When will voters care about the deficit?

A LOT of folks in Washington are busying themselves talking about America's federal deficit and debt issues. The deficit has obviously been forced to the front page by the sense that bond markets have had it with America's borrowing:
Come to think of it, markets don't seem that frightened of American debt, do they? But of course, public outrage over government red ink is also driving the issue to the forefront:
Huh. It actually looks as though the public doesn't care about the deficit either, at least relative to the state of the general economy. So why is the deficit such a big issue right now, at least in Washington?
The short answer is that President Obama has given the press a nice news peg in the form of the impending release of a report from his deficit reduction commission. Another question, then, is why the president felt the need to appoint a deficit reduction commission. And the answer there is some combination of "the deficit actually needs to be addressed" and "the president felt there was a political weakness that needed defending". Why the president felt a weakness on deficits is another, mysterious issue. While the deficit has risen significantly on Mr Obama's watch, much of the rise has been due to economic weakness, and one would have thought that the Republicans would have lost all deficit credibility after their performance during the Bush administration. But that's another matter.
The deficit actually needs to be addressed. As the economy recovers over the next couple of years, the deficit will decline. It will only decline, however (and depending on what Congress does), to the nearly but maybe not quite sustainable range of 3% to 5% of GDP, and it will then begin rising again around mid-decade, thanks mostly to increasing entitlement spending. By the end of the decade, America's debt-to-GDP ratio will be at troublingly high levels. And at some point between now and then, probably in a couple of years when America's economic slack has largely tightened up, interest rates will rise. Depending on how high and how fast they rise, America's economy will experience something between a slight drag on growth and a serious crisis.
All right, so America has both medium-term and long-term budget issues that need to be worked out, and the medium-term issues should ideally be worked out within the next couple of years. But there's no real sense in which the deficit is an emergent issue in America, in the way that a 9.6% unemployment rate is. Voters must be a little perplexed by the obsession with deficit issues. Either that, or they're internalising the view that fixing deficits is somehow emergent and/or crucial to economic recovery. But then you'd expect more people to put deficits high on their list of top concerns.
There is a very sensible view of deficit issues, broadly embraced by The Economist, which entails medium-term deficit reduction as a means to create the fiscal room for more stimulus. Take the bond market vigilantes out of the equation, and there's no way for stimulus opponents to cite bond market vigilantes as a reason to oppose stimulus. Peter Orszag has made a monetary version of this argument, suggesting that if medium-term fiscal issues were dealt with then the Fed wouldn't have to work as hard to hold rates down and there would be less fretting about debt monetisation.
As I said, these are sensible views. If I could point out troubles with them, one would be that, other than always just around the corner, it's difficult to spot any American bond market vigilantes. (They're all on holiday in Dublin.) The other would be that polling consistently finds that Americans are much more concerned about the economy than about the deficit. And it's a little difficult for me to spot the political path that runs from the present position through tackling the thing Americans aren't worried about and then on to handling the thing Americans are worried about. Maybe there's a path there, but it's sufficiently poorly marked that you're likely to lose your way before reaching the final destination.
Meanwhile there's this other route that looks relatively straight and clear. Boost growth now, through fiscal expansion if possible. The more rapidly you boost the economy, the sooner government debt looks like a lousy investment relative to other options and the sooner rates rise, giving deficit hawks an actual threat to point at. The more you boost the economy in the short run, the bigger a cushion there will be to protect against the contractionary impact of forthcoming austerity, and the bigger a role the natural winding down of automatic stabilisers can play in deficit reduction. And of course, by tackling the economic situation, one frees the voter's mind to concentrate on other issues—like the deficit. Who knows? In a couple of years' time, voters might actually be worrying about red ink.
Obviously, there are downsides to this approach, the biggest of which is a failure to insure against a sudden turn in market sentiment against American government debt. A responsible, reasonable, forward-looking government would clearly go for the pre-emptive consolidation planning. But suppose one lacks a responsible, reasonable, forward-looking government? Suppose legislators leap blindly from issue to issue, depending on what looks at a particular moment like the greatest threat to their electoral prospects? In that world, I'm not sure the clearer path doesn't promise better odds at achieving both strong recovery and eventual deficit cutting.

The non-cash benefits of Social Security

WHAT exactly do we get out of Social Security? Last week Karl Smith pointed out that young people seem to think we get a lot, as polls show they're willing to pay higher taxes rather than cut Social Security. He proposed that since they're the ones who'll be paying the taxes 10 to 20 years down the road when Social Security runs into trouble, perhaps we should honour their preferences. Megan McArdle responded by making the excellent point that many of those young people are likely to change their minds over the next decade or two: people tend to get more concerned about taxes once they actually start paying them. Mr Smith likes Ms McArdle's response, but suggests, if I understand it correctly, that there are good reasons from a small-government perspective why other programmes should be cut before Social Security:

There are important differences between pure transfers like Social Security and public goods like education and national defense. With education or defense there are society-wide benefits to estimate and important policy choices to be made regarding how much of the public good to produce and by what means. With a transfer you get out the same thing you put in: cash.
McArdle is right that since choices about Social Security restrict our taxing options that we can’t look at these programs in pure isolation. Still there is a fundamentally different sort of analysis going on. Social Security payments do not crowd out the private sector in favor of public goods. That basic trade-off does not have to be considered. If Social Security recipients want to buy iPads or shoes, American-made apparel or Chinese imports, it is up to them. Resources flow into the private sector under the direction of private individuals.

I think this is a pretty interesting point. It's not one that makes much difference, for me, in deciding whether to cut Social Security or something else, but for people with different ideological preferences it might. It's similar to the laissez-faire argument for pure cash transfer payments to the poor, rather than extensive social services or specific development initiatives. Which is an interesting argument.
The only thing that strikes me the wrong way in what Mr Smith writes, is the implication that we don't get any identifiable public good out of Social Security, because it's a "pure transfer" programme. I understand what Mr Smith is saying, but it still strikes me as a bit misleading. Obviously, all insurance programmes are pure cash transfers, but equally obviously, insurance programmes, whether public or private, provide something of value: namely security, peace of mind, hedging against risk. Retirement investments like annuities or Social Security are a type of social insurance. They provide guaranteed peace of mind about your financial future (at some minimal level) even if everything else goes to the dogs.
A universal public retirement annuity or pension, like Social Security, is a public good, even if it's intangible. (Don't get me into arguments that it's not a "public good" because pensions and annuities are excludable. A universal pension or annuity is by definition non-excludable.) Like all forms of insurance, Social Security allows people to do things they otherwise couldn't. If Americans had to worry that they might wind up in starvation-level poverty in their old age, they'd have to save more rather than spending on consumer goods, and they'd be more hesitant to take risks like changing jobs or careers. And as with any decision to insure yourself, this public good of social insurance costs money. The money our society spends to insure that its citizens won't be indigent in their old age is money that could be spent on something else. There is a modest opportunity cost there. But the public good that we're buying through that opportunity cost is a real one.
There's a temptation among those who want to reduce public spending on social insurance to minimise such intangible goods. In the health-care debate, arguments frequently surfaced that people don't need health insurance, they need health care. That's clearly not true; being insured against the possibility of getting cancer is a different kind of good from chemotherapy, and I want one of those goods right now, but not the other. Similarly, people who don't like Social Security tend to argue that it's a "Ponzi scheme" and so forth. This isn't true; it provides a good that is distinct from its transfers of cash from some people to others. The public good we get out of Social Security is universal insurance against dire poverty in old age. The programme probably ought to be made more progressive to bring it in line with that goal, but it's important to remember that this is the basic deliverable here.

Green view: How to save $300 billion

LAST time it met, in 2009, the G20 took a stand against a little discussed problem that unites environmentalists and economists: fossil-fuel subsidies. Over the course of the subsequent year, the nations contributed to a list of the “inefficient” subsidies they supported and the things they planned to do about it. So far, this list is unimpressive. According to an analysis of the G20 documents by Doug Koplow, who works with an environmental watchdog called Oil Change International, many of the countries are reporting only superficially, and the standards against which they measure themselves are far from uniform. Most damningly, none has as yet put a new subsidy-cutting policy on the table.
For a more objective view of the scale of subsidies for fossil-fuel consumers (as opposed to subsidies for production, which are a different kettle of fish) than that provided by the subsidisers themselves, turn to the World Energy Outlook of the International Energy Agency (IEA), a respected annual compendium of data and analysis. In the 2010 edition, released this week, the IEA puts the global total at $312 billion a year. The reduced energy demand that would follow on an abolition of these subsidies, it reckons, would be 5% of the world’s total, making it equal to the current energy consumption of Japan, Korea and New Zealand combined.
Some environmentalists try to turn this situation to their tactical advantage by comparing these figures to the much lower absolute level of subsidy given to renewables. This is a mistake in terms of logic, and quite possibly in terms of tactics, too. It is quite plausible to argue that the “size” of the subsidies in contention should be measured in terms of the amount of energy contributed. Since renewables contribute hugely less to world energy use than fossil fuels do, renewable subsidies ($57 billion in 2009) are already larger than fossil-fuel subsidies on a per-kilowatt-hour or per-tonne-of-oil-equivalent basis. Over and above that, renewable-energy boosters may not want governments to focus too closely on the benefits of cutting subsidies, lest they get a taste for it.
Better to eschew comparisons and concentrate on the straightforward case against the fossil-fuel subsidies, which is overwhelming. They encourage inefficient energy use, and they represent a lot of foregone export revenue in countries that produce oil and gas and at the same time subsidise their home markets (a common arrangement; Iran, Saudi Arabia and Russia are the three countries most invested in subsidising). Though they are often justified in terms of helping the poor, the lion’s share of the benefits—85% to 90%—typically accrue to those on middle incomes and the wealthy; the poor are typically not big energy users, and rarely drive. Money that could be invested in services the poor do need and use is spent on subsidising energy for the rest. And as Mr Koplow and his colleague Steve Kretzmann point out, subsidised fossil fuels for the rural poor can tip the balance away from renewable energy sources, such as solar, in the off-grid applications to which they are particularly well suited, and where they would otherwise be most competitive.
Subsidies can, if governments are willing to spend enough money, keep prices stable within a country even as they rise on the international market, which is another justification sometimes offered. But this is invidious. When some consumers are sheltered from a price signal, that signal has to get stronger in order for those who are facing it to take more drastic action than would otherwise be needed. Damping volatility in sheltered markets increases it in open ones. Fatih Birol, the chief economist at the IEA, points out that 95% of current growth in oil demand is coming from countries where the oil price is subject to subsidies.
And then there’s the climate. People obviously don’t need subsidies in order to produce carbon dioxide, but at the margin they help. The IEA estimates that removing all fossil-fuel consumption subsidies would reduce global carbon-dioxide emissions by 1.5 to 2 billion tonnes by 2020. Current emissions from fossil fuel are about 30 billion tonnes; but that potential 1.5 billion reduction is more than a third of the difference between business-as-usual emissions and the level needed to stand something like a 50:50 chance of limiting global warming to two degrees centigrade.
An attractive cut
One of the striking aspects of the IEA’s $312 billion figure is that more than a fifth of it comes from a single country: Iran. To get fuel prices as low as ten American cents a liter for gasoline (two cents for diesel) cost the government some $66 billion in 2009, according to the IEA: that’s $895 per person, or 20% of GDP. Saudi Arabia’s subsidy is actually higher per capita, but lower overall and under 10% of GDP; Uzbekistan’s is a remarkable 32% of GDP, but only $11 billion in total.
The outrageous subsidies are making Iranian industry inefficient as well as costing the government a bomb; the amount of energy used per unit of GDP in Iran has been rising by 1.6% a year since 1990, and the country spent about $5 billion in 2009 importing gasoline and diesel. Cognisant of the madness this all represents, the government has passed a new subsidy reform law aimed at moving the country to market-based prices by 2015, though, as the IEA notes, “the path to implementation is still unclear”. Among other things, driving up energy costs in a country that already has more than 10% inflation poses obvious problems.
Elsewhere there has already been some progress. The fall back of oil prices from their 2008 peak gave nations the possibility of reducing subsidies, which some, including China, took advantage of. Indeed while China’s subsidy is still quite large in absolute terms ($18 billion) consumers are paying 96% of market prices. Russian subsidies are falling; Indonesia hopes to get rid of its altogether by 2014.
Still, there remains a great deal to be done. As Mr Koplow points out, concerted G20 action will require common definitions of what a subsidy is and how to value it, as well as greater transparency from the countries involved. The case for removing such subsidies in general is obvious to all. The politics of removing each one in particular will doubtless prove trickier, even with better orchestrated peer pressure there to provide a helping hand. But there’s a lot of money to be saved, and good to be done, if countries can get this right.

China buys up the world

China buys up the world

And the world should stay open for business

Nov 11th 2010

IN THEORY, the ownership of a business in a capitalist economy is irrelevant. In practice, it is often controversial. From Japanese firms’ wave of purchases in America in the 1980s and Vodafone’s takeover of Germany’s Mannesmann in 2000 to the more recent antics of private-equity firms, acquisitions have often prompted bouts of national angst.
Such concerns are likely to intensify over the next few years, for China’s state-owned firms are on a shopping spree. Chinese buyers—mostly opaque, often run by the Communist Party and sometimes driven by politics as well as profit—have accounted for a tenth of cross-border deals by value this year, bidding for everything from American gas and Brazilian electricity grids to a Swedish car company, Volvo.
There is, understandably, rising opposition to this trend. The notion that capitalists should allow communists to buy their companies is, some argue, taking economic liberalism to an absurd extreme. But that is just what they should do, for the spread of Chinese capital should bring benefits to its recipients, and the world as a whole.

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• Chinese takeovers: Being eaten by the dragonNov 11th 2010

Why China is different
Not so long ago, government-controlled companies were regarded as half-formed creatures destined for full privatisation. But a combination of factors—huge savings in the emerging world, oil wealth and a loss of confidence in the free-market model—has led to a resurgence of state capitalism. About a fifth of global stockmarket value now sits in such firms, more than twice the level ten years ago.
The rich world has tolerated the rise of mercantilist economies before: think of South Korea’s state-led development or Singapore’s state-controlled firms, which are active acquirers abroad. Yet China is different. It is already the world’s second-biggest economy, and in time is likely to overtake America. Its firms are giants that until now have been inward-looking but are starting to use their vast resources abroad.
Chinese firms own just 6% of global investment in international business. Historically, top dogs have had a far bigger share than that. Both Britain and America peaked with a share of about 50%, in 1914 and 1967 respectively. China’s natural rise could be turbocharged by its vast pool of savings. Today this is largely invested in rich countries’ government bonds; tomorrow it could be used to buy companies and protect China against rich countries’ devaluations and possible defaults.
Chinese firms are going global for the usual reasons: to acquire raw materials, get technical know-how and gain access to foreign markets. But they are under the guidance of a state that many countries consider a strategic competitor, not an ally. As our briefing explains (see article), it often appoints executives, directs deals and finances them through state banks. Once bought, natural-resource firms can become captive suppliers of the Middle Kingdom. Some believe China Inc can be more sinister than that: for example, America thinks that Chinese telecoms-equipment firms pose a threat to its national security.
Private companies have played a big part in delivering the benefits of globalisation. They span the planet, allocating resources as they see fit and competing to win customers. The idea that an opaque government might come to dominate global capitalism is unappealing. Resources would be allocated by officials, not the market. Politics, not profit, might drive decisions. Such concerns are being voiced with increasing fervour. Australia and Canada, once open markets for takeovers, are creating hurdles for China’s state-backed firms, particularly in natural resources, and it is easy to see other countries becoming less welcoming too.
That would be a mistake. China is miles away from posing this kind of threat: most of its firms are only just finding their feet abroad. Even in natural resources, where it has been most active in dealmaking, it is not close to controlling enough supply to rig the market for most commodities.
Nor is China’s system as monolithic as foreigners often assume. State companies compete at home and their decision-making is consensual rather than dictatorial. When abroad they may have mixed motives, and some sectors—defence and strategic infrastructure, for instance—are too sensitive to allow them in. But such areas are relatively few.
What if Chinese state-owned companies run their acquisitions for politics, not profit? So long as other firms could satisfy consumers’ needs, it would not matter. Chinese companies could safely be allowed to own energy firms, for instance, in a competitive market where customers could turn to other suppliers. And if Chinese firms throw subsidised capital around the world, that’s fine. America and Europe could use the money. The danger that cheap Chinese capital might undermine rivals can be better dealt with by beefing up competition law than by keeping investment out.
Not all Chinese companies are state-directed. Some are largely independent and mainly interested in profits. Often these firms are making the running abroad. Take Volvo’s new owner, Geely. Volvo should now be able to sell more cars in China; without the deal its future was bleak.

Show a little confidence
Chinese firms can bring new energy and capital to flagging companies around the world; but influence will not just flow one way. To succeed abroad, Chinese companies will have to adapt. That means hiring local managers, investing in local research and placating local concerns—for example by listing subsidiaries locally. Indian and Brazilian firms have an advantage abroad thanks to their private-sector DNA and more open cultures. That has not been lost on Chinese managers.
China’s advance may bring benefits beyond the narrowly commercial. As it invests in the global economy, so its interests will become increasingly aligned with the rest of the world’s; and as that happens its enthusiasm for international co-operation may grow. To reject China’s advances would thus be a disservice to future generations, as well as a deeply pessimistic statement about capitalism’s confidence in itself.

The euro-zone crisis, again

Ireland’s plan for a brutal fiscal adjustment has done nothing to appease panicky bond markets. Portugal is also in their sights

Nov 11th 2010 | dublin

IN 2008 a strike by French and Spanish lorry drivers cut off the supply of components from Germany to Volkswagen’s Auto Europa plant, south of Lisbon, forcing the factory to close for a day. Two years on there is a more serious threat to the supply lines of countries on the fringes of the euro zone. The yield on Ireland’s ten-year government bond vaulted towards 9% on November 10th, 6.2 percentage points above the yield on safe German Bunds (see chart); Portugal’s topped 7%.

Such signs of distress may foreshadow a buyers’ strike that would eventually force both countries to turn to the European Financial Stability Facility, the euro zone’s rescue fund. At the very least, the panic should force the European Central Bank (ECB) to make bigger purchases of Irish bonds to stop a self-fulfilling run.
There are still some willing buyers for peripheral debt at the right price. On November 10th Portugal raised €1.25 billion ($1.7 billion) in a sale of six- and ten-year bonds, completing its fund-raising for this year. Portugal is aiming for a budget deficit of 4.6% of GDP next year, less than half Ireland’s target, though it has more debts to roll over. Ireland has no need to tap the markets soon: its debt-management agency has hoarded €20 billion of cash, according to Morgan Stanley (Portugal has squirrelled away €10 billion). That is enough to cover Ireland’s borrowing needs and bond redemptions well into next year.
Even if each government has a little breathing space, anxiety about public finances has eroded their banks’ ability to secure long-term debt finance, with knock-on effects for other types of corporate borrowing. Reliance on short-term loans from the ECB is worryingly high. Ireland’s banks fund 10.2% of their assets with ECB cash, according to Barclays Capital; the figure for Portugal is 7.2%. For now banks have access to ECB funds at its main interest rate, currently 1%, for up to three months. Some on the ECB’s council might have hoped soon to make the terms more restrictive, but that now seems unlikely. Portugal in particular has huge foreign debt, much of it channelled through its banks: some think this is the country’s main frailty. Fitch, a ratings agency, downgraded four of Portugal’s banks on November 8th, on concerns about funding.
Both Ireland and Portugal had hoped that bold efforts to cut budget deficits would appease bond markets and clear their funding channels. On November 4th Ireland’s government said that it planned budget cuts worth €6 billion (or 3.8% of GDP) in 2011. It will follow that with €9 billion of further measures in 2012-14. Details will be set out later this month in a four-year economic plan.

Our interactive Global Debt Clock calculates and compares all governments' debt

Portugal’s budget for 2011 was finally approved on November 3rd: the main opposition party agreed not to block it after securing a smaller rise in taxes and bigger spending cuts than first planned. The measures include an increase in the standard VAT rate and a 5% average cut in public-sector wages. The overall fiscal tightening in 2011, including actions announced earlier, will be an eye-watering 4.3% of GDP, estimates Julian Callow, at Barclays Capital.
It is hard for economies to prosper under this sort of fiscal squeeze. In Ireland the hope has been that clarity about the fiscal outlook might persuade consumers to save less and spend more. But taxpayers have barely had time to absorb the news that the cost of bailing out the banks will push Ireland’s budget deficit to 32% of GDP this year, even after raiding a fund set aside to pay for future welfare costs. They have now been told that a further €15 billion-worth of fiscal pain is still to come—twice the figure suggested in last year’s budget—because of higher interest costs and more realistic growth forecasts. The natural reaction for householders is to fear the worst. As European leaders discuss ways to make creditors bear losses when countries default, that goes for bond markets too.

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