Sunday, September 4, 2011

Short Termism and Politicians

Here's a thought, albeit perhaps a bad one. Maybe we should elect our politicians for longer terms instead of the current Constitutionally mandated 2, 6 and 4 year terms for house members, senators and the presidency, respectively.

It at least would begin to address the problem of today's topic, time inconsistency or short termism, which has been the political way of life these past several decades.

I'm kidding, of course, but the short term oriented approach of our politicians to decision making isn't a laughing matter. Not at all. If we don't change this approach sooner rather than later, the future is definitely not bright.

Time inconsistency, aka dynamic inconsistency, is an economic term which simply means that our different selves make different choices depending upon what timeframe we're considering. What we prefer at one point in time is inconsistent with our preference at another point in time. In other words, our choices aren't consistently aligned over time periods, and we tend to pick the here and now over the better but later route. We opt for one bird in the hand versus going after two in bush, as they say.

Here are a few simple examples of time inconsistency applied.

The teenager; I know I should study today, but I really want to see that movie, watch that game or whatever else will allow me to "justifiably" avoid hitting the books.

The politician; We really need to address the debt and deficits and economic growth over the long haul, but I'll have a better chance of getting re-elected if I vote for more short term gain today, even if it means long term pain later.

The smoker or dieter; I'll stop smoking or start dieting but not until tomorrow.

With respect to today's politician, the well established game of short termism is about to be terminated due to the massive debt and deficits our nation has accumulated over the years. It's happening all over the world, and we'll not be excepted. The future is now, or at least coming real soon.

If the U.S.A. were a company, it wouldn't use the cash basis of accounting. It instead would use the accrual method. So what' s the difference and why does it matter, you say? Well, here's a sampling of the what and the why, too.

Cash accounting looks only at what we're spending today. It doesn't concern itself with what we're obligated to spend in the future. Accrual accounting looks at the total picture, short and long term alike. It includes our promises about the future.

Often, when government officials negotiate with public employee union representatives, they agree to "invisible" huge pension and health care promised benefits for future retirees while keeping the current and highly "visible" pay raises down. The taxpayer only sees the near term visible payroll impact and is assured that the budget is balanced. Which it is, using the cash method of accounting.

What the taxpayer doesn't see, however, is what long term invisible costs have been incurred in exchange for the modest pay raise. By the time those promised benefit chickens come home to roost, there is a new set of politicians and negotiators who can say they weren't involved in granting the retirement benefits. And they probably weren't, but so what? The taxpayer still has to pay.

If the cost to the taxpayer, whether in more current compensation or greater retirement benefits later, were to be the same amount either way, it would make no difference. But it's not, not even close. Accordingly, what is not seen is misleading for sure and is what makes a huge difference in the end. But let's leave the local public union alone for now and focus on the federal budget instead.

What about future budgets? Will we balance the books, matching receipts with expenditures? If so, how do we expect to achieve that result?

Well, balanced budgeting is really a simple exercise in revenue and expense matching. Let's look at the federal government. Today we're expecting a $1.6 trillion deficit for 2011, meaning we'll spend $1.6 trillion more than we receive.

Next year the deficit is projected to come down somewhat but still remain higher than $1 trillion. Even that forecast, however, is based on achieving 2012 economic growth of ~3%, an unlikely possibility. Accordingly, it's at least an even bet that next year's fiscal woes will closely resemble this year's dismal results. And 2013, too.

More importantly, what about 2021, which is ten years from now? Well, that result will depend most importantly on the cumulative actual economic growth we achieve between now and then.

Even if we hit every savings target for spending reduction that the politicians agree upon, this stunning (and unrealistic) accomplishment still won't make up for any substantial shortfall (all too realistic) in projected economic growth. Yet sadly, we aren't even focused on doing the necessary things required to enable our absolutely best chances for sustainable and strong economic growth over the next ten years.

There's simply too much here and now feel good short term politics and too little concern for the now largely invisible longer term impacts of today's decisions. We need to change the dialogue and get time consistency into the decision making picture.

Let's review only two recent examples of government mandated short termism that may have seemed like a good idea at the time but in reality harmed our financial situation: the government funded rebates of cash for clunkers (buying cars) and new home purchases (buying homes) made during a short term timeframe.

For the most part, the result was that some people bought earlier than they would have. Of course, later they didn't buy the same thing again, and very few people were induced to buy more than they would have anyway. The government, aka the taxpayer, paid the early buyers to move up their purchases through rebates, and there was no long term economic effect other than additional government spending and borrowing due to the rebates. As usual, the non-buying taxpayers got nothing for something.

That kind of popular short termism means we spend taxpayer money in the here and now and receive nothing for it other than a temporary "sugar high". This kicker quickly wears off except for the additional permanent added financial burden assumed by the taxpayers due to funding the earlier but not additional purchase. Thus, we get no more economic activity other than the new government debt which will need repaying. Stated differently, all the taxpayers subsidize those taxpayers who buy during the government giveaway programs

In contrast, genuine and sustainable economic growth results in a winning combination of more tax revenues and fewer cash outlays by government. That's due to the resulting impact of higher employment and profitability in the private sector. Payroll taxes increase, income taxes increase, corporate taxes increase, taxes on dividends and capital gains increase, sales taxes increase, personal spending increases and so on. Many, many concurrent taxpayer and citizen favorable whammies all at once.

When business grows, companies hire more people. Those hired come off the unemployment rolls. We get more government revenue and less government spending. For the foreseeable future, consumer spending will be more modest than historically due to paying back the massive debt borrowed during the boom times. To offset the weak consumer spending effect on our economy, more than ever we need to emphasize private sector productive investment and exports. We also need to get more employment in our domestic economy by inducing businesses to bring more jobs to the U.S. Why not subsidize private sector investment, hiring and even payroll for some time?

For every barrel of oil we produce domestically, that's one less barrel imported. And more manufacturing on our shores equals more jobs and payroll, too.

Let's put the focus squarely on helping regain our global competitiveness quickly. If we don't we won't realize the necessary economic growth required to get America back on track.

Thanks. Bob.

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