There is reason for advanced economies to have entitlements. However, the size of those entitlements should not rise out of the potential for the current generation to pay them. Unfortunately, that's exactly what will happen in the near future--starting now. Medicare, social security (etc) are starting to become underfunded, and by 2020 will consume our entire government (100% of tax revenues at current rates). In fact, that day of reckoning may arrive faster with medical and health care costs skyrocketing.
The solution for a predictable entitlement-to-revenue ratio is to define retirement age dynamically--as the age such that the labor participation rate is constant (Something like 60%). By adjusting retirement age to keep the participation rate constant, and by capping per-capita payment growth to either the inflation rate or the fraction of per-capita GDP, the outflows for children (i.e. education) and retired people (social security) will be predictably constant. No more will the cost of entitlements spiral out of control.
As the general population ages, and as life expectancy rises, this will allow the more prosperous generation to work longer and be retired earlier (as a fraction of life span). It is not fair to pass the burden of your longer retirement onto your descendants; if you're retired for longer, you must work for longer (in aggregate).
Without some quick action, as Thomas Friedman said today in the NYT, what is happening in Greece and London is just a harbinger for what will happen in the United States as our demographics change to reflect an increasingly older population.
The run-up in commodity prices prior to the onset of the current recession was strongly driven by the quick appreciation of the Yuan during that time. The 21% appreciation in the Yuan effectively made commodities--oil, metals, the basic needs of an exploding industrial economy--relatively cheaper. That in conjunction with rising incomes caused one of the most dramatic climb in demand for those commodities.
During the recession, that climb paused as China paused its currency's appreciation and the global financial crisis sapped demand. However, as the world emerges from the current recession, demand will roar back to its previous levels. As a consequence, commodity prices will resume their rapid ascent.
In response to the resumption in growth globally, China will allow its currency to appreciate again, further pushing up demand, and hence prices, for commodities. It is clear that demand for ever-scarcer resources will not cease to rise. Sharp rises in commodity prices will only push up the price level in industrial economies, especially those that have generously minted money to cope with the recession. Lower-income workers, especially those that depend on commodity-intensive industries (construction, energy, transportation, etc) will be hit the hardest by the double-whammy of the rise in costs of business, and the subsequent erosion of their purchasing power.
But the rise in commodity prices--like the sharp rise in the price of oil in early 2008--is not the only force pushing inflation. A rise in the cost of imports, which (again) the lower-income workers depend on, will lower the effective living standards. Not only will imports from China be more expensive, but also those from Malaysia, India, even goods produced domestically. China's neighbors will undoubtedly let their currencies follow the Yuan as their fears of loss of competitiveness to China are mitigated. American producers, realizing that competition is less intense (higher import costs), will certainly raise prices to match demand.
Clearly, America's susceptibility to forces outside of its control demonstrate its loss of competitiveness. Potential consequences of changes in foreign demand for commodities and changes in exchange rates highlight its willful dependence on volatile inputs. America needs to demonstrate it has the political will to cope with the changing world.
Otherwise, rapid inflation is imminent. The trillions of dollars printed during the recession won't help.
Here is an excerpt from a superb article by Paul Krugman, highlighting the hypocrisy and misinformation of the critics:
What you hear from conservative opponents of a climate-change policy, however, is that any attempt to limit emissions would be economically devastating. The Heritage Foundation, for one, responded to Budget Office estimates on Waxman-Markey with a broadside titled, “C.B.O. Grossly Underestimates Costs of Cap and Trade.” The real effects, the foundation said, would be ruinous for families and job creation.
This reaction — this extreme pessimism about the economy’s ability to live with cap and trade — is very much at odds with typical conservative rhetoric. After all, modern conservatives express a deep, almost mystical confidence in the effectiveness of market incentives — Ronald Reagan liked to talk about the “magic of the marketplace.” They believe that the capitalist system can deal with all kinds of limitations, that technology, say, can easily overcome any constraints on growth posed by limited reserves of oil or other natural resources. And yet now they submit that this same private sector is utterly incapable of coping with a limit on overall emissions, even though such a cap would, from the private sector’s point of view, operate very much like a limited supply of a resource, like land. Why don’t they believe that the dynamism of capitalism will spur it to find ways to make do in a world of reduced carbon emissions? Why do they think the marketplace loses its magic as soon as market incentives are invoked in favor of conservation?
Clearly, conservatives abandon all faith in the ability of markets to cope with climate-change policy because they don’t want government intervention. Their stated pessimism about the cost of climate policy is essentially a political ploy rather than a reasoned economic judgment. The giveaway is the strong tendency of conservative opponents of cap and trade to argue in bad faith. That Heritage Foundation broadside accuses the Congressional Budget Office of making elementary logical errors, but if you actually read the office’s report, it’s clear that the foundation is willfully misreading it. Conservative politicians have been even more shameless. The National Republican Congressional Committee, for example, issued multiple press releases specifically citing a study from M.I.T. as the basis for a claim that cap and trade would cost $3,100 per household, despite repeated attempts by the study’s authors to get out the word that the actual number was only about a quarter as much.
A number of people and groups (President Obama, then members of Congress, and now the World Bank) have pressured the People's Bank to let the exchange rate move relative to the dollar, some more angry than others. If they had any knowledge of Chinese culture and history, they would realize that these calls are counterproductive.
The bankers in China realize that the exchange rate needs to change by the end of this year. However, they continue to assert that they will keep the Yuan-to-Dollar rate stable for four reasons, some more public than others:
China has let its currency appreciate in the past--starting the summer of 2006--as a part of its economic policy. The goal was to stifle the growth of asset bubbles and inflation. However, when the inflationary pressure disappeared in the summer of 2008, they stopped the appreciation. Instead, they turned to fiscal policy (a package whose total is a whopping 15% of their GDP) to support the world economy.
Now that the global financial crisis is over, and inflation is rising again, China will let its currency rise this year, but not as a result of foreign pressure. The best action for China is to assure President Obama privately that the Yuan will start appreciating before summer, at 5% a year for at least four years, but not because of foreign pressure. In the mean time, China should slowly unwind is positions in dollar assets before they depreciate any further--enough to get out of major positions, but not quickly enough to startle the markets.
In the long run, an appreciation of 20% in the Yuan-to-Dollar exchange rate will have negligible effects on the Yuan with respect to other currencies. China will move up the terms-of-trade scale, and other currencies (Japanese Yen and the Euro) will continue to be strong because of Japan and Germany. The Dollar's decline is only a sign of America's loss of competitiveness.
The currency problem is not one where the People's Bank has good options. Either way, it will lead to a massive capital loss; and it will have to balance employment and inflation (and pissing off trading partners), yet ward off speculators. Hopefully western legislators' lack of understanding of China does not lead to a trade war--that would benefit nobody.
In the previous article, I briefly laid out the case for a jobless recovery in the short run. However, despite the immediate pain, it has positive long-term consequences.
Perhaps the US will be in a less unsustainable path of unbridled consumption after this transformation.
There are three key reasons why this recovery will be fairly jobless in the short run:
The increased capacity due to both a larger workforce and capital expenditures, combined with lower aggregate demand for the final products will lead to a near-term squeeze on employment and wages. For the inflation hawks, this means wage-pressure inflation still has a long way to go before becoming an issue.
Before we worry about how many people go to bed hungry in the world, we must tackle an even more damaging yet easy-to-fix problem--how many people are simply malnourished.
It costs less than a dollar to fortify an entire ton of rice with essential nutrients like calcium, many metals (like iron), and vitamins, whether by genetically engineering them to be more nutritious or by artificially mixing them in. Yet, for that dollar, it produces at least a ten-fold (estimated 17x) return within that year in terms of boosted productivity--not to mention the higher standard of living, better health, and clearer mind. The social dividend from this minor investment will be on a scale magnitudes more significant than the global iodizing of salt.
So why don't developing nations invest in such a project? It has three options:
Each idea has issues with centralization, because farmers aren't as concentrated as salt-producers, but if implemented correctly, will provide tangible returns ad infinitum. So why not give it a try?
Let's start with China and India.
The popular attack of government-backed enterprises is that it encourages inefficiency and takes the enterprise's focus off of profit. Is that true?
In the cases where the corporation must have other social agenda (promoting social welfare as a general goal), government backing definitely encourages that. Now, they have a large financier for any social task that is conducive to the government's goals, whatever they may be (Think: Samsung and Korea).
In other cases, is that attack true? Think back to the bailout days when banks left and right got money (but with strings) from the treasury. In response, the companies clamored to climb back to profitability in order to pay back the treasury and drop any suggestions that they were acting against the interests of the taxpayer.
And just now, after GM is 60% nationalized (Yup, we own 60% of GM now), it announces that it "cannot afford business as usual," implying that it could prior to nationalization.
Clearly, it is not always the case that having government backing for some enterprises or industries is the worse way of organizing economic activity, and in many cases it is the better way--for industries that have significant national impact or cannot sustain themselves.
Samsung could not have achieved a fifth of Korea's entire GDP and a third of its trade volume without the backing of the South Korean government. Given the facts, America should reexamine its fears of national industries, say, starting with health, insurance, and energy.
Apparently we are considering a second stimulus package even before the bulk of the first one has taken effect. If I designed the stimulus package the first time, I would have included $300b of money transfers and the same in cheap credit to states. Because states do not have the borrowing power the federal government does--especially at the dirt-cheap rates that states would love to have, they will be cutting back significantly on services this year while paying significantly more on interest (because increased fears of delinquency), an effect that will surely negate the federal stimulus.
Look at California for instance--even after cutting essential services and even education funds, it's still over $20b short for the year. With one of the nation's highest unemployment rates, it cannot afford to cut spending--but it must. It needs the $35b to continue normal functioning, avert the need to tap the financial markets, and perhaps even pay down some of the most expensive debts.
If we are producing a second stimulus package, it must include a significant transfer of funds and borrowing power to the states so they can get by without squeezing the economy further.
It would be:
As you notice, that's somewhat less than the stimulus we have in place today and contains no tax cuts.
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