Why fiscal problems don’t have fiscal solutions

By Felix Salmon
March 6, 2013

The main lesson I’ve learned from the sequester fustercluck, and from the failure of austerity programs in Europe, is that you can steer yourself very, very wrong indeed if you try to find fiscal solutions to fiscal problems.

The two phenomena are different: the stated aim of the sequester was to focus attention on long-term fiscal problems, while European austerity is generally targeted much more at the short term. But both resulted in the same thing: governments cutting their spending and hurting growth, when growth is the only real solution to the problem at hand.

In Europe, the key short-term problem is unemployment; in the US, the long-term problem is America’s ability to pay its scarily-rising healthcare costs. In neither case do government budget cuts do anything whatsoever to address the problem; instead, they exacerbate it.

Unemployment is the more obvious case: if the government lays off thousands of workers, and stops injecting money into the economy through other channels, that’s never going to help people find work in the short term. But the case against a fiscal solution to the healthcare-cost problem is also a pretty simple one. Here’s John Carney:

The main challenge we face on entitlements is not financial — it’s demographic. It’s not really even a question of “entitlements” at all. The challenge is just whether the economy in the future will be productive enough to produce all the medical care, food, and shelter required by the elderly when there are fewer people actually working. How we pay for this is secondary matter.

To put it differently, no matter what budget reforms we enact, we have a long-term care problem — not a long-term deficit problem. Even if we dramatically cut down on the long-term deficit by slashing entitlement spending, so that any care in excess of that has to be funded privately, we’ll still face the same challenge.

That challenge cannot really be solved through budgets. No matter how much we tax now, no matter how much we save now, in the future the economy will be limited to what it is able to produce. The challenge is to set that limit as high as possible, so there is as much as possible for the young and the old to divide it among themselves.

Put aside, for one minute, the question of whether marginal discretionary government spending is good or bad for economic growth; the point here is that the problem of healthcare costs isn’t fiscal. Indeed, it’s easy to go even further than that, and to say that the more money the government spends on healthcare, the smaller that the problem of healthcare costs becomes. After all, everywhere in the world, including in the US, the government gets by far the best price in the market when it spends money on healthcare. If you switch healthcare expenditures from the public sector to the private sector, all you do is make them more expensive.

And as Joe Weisenthal points out, quoting Richard Koo, the more that a government worries about long-term fiscal balance, the less effective it becomes in attempting to stimulate the economy to provide the kind of growth that everybody wants to maximize. Just look across the Pacific, says Koo: Japan has never once met its fiscal targets in the past 20 years, precisely because it has been consistently far too worried about meeting its medium-term fiscal targets.

The solution to all these problems has to be to maximize the number of people with jobs; to maximize the amount of money those jobs pay; and to maximize the number of years that people are earning money in those jobs. Eduardo Porter, today, makes the case for raising the retirement age, which of course would reduce the increase in Social Security costs. But he also makes the point that if people stay in well-paying jobs for longer, that benefits the entire economy — which in turn will improve our ability to provide America’s seniors with the healthcare they deserve.

Meanwhile, the rhetoric of the sequester is making everybody look in exactly the wrong place for solutions to America’s long-term fiscal problems. The amount that the government spends on national parks, or on FBI salaries, or even on mine-resistant, ambush-protected Army vehicles, is of course irrelevant to the question of how to create an economy which can afford medical care for all over the long term. But it also creates a framing problem — making it seem as though government expenditures are the nail, and that therefore budget cuts are the necessary hammer. Even as, all the while, the deep and real problems become that much more structural, embedded, and intractable.


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Weak thinking, Felix. Just because wasteful spending is not **THE** problem does not mean it is not **A** problem. The sequester might not have been optimally targeted, but it isn’t a bad idea. Yes, it will dampen growth in the short term. No, it will not throw the economy topsy-turvy. In fact I would be amazed if a $100B/year cut had any noticeable impact at all on a $15T economy.

We still need to fix the entitlements problem. We still need to fix the embedded imbalance in Social Security. We still need to spend less on healthcare while serving more people. We have not yet addressed the large problems, and should not become complacent.

But that has nothing to do with the sequester.

Posted by TFF17 | Report as abusive

@TFF17 The biggest problem is low or no growth because if the economy grows, debts shrink without needing to be repaid (just like your mortgage gets smaller as a percentage of the house price when the house price rises).

While sensible spending is, well, sensible, the definition of sensible is moot. If your actions in reducing spending hurt growth more, you actually make the debt burden worse. OK, pushing for growth can be inflationary, but arguably a little bit more inflation right now could be a good thing as that too would shrink debt, and it’s a lot better than the stagflation many parts of the developed world are close to.

Posted by FifthDecade | Report as abusive

In response to the excerpts of John Carney’s article, the root issue isn’t how we pay for health care, or the cost of it. There is no question we can be productive enough to produce all the medical care, food, and shelter required by the elderly, or everyone else, for that matter. It’s more a question of income distribution – not that we need to have the government pay for it, but rather that profits generated from sales to people who can pay for those basic needs (and everything else) need to be more widely distributed. That isn’t happening now, and politics is demanding the government make up for it, which causes the fiscal problems.

Technology has reduced the cost of everything, the problem is the savings have not been evenly distributed among the population. These savings could be distributed by increasing the income of a bigger segment of the population, or by reducing unemployment, or by reducing the number of hours people need to work to pay for things, or by reducing prices. None of these things happen, and to make it worse, the undistributed profits get hoarded and kept out of circulation.

An economy only works when money flows round and round. If you take a chunk out every cycle, the economy shrinks. That causes all kinds of distortion, especially on the price of health care, which is not optional. Fix the distribution of income problem and the health care cost problem becomes more manageable.

Posted by KenG_CA | Report as abusive

“If your actions in reducing spending hurt growth more, you actually make the debt burden worse.”

I’ve read suggestions that deficit spending is generating less growth than in the past. The estimates that came out of the CBO suggested that in the short run, it takes roughly a dollar of deficit spending to generate a dollar of GDP. That ratio doesn’t shrink the debt burden, unless you assume that the projected increase in Medicare expenses will actually be realized.

Posted by TFF17 | Report as abusive

KenG_CA — I think part of the problem is that unless income is widely distributed, there is no incentive to reallocate our labor and capital to producing services for the masses. If income is highly concentrated, smart young people will prefer to be in a line of work where they can get paid very well to serve a small number of those wealthy people — finance, for instance.

Part of the reason there’s a shortage of doctors, is that there’s a shortage of customers who can afford their services. But part of the reason their services are so expensive, is that there’s a shortage of them. It’s kind of a chicken/egg problem. Generous universal coverage, and subsidies for med students going into underserved fields, could help break the cycle.

Posted by Auros | Report as abusive

@TFF17 Your figures don’t agree with normal expectations for the effects of spending, according to Case & Fair’s Principles of Macroeconomics. One example they give shows that cutting spending by $1 billion cuts the deficit by only $692 million. That’s a long way from the 1:1 ratio the CBO likes to use. I’d rather trust a dry textbook than anything coming out of Congress any day of the week!
http://wps.prenhall.com/bp_casefair_macr of_7e/32/8268/2116798.cw/index.html

Your link is?

Posted by FifthDecade | Report as abusive

Auros, you’re reinforcing my argument. If income is not distributed widely enough, all kinds of economic ecosystems collapse.

Posted by KenG_CA | Report as abusive

@KenG_Ca ” There is no question we can be productive enough to produce all the medical care, food, and shelter required by the elderly, or everyone else, for that matter.”

Let me be the 1st to question it then. I question the ability of working aged people to simultaneously care for two generations of non-workers. The demographic bomb has only blown up since about 2000 in western Europe and Japan and living standards have dropped in both places. In the younger US only the leading edge of a 20 year wave of baby-boomers have hit.

Social Security is solvable simply by lifting the cap on high earners. Make no mistake that’s a massive tax increase on high earners. At least 5x the one that just went into effect… but even if you stick it to the rich that hard you still have the full brunt of Medicare to deal with.

Only a move to a preventive/palliative care system solves that problem and surgeons & seniors will fight tooth and nail to preserve their tax payer funded joint replacements. The right probably needs to wake up to the idea that taxes will have to go up AGAIN. The left needs to open their eyes and realize that the demand for age defying medicine is virtually unlimited and the better you get at it, (ie the longer you keep people alive) the more care you need to deliver the following year.

Posted by y2kurtus | Report as abusive

I don’t think this is quite right.
The point is that there are investments that we can make today which have a longevity sufficient to displace future labor requirements. For example, replacing a bridge that is going to fall down means that the workers of tomorrow won’t have to do that and therefore they may be freed to work on health care for seniors. Investing in armored Humvees is unlikely to provide these long term benefits. While basic technology investments can satisfy this requirement also, more applied investments likely will not – e.g. the invention new type of transistors might be good versus the design of new iPhones which would contribute little. Up to an overall efficiency factor, I think it makes relatively little difference whether the investment is made by the public or private sector.

Posted by jfield | Report as abusive

y2k, I meant as a society we can produce all of that stuff, and more. However, it will require changing the distribution of work and income from the current model. Whether that will happen is another story.

The price of health care is distorted by the number of people who don’t pay for it, and how it is paid for. It’s not a question of do we have enough man-hours to provide all that care, or produce all of the equipment and medicine., but more so of our national policies and belief systems.

Posted by KenG_CA | Report as abusive

The biggest problem is a lack of confidence, both in the markets, and in government.


Wall Street has for the most part been able to block any meaningful reform that would prevent a reoccurence of 2008. Banks are still “too big to fail”.

The federal government, thanks to the obstructionist tactics of the GOP, has been unable to address many of the important issues facing the country, such as our crumbling infrastructure, the education system, etc.

Add the two together, and you get a lot of scared and pessimistic investors….and a market so insular that it has become totally out of touch with reality.

Posted by mfw13 | Report as abusive

@Fifth, the CBO estimates put out last year suggested that allowing the planned tax hikes and spending cuts to take hold would reduce GDP by roughly the same amount that they were projected to reduce the deficit. I’m sure you can dig up those reports as easily as I.

My other reference is the recent “Credit Supernova” essay from Bill Gross, arguing that today it takes $20 of new credit to produce $1 of new real GDP. Particularly disturbing is the suggestion that the efficiency has fallen by a factor of five since the 1980s, and continues to fall.

I am distrustful of “dusty textbooks” in this environment for the very reason that they are dusty. Macroeconomics is an art, at least as much as it is a science, and the economy is very different today than it was 30 years ago.

In any endeavor, those who trust in their complete understanding are dismissive of evidence that challenges this understanding, and thus get left behind in any and every paradigm shift. I fear that mainstream economists have fallen into this trap.

Posted by TFF | Report as abusive

TFF, be careful when comparing credit (which can include consumer credit and corporate credit, naturally) and debt (which I assume you are associating here with Government debt). Since consumers in the US love buying cheap imports from China on credit, a lot of the boost from the manufacture of those same goods – although borrowed in the US – actually increases Chinese GDP. Government spending on the other hand is mostly spent in the economy where it originates, so may actually be the debt sector with the best ratings for GDP creation. After all, if the government pays for healthcare, the Doctors and nurses and cooks and chefs and cleaners and admin staff et c do not do those jobs in China – they do them in the US.

Posted by FifthDecade | Report as abusive

The major problem facing democracy in America is the wholesale corruption of the US Congress. Every elected rep needs to be investigated. Charges need to be filed. It’s time to out the true criminals. Only way to save America …

Posted by Woltmann | Report as abusive

Good points, Fifth, but a drain anywhere in the economy still limits the power of recycling economic activity. Government spending may be the most efficient form, since it gets spent once in the US before its effects spread globally, but I still see signs that the multiplier is declining.

Posted by TFF | Report as abusive

I accept the multiplier may be changing, up or down, and it may even vary according to the economic cycle. In fact, we have been living through extraordinary times not seen since the 1920s. The mistake they made then was to increase interest rates in order to try to stop speculative borrowing wiping people out, but we now know they needed to reduce rates. So in the post-2008 world we’ve copied the solution we didn’t use back then (lower interest rates) but failed initially to do anything about the credit crunch which is the real problem.

With the government being pretty much the only entity feeding liquidity into the market, cutting that *now* can only harm growth, jobs, and future government revenues. Wait until the economy is back on its feet and then cut back the debt.

Posted by FifthDecade | Report as abusive

The danger, Fifth, is that we wait so long to cut back that we haven’t done so by the next recession. The economy might not be booming, certainly isn’t healthy, but it is once again moving in a positive direction. By this point it ought to be able to absorb at least small reductions in the federal spending.

Posted by TFF | Report as abusive

I understand what you are saying about timing – certainly in investment markets it is impossible to predict accurately. But with the economy there are a number of leading indicators that can be very helpful – eg unemployment/jobs figures and housing starts.

The danger is people on the right clamouring for tax cuts as soon as they think there is any money coming in to government coffers. That’s the money that should be used to repay the debt.

As for the spending, increase the tax revenues through growth and it shrinks of its own accord as a percentage which is all economists are really concerned about. Furthermore, if one finds it hard to tell the difference between stimulus spending and bailouts on the one hand, and normal and necessary everyday spending on the other… Well, it’s easy to shrink the education budget thinking its a cost when in fact it should be listed as an investment in the future. Ironically it is the private sector that shouts the benefits of “Human Capital” but for some reason governments don’t see it the same way, and see it as a cost – except in places like Germany, Switzerland and the Far East. Guess which economies are doing well right now?

As Felix says, Health spending across most G20 countries costs less per unit when paid for by Governments than when paid for through the private sector – Government spending here is the most efficient. While this cannot be said for defence spending or pork belly spending, these are unlikely to be significantly cut while Washington works the way it does.

Posted by FifthDecade | Report as abusive

@Fifth, I would like to recommend the following article to your attention — it puts my position better than I ever could myself:

http://www.huffingtonpost.com/jeffrey-sa chs/professor-krugman-and-cru_b_2845773. html

I could and would support a long-term program of spending on infrastructure, education, and public well-being. Unfortunately economists have convinced themselves that it doesn’t matter what the money is spent on — paying people to dig holes and fill them in again is equivalent to paying people to build things that will last for generations. That is obviously false!

Will also note that union rules and corporate profiteering make it exceptionally expensive for the federal government to invest in the future. Federal sector wages/benefits are $10/hr higher than for comparable private sector jobs according to the CBO. I could imagine hiring legions of unemployed at $30k/year to build, clean, landscape, and care for the nation and its citizens. But paying federal wages/benefits of $100k/year, that is no longer financially feasible.

Posted by TFF17 | Report as abusive