switching from \”defined benefit\” plans in which the employer promises a stream of future payments to \”defined contribution plans where the employee has a retirement account with a certain amount in that account acts as a way of transferring longevity risk from employers to workers. Of course, retirees can then protect themselves from longevity risk and outliving their assets by putting a substantial share of their retirement funds in annuities.

There are also proposals for innovative financial assets like \”longevity bonds.\” Say that a pension plan worried that it has underestimated longevity risk, and thus will have to make higher payments than it expects. The company buys a longevity bond, where the payments that the company receives from that bond would rise if longevity exceeds certain benchmarks. Because the return on the bond would offset some longevity risk, the buyers of the bond would be willing to accept a lower interest rate than they otherwise would demand. However, no longevity bonds have yet been successfully issued.

It\’s not enough just to set an expectation for how much the population will age, and to plan accordingly. We also have to plan for the historically likely possibility that life expectancies may grow faster than we expect.
 

Here\’s an European economy joke with an edge from the Chou Associates Fund Annual Report for 2011. Hat tip to the Stingy Investor website for the link:

\”Pierre, an expensively attired middle-aged French tourist on his first trip to Toronto strolls into the
bar of his 5-star hotel. The elegant hostess smiles, leads him to a table and beckons her prettiest
server to take care of him. They talk, flirt a little and she giggles a bit. When he draws her closer and whispers in her ear, she gasps and runs away.

The hostess frowns then sends a more experienced waitress to the gentleman’s table.They talk, flirt a little and giggle a bit. He whispers in her ear and she too screams, “No!” and walks away quickly.

The hostess is surprised … . Rather than alienate a high-powered customer, she asks Lucille, her seen-it-all, heard-it-all bartender, to take his order. They talk, flirt a little and Lucille even giggles a bit. When he whispers in her ear, she screams, “NO WAY, BUDDY!” then smacks him as hard as she can and leaves.

The hostess is now intrigued, having seen nothing like this in all her years working in bars. … Besides, she has to find out what this man wants that makes her girls so angry. … So she goes to Pierre’s table, wishes him a pleasant evening and tells him she’ll personally take care of his needs. … They flirt a little, giggle a bit and talk. Pierre leans forward and whispers in her ear, “Can I pay in Euros?”\”

The Emerging Market Research Institute at Credit Suisse has an intriguing report out on \”Opportunities in an Urbanizing World.\” From the \”Editorial\” at the start:

\”[T]he world\’s population is migrating from rural areas–accounting for 70% of global population in 1950–to cities–accounting for 70% of global population by 2050 based on United Nations projections. In 2009, the percentage of the planet\’s population living in urban areas crossed the 50% threshold and by 2037 cities in developing nations will contain half the world\’s total population. …. \”

Here\’s a figure to illustrate the point. World population is divided into four groups. As recently as the 1990s, more than half all the world population lived in rural areas of developing countries. The projections are that in 25 years, more than half of world population will live in urban areas of developing countries.

The coming urbanization will be almost entirely a developing country phenomenon: \”Looking at population projections in the world\’s 15 largest urban agglomerations in 2025, we note that just two–Tokyo and New York City–are in developed countries. Not a single one of the world\’s 25 fastest projected growing major cities is in a developed country.\” But even within developing countries, a number of countries are already seeing decelerating urbanization, because their levels of urbanization are already 70-90% of the population, and so there isn\’t much more room to urbanize. For example, Malaysia, Mexico, Peru, Colombia, Turkey, Czech Republic, Russia and Hungary all have urbanization rates already above 66%, and Argentina, Brazil, Chile, South Korea and Saudi Arabia all have urbanization rates already over 80%.

But another group of countries, mostly in Asia and Africa, but also including Poland, are seeing accelerating urbanization: South Africa, Morocco, Nigeria, Poland, China, Philippines, Indonesia, Egypt, Thailand, Pakistan, Vietnam, Bangladesh, India, Kenya. As the report points out, this list includes six of the eight largest countries by population in the world, and about 55% of world population.

The report argues: \”Exploring the relationship between per capita economic growth and urbanization, we find that there is a sweet-spot as countries urbanize (in the range of 30%-50% of total population), accompanied by peak per capita GDP growth.\” It offers a discussion of each these countries of accelerating urbanization.

Here, I\’ll just make the overall point that urbanization creates economies and diseconomies. On one side, it concentrates, consumers, workers, and firms in a way that allows a flow of information, goods, and services that feeds specialization, economies of scale, technological development, and economic growth. On the other side, it also concentrates problems of pollution, crime, poor health, poverty, and corruption, and raises needs for physical infrastructure and working institutions.  The politics and economics of the future are likely to be hammered out, one issue at a time, for better or worse, in the large cities of developing countries. I discussed some of these broader issues of urbanization in \”The Coming Urban World\” in a post last August 29, 2011.

I discovered the Credit Suisse report via a post by Alex Tabarrok at Marginal Revolution. 

The U.S. federal budget is typically measured on a cash basis: that is, how much tax money came in and how much spending went out. But for a more complete picture of any budget, it is useful to look at an accrual budget: that is, including not just current spending, but what spending has already been committed for the future. The federal government takes a stab at providing an overview of an accrual budget each year in a report from the U.S. Treasury called the Financial Report of the United States Government: the 2011 edition is here.

Here\’s a graphic showing all the assets and debts of the U.S. government from an accrual perspective. Federal debt held by the public, the usual measure of federal debt, is about $10.2 trillion. \”As of September 30, 2011, the Government held about $2.7 trillion in assets, comprised mostly
of net property, plant, and equipment ($852.8 billion) and a combined total of $985.2 billion in
net loans receivable, mortgage-backed securities, and investments.\” The big addition here is the $5.8 trillion in already owed in employee and veterans\’ benefits. Taking these legal obligations into account increases the government\’s liabilities by more than half.
 

What about future obligations for Social Security and Medicare? Legally speaking, these are not legal obligations in the same sense as benefits owed to federal employees and to veterans. The U.S. government can and probably will adjust the revenue and spending side of Social Security and Medicare. That said, the report does offer some estimates of current federal obligations in this area. Here are some numbers for Social Security and the different parts of Medicare. The numbers are \”present values\” over 75 years (that is, how much money in the present, at an assumed rate of interest, would be equal to the sum over 75 years).

Thus, for example, the present value of all the revenues Social Security is scheduled to receive over the next 75 years is $41.6 trillion, the present value of total expenditures over that time is $50.8 trillion, and the current unfunded gap is $9.2 trillion. The multi-trillion dollar gaps for Part A (Hospital Insurance), Part B (Supplemental Medical), and Part D(Pharmaceuticals) of Medicare are also shown. The total gap is about $33 trillion–which for comparison is about twice as large as the $17.5 trillion in legally obligated liabilities in the chart above.

Two main lessons emerge from these figures. First, the debt obligations of the federal government are far larger than the $10 trillion or so in debt owed to the public. Adding what is legally owed in benefits to federal employees and veterans, together with promises already made to Social Security and Medicare, the total amount owed would reach about $50 trillion.

Second, of this $50 trillion in what is owed, about half is because of Medicare. America\’s health care the system is a huge part of what is driving our long-term fiscal problems. Indeed, the numbers in the table probably understate the effect of future rises in health care spending for several reasons. The table shows only Medicare, but Medicaid is also a substantial spending program without any dedicated payroll tax or funding source. Moreover, the estimates of Medicare costs in the table are likely to be far too low. At least, this was the conclusion of  Richard S. Foster, Chief Actuary, Centers for Medicare & Medicaid Services, who wrote in a \”Statement of Actuarial Opinion\” in an appendix to the 2011 Annual Report of the Medicare Trustees:

\”[T]he financial projections shown in this report for Medicare do not represent a reasonable expectation for actual program operations in either the short range (as a result of the unsustainable reductions in physician payment rates) or the long range (because of the strong likelihood that the statutory reductions in price updates for most categories of Medicare provider services will not be viable). … Although the current-law projections are poor indicators of the likely future financial status of Medicare, they serve the useful purpose of illustrating the exceptional improvement that would result if viable means can be found to permanently slow the growth in health care expenditures.\”

There is a raging argument over whether to attack the federal budget deficits now, or whether to wait until the economy recovers further and the unemployment rate falls. Compares with this picture of current federal debt from an accrued perspective — a low-ball estimate of $50 trillion in accumulated obligations — the short-term decisions are relatively small potatoes.

For many people, saying that a little bit of inflation can have good effects is akin to saying that a little bit of leukemia can have good effects. Too much inflation, especially volatile rates of inflation, does operate like sand in the gears of an economy, by making it unclear how much prices throughout an economy are rising or falling in real terms. But But when an economy is trying to climb out of a recessionary episode caused by a wave of overindebtedness, and is suffering sustained high unemployment at the same time, a bit of inflation can grease the transition.

When it comes to overindebtedness, a bit of inflation means that past debts can be repaid in inflated dollars. For the millions of homeowners struggling with mortgages that are worth more than the value of their property, as well as others with high debts, a bit of inflation is a breath of fresh air. In the case of wages, standard price theory suggests that when unemployment is high and a large quantity of labor is available, wages should fall–for the same reason that at when the quantity of apples at an autumn farmers\’ market is high, the price of apples be lower than at other times. But employers are reluctant to cut wages. It decreases morale of existing workers, and encourages the more high-productivity workers–who have better outside options–to look for  other jobs. In contrast, apples don\’t get sulky and inefficient when the price of apples declines.

But here\’s a kicker: Workers strongly dislike cuts in nominal wages, but they are typically less annoyed by cuts in real wages. Here\’s an intriguing figure from Mary Daly, Bart Hobijn, and Brian Lucking at the San Francisco Fed. The  solid thin blue line shows the inflation rate; the thicker red line shows nominal growth in wages; and the dashed black line shows the real wage growth–that is, the growth in the buying power of wages after taking inflation into account.

This data suggests that average wage growth in the U.S. economy was negative for most of the 1980s and half of the 1990s, and then crept into positive territory for a time, before dropping off to negative again in 2011. This graph must be interpreted with care, because it doesn\’t mean that the average real wage of those who held jobs 1982 was falling for a decade.  The workforce changes over time. In the 1980s, for example, there was a dramatic increase in the number of women entering the (paid) labor market, and many of them took relatively lower-wage work. This factor would tend to reduce the rise in \”average\” wages in any given year, even if those who were already in the workforce in the late 1970s saw a rise in their wages over that decade. However, the graph also helps to explain how the U.S. economy adjusted from very high unemployment rates in the early 1980s to low unemployment rates by the mid-1990s: in short, average real wages were lower, which encouraged more hiring.

My point is that a bit of inflation can help an adjustment in real wages across the economy during a time of sustained high unemployment, because it affects all employers and all workers, and doesn\’t require individual employers to cut nominal wages. Those interested in some additional background on the extent of nominal and real wage stickiness at a more technical level might begin with an article from the Spring 2007 issue of my own Journal of Economic Perspectives: \”How Wages Change: Micro Evidence from the International Wage Flexibility Project,\” by William T. Dickens, Lorenz Goette, Erica L. Groshen, Steinar Holden, Julian Messina, Mark E. Schweitzer, Jarkko Turunen, and Melanie E. Ward.