Accordingly, we must first attempt to be sure we're doing the right thing, and only thereafter can we focus on doing that right thing right.
In other words, accurate problem identification is critical before proceeding to the doing or remedial stage.
In my view, growing government spending is the wrong thing to be doing. Thus, we're probably also doing it poorly.
What we should be doing, of course, is emphasizing private sector economic growth. Not more redistributive government spending.
Here's the recent situation in the U.S. In a $15 trillion economy where government spending amounted to 40% of that total, or $6 trillion, we owed interest on government debt of $6 trillion. At a recessionary interest rate of a low 3%, that's $180 billion in interest charges--a manageable 1.2% of GDP.
But as the debt grows and interest rates rise, the situation can change quickly for the worse.
For example, if the rate rises to a more normal 6% as the economy begins to recover, interest costs become $360 billion-- still a manageable 2.4% of GDP.
But if government spending continues to grow unabated and debt increases to 120% of GDP, then interest rates will rise to perhaps 10% as a result of anticipated inflationary conditions.
With the economy's GDP at close to that same $15 trillion, that's $1.5 trillion in interest charges--10% of GDP.
Going from 1.2% to 10% on interest as a percentage of GDP means an unsustainable situation. The economy wouldn't be able to support that level of debt service in addition to the other government spending already in place. And the private sector won't be able to take up the slack.
If that point is reached in the U.S., debt will simply become too burdensome in relation to the size of the economy and its economic growth rate. Game over for economic stability and economic growth.
That's pretty much where Greece and Italy, among others, are today. We're also headed that way, unfortunately, due to the combination of growing government spending and an accompanying stagnant economy.
Growth Key for Euro-Zone Deal describes the dilemma this way:
"Despite all the cheering about Europe's latest debt deal, worries are mounting that it won't succeed without stronger economic growth.
At the current pace of expansion, unemployment will stay high and incomes will stall. Debt-saddled governments will have an even tougher time generating revenue to pay bills. That could spark more default fears or higher interest rates in Greece, Italy and others under pressure.
Projections for global growth have been falling. The forecasting firm IHS Global Insight now expects the world economy to expand just 3% this year and next, down from 4.2% in 2010. The U.S. is forecast to grow just 1.4% next year, a pace that could push the 9.1% jobless rate higher. The 17-nation euro zone, meanwhile, will flirt with recession in 2012 with projected growth slightly above zero."
But what's the biggest problem? The ever expanding size of government spending gets my vote.
Here's what it says about the size and role of government:
"It seems everyone is worried that problems in Europe will derail our fragile recovery. For this reason, markets breathed a sigh of relief when the Europeans came up with a plan to provide yet another reprieve to Greece. The main worry, now somewhat eased, was that a Greek default would spread to countries like Italy, Spain and Portugal.
Although there are legitimate concerns about contagion, the fundamental problem facing Europe is one of governments becoming too big to be supported by the economy. Unless Europe solves its fundamental problems with meaningful structural reform, a temporary debt restructuring, no matter how clever, will fail to right the ship. Closer to home, the same issues that threaten Europe may soon become immediate concerns to Americans.
To understand why, consider two theories of economic destruction, which can be labeled the domino theory and the popcorn theory. Everyone knows the domino theory; it is the analogy that is commonly used to denote contagion. If one domino falls, it will topple the others, and conversely, if the first domino remains upright, the others will not fall. It is this logic that underlies most bailout strategies.
The popcorn theory emphasizes a different mechanism. When popcorn is made (the old fashioned way), oil and corn kernels are placed in the bottom of a pan, heat is applied and the kernels pop. Were the first kernel to pop removed from the pan, there would be no noticeable difference. The other kernels would pop anyway because of the heat. The fundamental structural cause is the heat, not the fact that one kernel popped, triggering others to follow."
Mr. Lazear, chairman of the President's Council of Economic Advisers from 2006-09, believes in the popcorn analogy to government spending, deficits and debt:
"But our financial crisis was caused by factors that affected the entire system, just as all corn kernels pop when they are warmed by the same flame. This lesson is important because interpreting our crisis as primarily a contagion event leads to the wrong strategies for dealing with potential disasters. After Lehman, Europeans seem to be so taken with worries of contagion that they are failing to emphasize remedies that actually have a chance of making things better. In their case, and in ours, the solution is primarily a reduction in the bloated size of government expenditures that come about by making promises that cannot be kept.
Especially in Italy and Portugal, as in Greece, the government has grown more rapidly than the economy, which has meant unsustainable government borrowing. Preventing a Greek default will not reverse the lackluster growth that has plagued the other vulnerable countries for many years now. As for the U.S., our economy will be stronger if Europe's health improves, but we must address our own underlying structural problems that are associated with a doubling of our 2008 debt levels by next year. No bailout of another economy will restore our fiscal health or that of Europe."
Accordingly, the popcorn approach means that reducing the size of government relative to the size of the economy is essential and needs to be attacked aggressively, both in Europe and the U.S..
The trick will be how to achieve meaningful economic growth alongside government austerity measures. The straightforward answer is that we must curtail redistributive government spending.
We must cut tax rates and reduce government spending at the same time, even though on the surface that's a very hard sell to make with a 9.1% rate of unemployment and a presidential election on tap for 2012.
Nevertheless, if we continue to run deficits in excess of one trillion each year, soon our government debt burden will become unsustainable, interest rates will rise rapidly and the private sector won't be able to keep up.
And if and as we continue down that path of no return, debt levels will continue to grow while the economy stagnates. At that point, high rates of inflation and a weakening U.S. dollar is the only way out. That will mean even more economic difficulty and perhaps this entire process will not be completed for another twenty years.
Thus, we have big decisions to make as a society and how we can limit government spending while achieving economic growth. Of course, we need economic growth to provide more jobs and reduce unemployment levels. Also, we need to generate private sector jobs to get government receipts up and government spending under control.
If we don't grow sufficiently while continuing to spend money that we don't have, our financial problems will get steadily worse, as they have in Greece, Italy and several other European countries.
Let's all hope our politicians understand the seriousness of the dangerous game they're playing on our behalf. To repeat, we grow the private sector and stop the growth of the public sector at the same time. And we need to do both these things real soon before we arrive at a point of no return.
While we're all betting on us to do the right thing, it's only fair to point out that our bet is not a sure thing. That depends on what we do and not on what we say we'll do.
Thanks. Bob.
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