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Monday, December 20, 2004


productivity and social security

the ongoing debate about the solvency of social security often hinges on finding a way for fewer workers to pay for more retirees, so that retirees will not have to see serious reductions in entitlements. i remain unconvinced that this is likely to happen.

productivity growth is central to the idea that fewer can pay for more. that's what productivity is, roughly -- gross domestic product divided by labor hours. getting more out of every hour is the idea.

i'd agree that we will probably continue to get more out of less, though maybe not at the recent blistering pace.

but one also has to note that recent productivity gains are the result of capital deepening -- the amount of capital and it's important to understand that investment booms end.

Though capital-deepening productivity change may seem desirable, it is important to understand what it means in the long run. As a nation's share of income devoted to capital increases, its capital per worker rises, and there is capital-deepening productivity change. But as long as the nation does not indefinitely squeeze the share of output devoted to consumption, and what nation can, eventually capital's income share will stabilize at some higher level. Capital per worker will, too, and the capital-deepening term will then no longer contribute to increases in the rate of productivity change. Under most circumstances the nation will still be better off because the level of income per capita will be growing along a higher path, but rates of productivity change will no longer be increasing. Paul Krugman (2000) attributes some of Asia's recent economic difficulties to the fact that their earlier rates of productivity change were predominantly due to capital deepening and could not be sustained.
the united states is at the end of a massive period of investment/malinvestment -- of which increased borrowing is a major facilitator -- coming out of which it is unlikely to see capital deepening of this type for a long time. as such, productivity growth is likely to level.

and to the extent that multifactor productivity grows -- well, it did healthily in the great depression. as field notes, "the Depression years were, in the aggregate, the most technologically progressive of any comparable period in U. S. economic history."

this gets to the core of what the united states really faces, which is not so much a social security crisis -- after all, general fund dollars can be rerouted to pay-go when payroll taxes are no longer sufficient to cover the outlays -- as a debt dependency problem that threatens to unmake the american economy by destroying the dollar.

for all the fond remembrances of the "fiscal prudence" of the 1990s, the period was one in which the government benefited throughout by capital gains taxes on a massive and irresponsible leveraging-up of america that has continued to this day. gramlich notes, "As a nation's share of income devoted to capital increases, its capital per worker rises, and there is capital-deepening productivity change," without saying that the income diverted from american consumption for this deepening was instead borrowed by american consumers such that the savings rate has all but vanished. that process appears to have accelerated since 2000, with mortgage/home-equity debt skyrocketing with the help of greenspan's suppressed interest rates.

now, with interest rates rising, the costs of debt dependency are likely to become more apparent, diverting national income to debt service where it will not fuel consumption or investment. the united states is responsible for some three and a half times its gdp in explicit debt instruments. america is in debt territory never seen by any major civilized nation.

our government, by means of its fiat control of the dollar, is likely to choose to continue inflating the money supply in an effort to quietly default on american debt as a form of relief. by printing money, dollars become worth less -- and debtors can effectively pay off debt with money that is worth less than the money they borrowed. this seems the most politically expedient solution to a debt-burdened nation, and is the option chosen in most fiat currency crises.

this does not constitute technical default, of course -- but it will be an effective default to many. with 40% of american debt instruments foreign-owned, the likelihood is that continued dollar weakness will compel those holders to sell as the currency devaluation destroys their investment as measured by their home currency. persistent -- or, worse, panic -- selling will force painful consequences. it is not clear that the federal reserve could soak up these dollars under such circumstances using their normal means (the fomc), which issues -- you guessed it -- debt obligations for dollars it wants out of circulation.

anything we do that could spark such debt selling and dollar abandonment should obviously be avoided -- but the truth is that we already walk a very dangerous line that likely will end in tears.

and social security reform such as we are contemplating may well make it worse. the privatization plan is, at heart, a mechanism for taking future implicit liabilities -- the promises of the government to pay for retirees -- and making them into immediate explicit liabilities. to do this is to ask for the issuance of some $5 trillion or more in new american treasury bonds -- effectively doubling the national debt.

such may well be the event that catapults american finances into the abyss. most debt traders, in observing the outline of the problems, i think assume that the administration will have to scale back its promises to seniors to assure the well-being of the country. if that view is challenged -- and the administration makes plain that debt will be issued to cover all the promises now made to seniors -- they may start to abandon the treasury bond wholesale.


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