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Salmon: Why Fiscal Problems Don't Have Fiscal Solutions

NEW YORK (Reuters Blogs) -- The main lesson I've learned from the sequester fustercluck, and from the failure of austerity programs in Europe, is that you can steer yourself very, very wrong indeed if you try to find fiscal solutions to fiscal problems.

The two phenomena are different: the stated aim of the sequester was to focus attention on long-term fiscal problems, while European austerity is generally targeted much more at the short term. But both resulted in the same thing: governments cutting their spending and hurting growth, when growth is the only real solution to the problem at hand.

In Europe, the key short-term problem is unemployment; in the U.S., the long-term problem is America's ability to pay its scarily-rising healthcare costs. In neither case do government budget cuts do anything whatsoever to address the problem; instead, they exacerbate it.

Unemployment is the more obvious case: if the government lays off thousands of workers, and stops injecting money into the economy through other channels, that's never going to help people find work in the short term. But the case against a fiscal solution to the healthcare-cost problem is also a pretty simple one. Here's John Carney:

The main challenge we face on entitlements is not financial -- it's demographic. It's not really even a question of "entitlements" at all. The challenge is just whether the economy in the future will be productive enough to produce all the medical care, food, and shelter required by the elderly when there are fewer people actually working. How we pay for this is secondary matter.

To put it differently, no matter what budget reforms we enact, we have a long-term care problem -- not a long-term deficit problem. Even if we dramatically cut down on the long-term deficit by slashing entitlement spending, so that any care in excess of that has to be funded privately, we'll still face the same challenge.

That challenge cannot really be solved through budgets. No matter how much we tax now, no matter how much we save now, in the future the economy will be limited to what it is able to produce. The challenge is to set that limit as high as possible, so there is as much as possible for the young and the old to divide it among themselves.

Put aside, for one minute, the question of whether marginal discretionary government spending is good or bad for economic growth; the point here is that the problem of healthcare costs isn't fiscal. Indeed, it's easy to go even further than that, and to say that the more money the government spends on healthcare, the smaller that the problem of healthcare costs becomes. After all, everywhere in the world, including in the US, the government gets by far the best price in the market when it spends money on healthcare. If you switch healthcare expenditures from the public sector to the private sector, all you do is make them more expensive.

And as Joe Weisenthal points out, quoting Richard Koo, the more that a government worries about long-term fiscal balance, the less effective it becomes in attempting to stimulate the economy to provide the kind of growth that everybody wants to maximize. Just look across the Pacific, says Koo: Japan has never once met its fiscal targets in the past 20 years, precisely because it has been consistently far too worried about meeting its medium-term fiscal targets.

The solution to all these problems has to be to maximize the number of people with jobs; to maximize the amount of money those jobs pay; and to maximize the number of years that people are earning money in those jobs. Eduardo Porter makes the case for raising the retirement age, which of course would reduce the increase in Social Security costs. But he also makes the point that if people stay in well-paying jobs for longer, that benefits the entire economy -- which in turn will improve our ability to provide America's seniors with the healthcare they deserve.

Meanwhile, the rhetoric of the sequester is making everybody look in exactly the wrong place for solutions to America's long-term fiscal problems. The amount that the government spends on national parks, or on FBI salaries, or even on mine-resistant, ambush-protected Army vehicles, is of course irrelevant to the question of how to create an economy which can afford medical care for all over the long term. But it also creates a framing problem -- making it seem as though government expenditures are the nail, and that therefore budget cuts are the necessary hammer. Even as, all the while, the deep and real problems become that much more structural, embedded, and intractable.

-- Written by Felix Salmon.

Read more of Felix's blogs at Reuters.

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