Why Economists Are Confused

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- Jim

As you know, the crystal ball of all economists remains murky these days. This results in a wide range of opinions about the economy for the next year or two. The biggest issue is whether PCE will stay around 70.0 percent of GDP or decline as consumers return their debt-to-income ratios to the 90.0 percent or so that was ” normal” in the 1990s or if they’ll return to more recent spending patterns with debt ratios around 110.0 percent. If the former develops (Ian Shephardson is quite articulate in this camp), then consumers will save much more than in the last 3 decades and the US economy will be on a permanently lower growth path. Variations on this theme fuel the predictions of Nouriel Roubini, who is not in any forecasting panels, and Rajeev Dhawan, who is.

If consumers find a way to keep spending (drawing down assets or finding new ways to raise their incomes) then the recovery will be robust. No one knows how this will turn out, so the arguments are endless and occasionally, even interesting.

Perhaps more harrowing than the prospect of slow growth is the oncoming bankrupcty of the US. The Pete Peterson- and Rudy Penner- or Larry Kotlikoff-types keep talking about the $55-75 trillion net present value of the deficit. Click here to read the full post and comment (Insights subscribers) »

Thoughts on Health Care Reform

The President’s Council of Economic Advisers released a 50-page report making the case for “health care reform.” It alleged that reform could, over twenty years, raise family income by $20,000 (assuming a reduction in health care cost growth by 1.5% a year) and covering the uninsured would increase “net economic well being” by $100 billion a year. But, just how is the reduction in the growth of medical care costs going to be accomplished? Great Britain and Canada control health care costs by deciding how much to spend and then rationing care to meet the target. Generally this means that older people get less care. Ask my students what “a dollar spent on Dr. Dunk’s health care” is and they will reply, “a bad investment,” recognizing my advanced age and a budget constraint – we can’t spend an infinite amount of money on anything, so a dollar spent on my health care is a dollar not spent on a young person who would be productive for a lifetime. Such thinking makes people uncomfortable, but such choices are a necessity. We tolerate 50,000 auto deaths a year so we can drive fast. These are choices we make.

In our last assault on health care costs, we were told that we had a “health care crisis” because we spent an amount equal to 12% of GDP on health care. But people choose to make these outlays, they are not compelled to. Part of this is due to a mispricing of health care services. You might pay $5 for a doctor visit with your insurance, but doctors won’t work for $5 a visit. When visits are cheap, we take more than we would if they were accurately priced. In short, we take too many visits because they are underpriced, just as we buy more apparel at a half price sale. Compounding this, states require many procedures be covered in basic insurance that most people wouldn’t use. This raises the price for everyone, and subsidizes the few that take those services. Case in point, Medicare covers penile implants. Quality of life and all that. Medicare costs are out of control. Most of this money is spent in the last few months of life.

Most medical and drug innovations originate in the U.S. Once available, everyone wants the “best.” Always expensive, but we all can’t drive a Cadillac to work. Yet our politicians claim to want access to the “best” for everyone, an impossibility.

How we finance medical care does need to be changed. Health care insurance is provided by employers because Congress made it a tax deductible cost decades ago. All other insurance we buy from competitive providers. Auto insurance doesn’t cover oil change and maintenance for the car, it only kicks in when there is a “disaster.” Health care insurance typically pays for everything, “tune ups” (check up), routine maintenance, etc. Necessary, but this should be the responsibility of the consumer, not the insurer. Catastrophic health care insurance that covers serious “accidents” is not expensive, but “prepaid medical care” (which most of us have) is very expensive!

What to do: (1) make health care benefits taxable (Obama would love this, companies would get out of the business of helping health care insurers manage their insured, workers would get the cash and shop for the health care package that fits their needs. At the moment, I have no health care choice, just what someone at my employer negotiated for me. One size fits all?); (2) price medical care appropriately, no “free visits”; (3) let providers compete for customers; (4) provide a catastrophic insurance that removes the risk of financial ruin (how about you pay up to 10% of your income, the rest is covered?).

Be Afraid, Be Very Afraid

In a front page story in USA Today, on May 29, Dennis Cauchon laid out the stark picture of how deep a hole Congress has dug for all citizens of the US. The net present value (NPV) of all the commitments that Congress has made added up to $546,668 for every household in the country in 2008. That was an increase of $55,000 or 12.0 percent per household.

The total NPV was $63.8 trillion at the end of last year. That dwarfs our $14.3 trillion in GDP in 2008 and is 23.9 percent larger than the $51.5 trillion in net worth held by consumers on December 31, 2008.

By far the biggest problem is Medicare. It accounts for $284,288 or 52.0 percent of the obligation per household. Social Security is second at $160,126 or 29.3 percent. The two entitlement programs combined account for $444,414 or 81.3 percent of the total.

There are no simple and obvious solutions or Congress would have used them by now. One possibility is a flat tax on consumption with a cap on total spending for Medicare. Social Security can be solved by raising the retirement age in the future (ten years or so from the change) and indexing the annual increase in benefits to wages rather than prices.

The national debt accounts for only $54,537 per household. That part is manageable.

The debate on how to resolve this huge gap between commitments and reserves to pay for them will consume increasing amounts of time until the situation is resolved. That is unlikely to be soon. Sadly.