The "Fly" In Ryan's Budget Ointment
In the last few days there have been a litany of articles written both in favor of and against Paul Ryan's proposed budgetary plan. (See here, here, here, here) Before I get into the major overriding "fly" that no one is addressing, let me just say the Ryan's proposal, while far from perfect, is at least a plan - which is more than we have today.
The problem with the proposal, and in fact all proposals presented so far, is that they are all identical in their dependence on increasing economic growth rates while at the same time cutting debt and reducing spending. The problem is that those two goals are diametrically opposed to each other in an economy that is dependent upon the latter.
My recent post on why 4% economic growth will remain elusive speaks to the very core of this problem. In an economy that requires $4 of debt to create $1 dollar of economic, growth implementing austerity measures to reduce debts and deficits will reduce economic growth - not increase it. This, in turn, will create lower revenues with which to reduce the debts and deficits on the government's balance sheet, and the expected "savings" will be vaporized by the debt service requirements on the current debt levels.
Secondly, the current level of anemic economic growth in the country depends upon the consumer. 70% of current GDP is based upon personal consumption. Unfortunately for Ryan's plan, roughly 35% of personal incomes which are used to reach those consumption levels currently comes from government transfers. Working to reduce the governmental assistance programs, when such a large portion of personal incomes depend on it, will not be a boon to creating the economic growth needed to make the plan work in the future. The problem lies in the demographics.
There are over 70 million individuals currently moving into the retirement system. This demographic shift will further complicate the net drag on savings – which are integral to productive investment and the creation of an expanding economy – as well as the increased demand on welfare and healthcare programs. While Ryan's budget plan proposes changes to these systems, which are most definitely needed to keep them viable in the long term, the near term impact on economic growth will most definitely be felt.
The final piece of the equation comes down to interest rates. All of the proposals that have been submitted by both parties not only fail at examining the impacts to economic growth but also assume a low interest rate environment into the future. The current level of historically low interest rates, which have been artificially manipulated by the Federal Reserve though a variety of spending intensive programs, most likely cannot be sustained indefinitely without ramifications to economic growth.
Japan has learned this lesson from experience as maintaining ultra-low interest rates, combined with an aging population, has led to very anemic economic growth and a depletion of savings over the last 20 years. And if interest rates rise due to inflationary pressures or as a normal result of the supply/demand balance in the open market, then many of the assumptions contained in the budget proposal go out the window.
The time to implement austerity measures is when you are running a budget surplus and are close to full employment. That time was two Administrations ago when the economy would have slowed but could have absorbed and adjusted to the measures. However, when things are good, no one wants to "fix what isn't broken". The problem today is that with a high dependency on government support, high unemployment and near record budget deficits implementing austerity measures will only deter future economic growth, which is dependent on the very things that are needing to be "fixed".
Don't misunderstand me - we need a plan and we need to take action. Ryan's plan is as good as any that have been proposed and the debates that will take place will hopefully yield a plan that will truly began to set us back on the course of long term sustainability and growth. However, in the near term, there is no way to achieve those goals "pain-free". Sacrifices will have to be made, the economic will drag an subpar rates of growth, individuals will be working far into their retirement years and the next generation of Americans will lead a far different life that what the currently retiring generation enjoyed. It is simply a function of math.