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America’s True Crisis

Health care spending in the United States is out of control, limiting the country’s competitiveness and leading it into a messThe Republican presidential nominee, Mitt Romney, just chose Paul Ryan, a congressman from Wisconsin, as his running mate. Ryan has earned a reputation for his willingness to tackle popular welfare programs like Medicare and Medicaid. His budget, passed by the House but rejected by the Senate, changes Medicare into lump sum grants for seniors, who must buy insurance on the market, and Medicaid into a fixed transfer to states that must cap spending on their own. The U.S. government devoted 24.3 percent of its expenditure to health care last year. And the total health care expenditure was 18 percent of GDP and had been rising 50 percent faster than GDP. If the trend is unchecked, the U.S. government and the country as a whole are heading towards bankruptcy. Ryan has gained fame for his willingness to discuss the inevitable. However, Ryan isn’t always a fiscal conservative. During George W. Bush’s two terms he largely supported the government’s fiscal priorities. The U.S.’ fiscal deficit is mostly due to the Bush era tax cuts, which lacked spending cuts to match. Between 2000 and 2008, the federal government spending rose by 6.6 percent per year but revenue by only 2.8 percent. In Barack Obama’s nearly four years in office, spending has risen 6.2 percent per annum and revenue fallen 0.5 percent, largely due to the recession. One can blame Obama for not addressing the fiscal mess, but Bush started it. The selection of Ryan brings Medicare and Medicaid reform to the fore. This does bring some substance to the election. I want to use this opportunity to discuss the role of the U.S. government and the lessons that China and other countries can learn from it in reforming their own governments.   I don’t view Ryan as a pure fiscal conservative. His budget cuts health care and other welfare spelling, but won’t balance the budget for decades because he wants to cut taxes at the same time. He cuts Medicare for future retirees because today’s seniors won’t vote for a politician who cuts their benefits. He cuts Medicaid immediately because it is mainly for poor people who don’t vote regularly like seniors. Ryan has an ideological bent and knows who he can upset. Not Too Big Yet Total U.S. government spending in 2011 – the local, state and federal levels combined – was 34 percent of GDP and a deficit of 9.5 percent. The current debt levels are 103 percent of GDP for the federal government and 25 percent for local and state governments. While we talk about a runaway U.S. government, it is not so bad by international comparison. European governments spent 49.1 percent of GDP last year with 4.5 percent of GDP in deficit. The Chinese government can’t be compared to others directly because it spends mostly in investment projects, not on welfare programs. According to the Academy of Social Sciences, in 2011 the government took 22 percent of GDP in fiscal revenue, 5 percent in social security and 8.8 percent in other government funds, totaling 35 percent of GDP. Local governments also gained 6 percent of GDP in land sales. Governments and state-owned enterprises, mostly through debt, invested 22 percent of GDP. Even though the three components have some overlap, there is little doubt that the Chinese government is by far the largest in the world. The issue for the Chinese government is how efficiently it invests money. Even though the euro zone has 87 percent of GDP in government debt and 4.1 percent of GDP in fiscal deficit, much better than in the United States, it is experiencing a debt crisis already. That is due to (1) lack of a central government in the euro zone and (2) lower growth potential. The euro debt crisis, though still unfolding, will surely to change the debt trajectory in the future. So, when the euro debt crisis ends, Europe will become stable. The same cannot be said about the United States.   The Trend Is the Problem The U.S. national debt has been rising at 9.3 percent per year since 2000 and, excluding the debt held by government accounts like social security trust fund, 10.8 percent per annum. In the past decade, the federal government’s debt has increased by 156 percent. The U.S. government forecast is for gross debt to rise at 5.7 percent over the next four years. Considering what has occurred in the past and accelerating expenditure associated with aging, it is hard to see how the debt will slow down so much. Of course, one could always assume better revenue collection in the future, which isn’t likely. The U.S. economy may be stuck around 2 percent growth rate for the next decade. If so, government revenue would be less than expected and the debt may continue its past trend. The odds are that U.S. government debt will rise five percentage points above nominal GDP. In a decade, total government debt would surpass 200 percent of GDP, similar to Japan today. While Japan’s high level of government debt is entirely funded by domestic savings, the same cannot be said about the United States. The United States imports 4 percent of GDP in capital per year. When its government debt reaches 200 percent of GDP, foreign capital is likely to panic. A currency-cum-debt crisis is likely to follow. Basically, the United States’ current trend is not sustainable. For a mature economy, government size of one-third of GDP is probably necessary. While the Republican Party wants to wrestle it down, considering aging and rising income inequality, its goal is unlikely to be realized. The U.S. government has to increase revenue to keep the deficit under control. Until we see significant tax increases, the government fiscal situation remains on a dangerous path. The financial market is worried about the “fiscal cliff” that the U.S. economy faces in 2013. The Bush tax cuts are supposed to expire at the end of this year. So do Obama’s payroll tax reduction and the extended unemployment benefits. In the last fight for raising the debt ceiling, there are mandated automatic spending cuts. They amount to 3.5 percent of GDP, a significant fiscal tightening relative to the 9.5 percent of GDP in total government deficit. Of course, such a big contraction in fiscal deficit through raising taxes and cutting spending is likely to cause a recession, considering that the economy is growing at below 2 percent. The odds are that the Democrats and Republicans will compromise after the election to postpone raising taxes or cutting spending. Essentially, if the economy is anemic, the deficit would remain forever. The European model is based on a philosophy of using government to even out income distribution. Europe has its problems; they are just not the same as the United States’. The reasons for this are its low growth potential and, hence, lower capability to support debt and deficit. The euro zone is resorting to cutting some spending and raising taxes to deal with the crisis. The policy, if pursued to the extreme, could stabilize the situation. But, it won’t be pretty. Large swaths of Europe will become poor and join the developing world. A better approach for Europe is to increase growth potential through reforms, dramatically shrinking government and opening markets to competition. Health Care Is the Crisis The United States spends 18 percent of GDP on health care, about twice as much as in other developed economies. It has grown from 13 percent a decade ago and may reach 25 percent of GDP by 2020. And, its health indicators like life expectancy and the incidences of chronic diseases are worse than in other developed countries, showing the futility of spending more. U.S. health care spending has risen slower in the past three years. The obesity rate has done the same. Do these signs point to plateauing in U.S. health care spending? I doubt it. In recessions, people visit doctors less and may eat less, too. Either may revert to the old pattern when the economy improves. Also, as baby boomers retire, the pool of high health spending population increases. I have written for a decade that the U.S.’s economic trouble is due to out-of-control health care. The excessively high spending is due to (1) the exceptionally high and rising obesity rate and (2) unregulated supply pricing combined with insurance and government-funded expenditure. The U.S.’ health care catastrophe is a combination of dangerous lifestyle and a bad system. And it is not purely a government size issue. Though the government pays nearly half, the other half is mostly funded by company-sponsored insurance. What a company pays for an employee’s health insurance is twice the total labor cost in emerging economies. Unless the cost of health care is brought under control, the U.S.’ unemployment rate is likely to remain high. Obama passed a health care law to expand coverage to tens of millions who had no insurance and were not qualified for government assistance. That law doesn’t seriously touch the cost issue. Hence, it is likely to increase total health care spending. The health care crisis is a systemic and social crisis. The United States’ food consumption increased from 3,300 calories per day in 1970 t0 3,800 in 2000. The increase is likely to have continued. But its economy has become less labor intensive through outsourcing factory jobs to Asia. The resulting increase in obesity rate is inevitable. The country suffered a 36 percent obesity rate among adults and another 33 percent overweight in 2010. Unless these numbers are brought down significantly, the health care cost won’t be under control. The reforms to how health care is supplied and funded could only play a marginal role. The Wrong Priorities Ryan is a follower of Ayn Rand, who advocates everyone for him or herself and zero government intervention in market competition or income distribution. This view is certainly extreme. Some government intervention in market competition is inevitable. Banks that are “too big to fail,” for example, can cost a society dearly, as the last financial crisis shows. The government has to either break up big banks or regulate them tightly. The government as a tool for income redistribution is a modern ideal, mostly happening after World War II. Northern European countries epitomize the vision of a government guaranteeing a minimum living standard and safeguarding human dignity. This philosophy has guided European economies to governments spending half of GDP, mostly for redistribution and egalitarian welfare programs like education, health care, pension and unemployment benefits. This vision is being tested in the current euro debt crisis. While northern European economies are still stable, their southern brothers are falling apart. Through this crisis, a balanced view on how much the government should redistribute may come out. The United States is not a big-government country at all. The government at the federal and local level took in only 24.5 percent of GDP last year. It is one of the most lightly taxed economies in the world. The fierce debate on the role of government in the United States is mainly due to rising income inequality. The views on the government’s role become radicalized as a result. Ryan, while marketing himself as a thinker, is really a creature of the anti-tax movement. I believe that a government should be moderate in size (e.g., 25 percent of GDP for developing economies and 35 percent for mature economies) and balanced in redistribution and investment (e.g., half in investment and half in redistribution). The best means for social equality should be through keeping housing prices down, education quality high and cost low for all, and health care affordable. When these elements are in place, the need for income redistribution is pretty low. To achieve these goals requires good policies more than government spending. The whole world is experiencing aging. Resources are increasingly allocated for retirees. The investment in youth is declining. This trend cannot be good for the world. There has to be a debate on how to balance the two. In that regard, the U.S. presidential election is a disappointment. It is talking about cutting, not about balancing and prioritizing. Regardless of who wins the election, though I believe Obama will win, the U.S. continues to slide down the path of deficit spending on seniors without investing in youth. It is likely to suffer a debt crisis within a decade.

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