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July 19, 2006



While financers always like to compare a dollar now with one in the future, I really think this is a flawed concept at the macro level. What a dollar means for a society changes too much over time. An excellent comment on this is

Brad Setser from http://www.rgemonitor.com/blog/setser/136463#readcomments

I am actually not a big fan of the Kotlikoff style analysis.

That isn't to say that he doesn't have a point -- meeting the United States pension commitments likely implies higher taxes. But the obvious solution for some of the fiscal gap identified is higher taxes. The Kotlikoff style calculations of the NPV of future pension promises assume that current revenues don't adjust.

Apply this technique to Social security and its finances look bad -- since there is a 1.5 to 2% of GDP fiscal gap between dedicated social security revenues and likely promises (tho a lot depends on demographics/ immigration) from say 2050 to eternity. That isn't great -- but I also don't think there is any fundamental reason why social security taxes couldn't be increased to 6% of GDP (from @4.5% now) to cover future costs.

Particularly since social security is by far the united states most effective program of wage insurance (just retirement wage insurance) and best way of insuring many folks against the down side risks from globalization.

Medical program finances are in worse shape. But as lots of folks have noted, that is also true of private medical programs. There is a much bigger issue here. And having spent a little bit of time w/o health insurance, I can say that there are a range of problems in the health system -- problems with access as well as problems with rapid cost growth and the gov's unfunded commitment to pay future medical expenses.

what I dislike about this style of analysis is that is implicitly tends to downplay current cash flow gaps at the expense of future cash flow gaps, and it prioritizes fiscal gaps rather than external payments gaps.

i assure you that if you did this kind of analysis with a trade revenue stream from exports of 10.5% of GDP and an import bill of 16.5% and project that out from now til eternity, you have a much bigger problem than social security's 1.5 to 2% of GDP cash flow gap after 2050. (remember soc security still has a cash flow surplus). Yet the Kotlikoff style analysis -- and the political priorities that follow from it -- put a premium on fixing entititlements by scaling back future promises -- while often ignoring what strikes me as a far bigger problem. The huge cash flow gap between US external revenues (exports and perhaps income payments on FDI) and US external spending (imports, payments onFDI in the US, increasingly interest payments). The external side of the US looks to me to be far more bankrupt than anything on the domestic side it you assume unchanged exports and imports and don't believe in dark matter so interest payments will rise over time, and it has a far bigger cash flow gap.

And remember that the rest of the US gov is actually more unfunded in lots of ways than the entitlements side -- it is just harder to project those costs out because they aren't mandates and don't depend as directly on demographics. but the cash flow gap ex social security right now is far larger than the projected social security cash flow gap in 2050. It just is a lot harder to forecast out the rest of the gov, so lots of analysis ignores it and just hits at entitlements.

Sorry - i had to get that off my chest. And I haven't yet read kotlikoff's latest -- so i am basing my critique of the general methodology of all those who calculate the NPV of future US commitments 9mostly entitlements) and compare them v. expected revenues.
Written by bsetser on 2006-07-16 10:35:41


Thanks Lord (What a nice ring that phrase has!)

I sometimes think that the world would be a better place if second-rate bloggers like me would just stop blogging, and give the first-rate bloggers -- like Roubini and Setser and the rest on, say, my "Top Shelf" sidebar -- more chances to attract attention. That reminds me, I need to move Barry Ritholtz's THE BIG PICTURE up to the top shelf.

As I moved through developing the post, I began to think more and more that the whole affair was more politics than economics. But I decided to post it anyway, if only to prod me (and evidently you) into thinking it through a bit more.

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