Misguided Fiscal Policy: Is it a case of fool’s gold, or the consequences of economic ignorance?
A number of pundits have been telling the public that when the Obamacare becomes effective, many older workers will retire early and pay the health care penalty [tax] as Chief Justice Roberts insists it to be understood as, or continue to apply for permanent disability; and once either is achieved, their problems are solved, i.e., until they cross the scriptural bar to eternal life.
Who really cares, if for example the Labor Force Participation Rate remains low or even decreases further? Why does it matter if fewer people are in the labor force (Labor Force = Employed + Unemployed), as long as the unemployment rate falls (Unemployment Rate = Unemployed as a percent of the Labor Force)?
Hold on a minute!
Let’s go back to Economics 101 and review the basics of coping with scarcity, which is why economic systems are formed in the first place. Ideological rhetoric is fine for stirring up the masses but has shown it ends up causing a lot more serious problems than had existed when the revolution occurred. It also results in tens, if not hundreds of millions of people like you and me being killed in the process. In recent memory, there were the fascists and communists. How about Nazi Germany and the communist Soviet Union for starters?
BACK TO THE BASICS: a society copes with scarcity
All of us cannot have all we want of everything we want, aka, scarcity. To produce the goods and services all of us want require the transformation of limited productive resources that exist (labor, debt and equity capital, entrepreneurship, and land) in a process termed, production.
The nation’s Gross Domestic Product or GDP is the aggregate of market values for all goods and services produced during a period of time such as one year. Note that we cannot and do not simply add the myriad of goods and services produced. We can, however, aggregate or add the market prices of said goods and services. That is the real meaning of one of the definitions of money; money as the unit of account.
Unfortunately, the value of money changes as the price level or average of prices changes. When prices on the average rise, it is termed inflation and reduces the real value of a nominal amount of money. When prices on the average fall, it is termed deflation and increases the real value of a nominal amount of money. To eliminate the changing value of money as the unit of account, the nominal GDP must be adjusted to arrive at the real GDP. Using Real GDP is necessary to compare [Nominal] GDP and its changes over time.
GDP includes the goods produced to replace the capital goods that have worn out or have become obsolete. When this depreciation of the capital stock is netted out, what is left is called Net National Product or NNP and is available for current consumption (Personal Consumption Expenditures – PCE), Gross Private Domestic Investment (GPDI), Government Consumption Expenditures and Gross Investment (GCE&GI) and Net Exports. Imports add to the Net National Product and are available for these types of spending.
Usually Imports of Goods and Services are netted from Exports of Goods and Services to arrive at Net Exports of Goods and Services (NEGS), often referred to simply as Net Exports which is equivalent to the term, Trade Balance. When such exports exceed imports, it is called a trade surplus and when such imports exceed exports, it is called a trade deficit.
U.S. Trade Deficit: Good, Bad, or Irrelevant? October 10, 2003
That, the GDP, is the total pie of goods and services that our economy has to distribute. If we want to grow the pie, we must either increase the productive resources, labor, debt and equity capital to finance the increased stock of capital goods, entrepreneurship, and exploitable land (natural resources and space) or increase the productivity of our productive resources by such things as investing in technological improvements and human capital.
The cost of growing the economic pie is that consumption (both personal and collective) must be reduced to free resources for growing the economic pie (the measure of which is real GDP).
Collective consumption (such as paying salaries for public safety, public officials, public school teachers, etc.) and collective investment (such as paying for the construction of a public road system that lasts for several years…hopefully) refer to government purchases and of goods and services plus government investment (currently called Government Consumption Expenditures and Gross Investment (GCE&GI)).
It is important that you understand the difference between Government Consumption Expenditures and Gross Investment (GCE&GI) [again, it was formerly referred to as Government Purchases of Goods and Services (GPGS)] and Government Transfer Payments (GTP), such as Family Income Allowances. The former is part of aggregate demand and is one of the sources of spending on the GDP. The latter is a subsidy to households that increases households’ Disposable Income. Both GCE&GI and GTP are financed either by government taxes or government borrowing. To the recipient, a transfer payment benefit is NOT currently earned, that is, it is NOT the reward for the households’ [currently] supplying of productive resources in the transformation process called production. Since they are paid for by government taxes or government borrowing, it simply reflects the fact that there are no true free lunches. Somebody pays even if the recipient of the ‘lunch’ does not. Also, remember that when government borrows to finance its spending that results in a tax burden for debt service (interest and retirement of debt).
Total government spending is the sum of GCE&GI and GTP. If the total of government spending exceeds government revenues, which are overwhelmingly taxes, a government budgetary deficit occurs. This causes the outstanding government debt to increase.
The following charts reflects the current figures related to the discussion above and in most cases contrasts them with earlier periods to show the changing picture.
Be sure to realize that interests rates are currently well below long-run averages as a result of the weak economy and the policies of the Federal Reserve Authorities. This causes the understatement of the future burden of debt service of all governments. It also should warn investors that when such interest rates eventually rise toward their long-term averages, it will trigger the realization of interest rate risk as the market prices of existing government securities fall, as well as those private sector debt securities. This is due to the inverse relationship of the market prices of debt securities to interest rates. The risk is lessened if the debt securities are adjustable, but they are a relatively small portion of outstanding debt securities.
If we want more collective consumption and investment or more transfer payments, which are funded by government taxes or borrowing, aggregate spending by the rest of the economy on goods and services must be reduced, including personal consumption. This can only be avoided if the overall economy is growing sufficiently. Unfortunately, many government spending policies are anti-economic growth in their effects, especially if the government attempts to fund them with tax rate increases.
If we attempt to import more than we export to add to domestic production, our nation will incur a trade deficit and we will have to borrow from other nations to finance the trade deficit. This is the major reason some European nations such as Greece and Portugal are facing default on their international debt. Their debt burden is restricting personal and collective consumption and is the major cause of political unrest often leading to riots. We have come close to it recently in some of the states in the Great Lakes’ region.
What happens when workers retire as the pundits tell us will happen in significant numbers as Obamacare gradually takes effect? They will stop producing goods and services, and begin to liquidate their pool of retirement funds making debt and equity capital more scarce, etc. In short, the size of the economic pie from which we all must obtain the goods and services we want, will necessarily shrink. We are now experiencing increases in labor going into permanent disability status, also reducing the labor force participation rate. We are beginning to look a lot like Europe.
Disability Ranks Outpace New Jobs in Obama Recovery
By JOHN MERLINEJOHN MERLINE INVESTOR'S BUSINESS DAILY
“The economy created just 80,000 jobs in June, the Bureau of Labor Statistics reported Friday. But that same month, 85,000 workers left the workforce entirely to enroll in the Social Security Disability Insurance program, according to the Social Security Administration.
The disability ranks have outpaced job growth throughout President Obama's recovery. While the economy has created 2.6 million jobs since June 2009, fully 3.1 million workers signed up for disability benefits.”
This is the ultimate significance of any reduction in the Labor Force Participation Rate – whatever its cause: a shrinking labor force shrinks the size of the economic pie from which we all partake.
When the economic pie is NOT growing or even worse, when it is shrinking, those who receive more for whatever reason, i.e., a bigger slice of the economic pie, others will receive less; i.e., an absolutely smaller slice of the pie, not just a relatively smaller piece.
This is the real meaning of the terms income redistribution.
Only if the economic pie grows and becomes larger, can we lessen this conflict. With or without the rhetoric of redistribution, the conflict will occur. Look at Greece and other European nations when they attempt to address the problems of income and wealth redistribution. Do not take the lesson lightly. For most of us, our roots are at least partly European; just the same, Africa, Asia, and South America, are not experiencing domestic tranquility, either. Perhaps the penguins of Antarctica are the exceptions!
This website has presented in several newsletters, the reasons for income inequality. Some are justifiable and necessary in coping with scarcity. Others are not and on a per capita or average basis, and cause more scarcity rather than less. Households (human beings) that supply more productive resources, including more hours per work year (sacrificing more leisure) or are more productive due to the sacrifice of embodying in themselves more human capital and supplying more of other types of productive resources such as debt and equity capital (savings), to the transformation process called production, earn and deserve more income as a result. Households (human beings) that defer more consumption, i.e. save and take greater risks as they invest, earn more and in the context of commutative justice, deserve more. And so it goes for all productive resources. Equity is not equality!
However, when productive resources are emplolyed by firms that have market or monopoly power, for reasons we have examined in these newsletters posted on this web site, they can earn incomes that are excessive or inequitable. As Shakespeare said, “Ay, there's the rub.”
This market or monopoly power means the firms or groups of productive resources such as labor unions, by reducing supply, can earn more than what is equitable. Ill-conceived laws, or inept enforcement of even good laws that regulate the degree of competition in the product and productive resource markets, result in an INEQUITABLE income distribution. It is more unequal than is needed and destroys EFFICIENCY as well; such market or monopoly power also tends to cause higher unemployment rates than would otherwise occur and tends to also to introduce into the economy, an inflationary bias bringing us periods such as occurred in the late 1970s.
If income redistribution is solely to reduce this excessive inequality arising from the exercise of market or monopoly power that results in inequities and inefficiencies, it is not due to capitalism but to the refusal to pass legislation to assure significant competition and/or to the inept, even if not corrupt, anti-trust authorities, legislatively mandated and well compensated to enforce the many laws on the books.
Referring to the timeless, Adam Smith:
“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
THE CONSEQUENCES OF ECONOMIC IGNORANCE
It is predictable, indeed the evidence is already beginning to appear, that redistribution schemes that fail to distinguish between EQUITY and EQUALITY will initiate economic meltdowns. We must promote competition to prevent excessive inequalities and inequity in the distribution of income from happening in the first place and the need for redistribution will diminish significantly.
Before you act rashly and assume your lunch will be paid for by others, remember that when the problems mount from ill-conceived redistribution schemes, some will have to be thrown under the bus. A word to the wise should be sufficient.
It is always easier to lock the barn door so the horse does not run away than to give chase to the horse pursuing its self interest. “An ounce of prevention is worth a pound of cure.”
Pearls of wisdom spoken by those of the past
1. We are ignorant of history or we ignore the lessons of history and as George Santayana warned us: “Those who cannot remember the past are condemned to repeat it.”
2. Recall the words of Alexis de Tocqueville: “The American Republic will endure until the day Congress discovers it can bribe the public with the public’s money.”
3. Reconsider the words of Margaret Thatcher: “"The problem with socialism is that eventually you run out of other people's money.”
4. Or is political chaos inevitable when elected representatives are so generously compensated and desire to be elected for life and political campaigns cost in the billions of dollars.
“And remember, where you have a concentration of power in a few hands, all too frequently men with the mentality of gangsters get control. History has proven that. All power corrupts; absolute power corrupts absolutely.”
Lord Acton (John Emerich Edward Dalberg-Acton)
5. Perhaps it is all of the above.
Please God, bless America.
The following charts address some of the issues examined above.