Why I am not as pessimistic as Alex

Alex, citing Larry Kotlikoff, despairs for our fiscal future, read his earlier post as well.

I agree with the Krugman-DeLong-A.Sullivan-Tabarrok (if I may call it that) critique of current fiscal policies. But I don’t agree that our government is “bankrupt,” or accept the cited claim by Kotlikoff that “our country is in worse long-term fiscal shape than Brazil.” Neither is close to being true, check out Brazil’s BB bond rating for a start.

What is the real cost of our fiscal irresponsibility? First, we could be using current resources more effectively. But productivity trends have been strongly positive for some time now. So while things could and should be better, current magnitudes are not themselves evidence of disaster.

Second, when the time comes to pay off the debts, we will require some combination of inflation, spending cuts, and tax increases. Since most of the debt is short-term, inflation won’t do it. The real problem has to be taxes. Spending cuts Alex probably favors, at least I get that feeling reading the guy’s blog. The danger is that we will end up with Western European levels of taxation, stifling our entrepreneurial culture.

So the real cost of our current fiscal irresponsibility is the increase in deadweight loss, resulting from the required increase in taxation, as will be needed to pay off all those trillions. The real cost is not equal to the number of trillions that need to be paid back. And most of the associated transfers are within a generation (tax some living people to pay off bondholders, other living people at the time), rather than across the generations. Let’s not confuse the size of the deficit, or the debt, with the size of the intergenerational transfer.

Keep two other things in mind as well. First, there is some chance that the growth rate of the economy will exceed the real rate of interest. In that case we can simply grow out of our debt, which over time will become small relative to the size of the economy. It is irresponsible for a government to take the risk of spending on this basis. Nonetheless it is at least possible that, in technical parlance, “g > r”.

Second, America will likely experience favorable demographics. Here is Nicholas Eberstadt:

…the United States is envisioned to grow from 285 million in 2000 to 358 million in 2025. In absolute terms, this would be by far the greatest increase projected for any industrialized society; in relative terms, this projected 26 percent increment would almost exactly match the proportional growth of the Asia/Eurasia region as a whole. Under these trajectories, the United States would remain the world’s third most populous country in 2025, and by the early 2020s, the U.S. population growth rate – a projected 0.7 percent per year – would in this scenario actually be higher than that of Indonesia, Thailand, or virtually any country in East Asia, China included.

No, that won’t solve the problem but it is a help.

I should note that Alex and I probably do not disagree about the economics of the matter (if we do, you will hear from him soon enough). But I think he is neglecting the importance of the following:

The United States remains a strong and prosperous country. Our infrastructure, national culture of innovation, human capital, and economic dynamism are unparalelled in world history. The Bush fiscal policies, whatever their irresponsibilities, costs, and drawbacks, haven’t changed those core facts.

So I walked down to Alex’s office and issued him the following challenge: if you think I am wrong, sell all your stocks and go short on U.S. Treasury securities (and long on Brazil, if you wish!). With all the money you will make, you can buy out my half of this blog.


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