There's no question that you've seen charts like this before. This one is from Paul Ryan. The point he makes is that if we don't get our spending on Medicare under control, the economy will be overwhelmed by government debt, and that a Greek-like future is sure to be in the cards.
Now all charts are quite this dramatic looking, but you get the point. We're supposedly HOSED unless we don't come up with a scheme soon to cut healthcare spending on America's seniors.
But as economist James Galbraith tells Business Insider, the charts contain an inherent, internal flaw.
First of all, he notes that they're not actually macroeconomic forecasts, but baselines done by the CBO, so they can asses the budgetary impact of a given law.
But there's another reason why the charts are inherently flawed. They assume a scary trajectory in healthcare inflation going out years. But if that were to happen, then healthcare would grow to a gigantic share of GDP, and take on a growing share of the CPI, and that would mean nominal GDP would grow much faster than what people estimate, meaning the denominator of the debt-to-GDP ratio (GDP) would be much bigger than anticipated.
In other words, they assume healthcare inflation in isolation, but don't assume that other inflation or GDP will keep up, an impossibility if healthcare inflation gets as bad as it is. So either healthcare inflation will keep soaring (and that will lift up other measures, like nominal GDP) or a combination of market and government forces will bend down the cost curve (something that's already happening) and the doomsday scenario isn't that bad.
BI: When people look at these CBO charts showing national debt-to-GDP soaring into the future if everything is left unchecked - obviously that prompts a lot of knee-jerk concern that this is inherently unsustainable for some reason. What is your response to that?
JG: First of all, I say read the fine print and you will see that the CBO itself says that these charts are not macroeconomic forecasts. They are baselines. Their function - the reason the CBO does them - is to provide a common framework for evaluating legislation. The CBO's function is to cost-out legislative proposals. In order to do that in a fair way, you have to have a common baseline for everyone. And that's what the baseline is.
The baseline itself doesn't have to be a good macroeconomic forecast. But if you use it as such, and i't been sort of conscripted into that by a lot of people who, maybe, are negligent or irresponsible, then you have to ask: Is this baseline internally consistent? And obviously it's not. The fact that it shows that over a long period of time, health care costs rising to 30, 40, 50 percent of GDP, and then with their costs continuing rising more rapidly than GDP, but overall inflation standing at 3%, even though the share of health care costs rises and rises and rises, is an absurdity. And it'll never happen.
BI: Explain that further.
JG: Let's flash forward half a century. If health care costs are 50 percent of GDP, then their weight in the inflation index will be 50 percent. And their rapidly rising costs will be reflected in inflation, in which case inflation will not be 3 percent. It's not difficult, it's not.
BI: Are you saying inflation will be much higher, therefore GDP will be much higher?
Inflation will be much higher, in which case nominal GDP would be much higher, in which case the debt GDP ratio will not be what the CBO is predicting. I'm not saying it's a good thing - but even before you reach that point, if medical care costs continue to rise the way the CBO projects, other costs will weigh up to that. But if your doctor asks for $50,000 for a tonsillectomy you're going to be asking your boss for $250,000 in salary. It's just not reasonable to think that the medical sector can get away with extracting a much larger share of our GDP than it does anywhere else in the world, and the reality of course is that it isn't. The more you see that the cost curve is bending, that the increase in health care costs is much lower than the CBO is projecting.
BI: This is a crucial point, that there is no way for these CBO debt-to-GDP charts to actually be accurate because there is no way that you could have this one sector of the economy swamping everything else.
JG: Correct, correct, absolutely correct. And the second thing which is in there, and the CBO has adjusted this since four years ago, is the assumption that interest rate on the federal debt is going to go up higher than the growth rate of GDP. This is compounding over time, which drives up the share of debt-to-GDP in a very artificial way. Can't happen, won't happen.
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