May 4, 2012

Game Over for the American Dream? 3 Economists’ Bleak Answer

Laurence Kotlikoff, candidate for president for Americans Elect, says the government’s excessive spending habit amounts to “fiscal child abuse”

Laurence Kotlikoff, an economist and candidate for president on the Americans Elect third-party platform, says the government’s excessive spending habit amounts to “fiscal child abuse” and has played “a major role” in the current economic malaise.

Laurence KotlikoffIn a scholarly article published Friday, Boston University’s Kotlikoff together with Richard Evans and Kerk Phillips, both of Brigham Young University, argue that conventional econometrics fail to dynamically account for risk to future generations.

Turning to concepts such as “generational accounting” to obtain what they regard as a more precise understanding of the fiscal imbalance caused by growing government debt, results in “a picture of the fiscal positions of countries that is wholly different from that based on official debt,” the economists write.

So, for example, by incorporating present values of projected future spending and taxes, the three economists find that U.S. government liabilities exceed assets by $211 trillion, or 14 times GDP. “This fiscal gap is formed using congressional budget projections and appears, when scaled by GDP, to exceed those of all other developed countries,” the authors write.

Kotlikoff, Evans and Phillips also use an alternative method—a simulation approach—to evaluating U.S. government finances by asking how long current spending can continue until reaching what they call “game over.”

In their simulation, “the government takes … a fixed amount each period from the young and hands it to the old, independent of the state of the economy … When the hit on the young exceeds their earnings, the game is over, with the government either extracting all the income of the young and terminating the economy or switching to a new policy regime, which leaves the young with something to eat.” The simulation produces an average duration of “roughly one century” to game over, “with a 35% chance of reaching the fiscal limit in roughly 30 years.”

Aside from the lack of generational unfairness, the economists note the serious collateral damage the U.S. spending habit, which they refer to as a “Ponzi scheme,” has had on wage growth. They write:

“In taking from young savers and giving to old spenders, which Uncle Sam has spent six decades doing on a massive scale, the lifecycle model predicts a major decline in U.S. net national saving associated with a major rise in the absolute and relative consumption of the elderly. This is precisely what the data show.”

Thus, the U.S. savings rate in 1965 was 15.6% compared with just 0.9% today, and this decline in saving “has coincided with a spectacular rise in the consumption of older Americans relative to that of younger Americans.” The economists say the reduced savings rate has meant a reduced rate of investment—from 14% in 1965 to 3.6% in 2011, thus suppressing real wage growth.

“Indeed, the level of private-sector average real earnings per hour, exclusive of fringe benefits, is lower today than it was 40 years ago,” the paper says.

The economists warn that a continuation of these trends will drive the savings rate (which reached -1.2% in 2009) into permanent negative territory, taking investment and real wage growth with it. This, together with the massive tax burden being heaped on the young, “will transform the American dream into something it has never been—just a dream,” the authors conclude.

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