By Kevin Meyer
Bloomberg BusinessWeek had an intriguing article a week or so ago by Peter Coy on the impending debt crisis – now temporarily shoved under the carpet – and the impact of fiscal language. It references an equally intriguing study from the National Bureau of Economic Research that can be downloaded for a mere $5. In it the authors, Jerry Green of Harvard University and Lawrence Kotlikoff of Boston University, describe how current fiscal terminology affects understanding of the real condition – and thereby the debate.
From the preamble of the paper:
A century ago, everyone thought time and distance were well defined physical concepts. But neither proved absolute. Instead, measures/reports of time and distance were found to depend on one’s reference point, specifically one’s direction and speed of travel, making our apparent physical reality, in Einstein’s words, “merely an illusion.”
Like time and distance, standard fiscal measures, including deficits, taxes, and transfer payments, depend on one’s reference point/reporting procedure/language/labels. As such, they too represent numbers in search of concepts that provide the illusion of meaning where none exists.
This paper, dedicated to our dear friend, David Bradford, provides a general proof that standard and routinely used fiscal measures, including the deficit, taxes, and transfer payments, are economically ill-defined. Instead these measures reflect the arbitrary labeling of underlying fiscal conditions. Analyses based on these and derivative measures, such as disposable income, private assets, and personal saving, represent exercises in linguistics, not economics.
The concept of a reference point makes sense, especially direction, but how often do we really understand the impact of speed and acceleration? But especially intriguing is the "illusion of meaning where none exists." An example, from the BusinessWeek article.
The national debt itself is one such Einsteinian (that is, squishy) concept. The Treasury Dept.’s punctilious daily accounting of it—$14,342,841,083,049.67 as of July 25, of which just under $14.3 trillion is subject to the ceiling and about $10 trillion is held by the public—gives the impression that it’s as real and tangible as the Washington Monument. But what to include in that sum is ultimately a political choice. For instance, the national debt held by the public doesn’t include America’s obligation to make Social Security payments to future generations of the elderly. Why not?
Well for starters there's a group of folks out there that claim that Social Security doesn't impact the deficit. Technically they are correct using current terminology. Social Security was set up as an insurance program to be standalone and self-funding. The problem is that those mischievious politicians discovered a boatload of idle funds and couldn't keep their grubby hands off it. So they had Social Security "loan" it to the government for supposedly more worthwhile purposes like studying the ignomanious flying Appalachian spotted forest shrimp, in exchange for special Treasury bonds. Guess what happens when the aging population tilts the inflow/outflow balance and funds are required from those bonds. Yep – spending from the government to repay those special bonds, and spending from the government without offsetting income or cuts to "worthwhile" programs creates deficits. So, although not intended, Social Security will contribute to the deficit.
But by changing the frame of reference another problem arises with Social Security.
Suppose that instead of paying Social Security payroll taxes, working people used that amount of money to buy bonds from the Social Security Administration, which they would redeem in their retirement years. In such an arrangement, the current and future cash flows would be identical, but because of a simple labeling change the reported debt held by the public would skyrocket. That example alone should generate a certain queasiness about the reliability of the numbers that are taken for granted by budget combatants on both sides of the aisle.
Now let's look at the frame of reference problem in terms of the overall debt.
A more revealing calculation is the CBO’s measurement of what’s called the fiscal gap. That figure is conceptually cleaner than the national debt—and consequently more alarming. Boston University’s Kotlikoff has extended the agency’s analysis from 2085 out to the infinite horizon, which he says is the only method that’s invulnerable to the frame-of-reference problem. It’s an approach used by actuaries to make sure that a pension system doesn’t contain an instability that will manifest itself just past the last year studied. Years far in the future carry very little weight, converging toward zero, because they are discounted by the time value of money. Even so, Kotlikoff concluded that the fiscal gap—i.e., the net present value of all future expenses minus all future revenue—amounts to $211 trillion.
Well that's a fun gut-wrencher first thing in the morning.
The article spends the next several pages diving into the political ramifications of such an analysis – especially how politicians basically ignore it since it goes past their 2 to 6 year re-election horizon. The trajectory, and acceleration, is frightening though.
Language is a funny thing. Small nuances can change the perception, analysis, debate, and solutions. Moving off the financial track, I'll give you one example from my company's long-term hoshin plan. Like many companies we had too much business tied up into too few customers. So years ago we decided one of our long-term strategies should be:
Protect our business by diversifying the customer base.
Simple and sweet. Except that we cowered in fear. A couple years ago we re-worded that same strategy to:
Grow our business by diversifying the customer base.
Guess what happened. From sales folk to the shop floor we became motivated – to the extent that now we have transactional issues exposing inherent inefficiencies when dealing with a rapidly-growing customer base. A nice problem to have, quite frankly. I'll take it.
So think about your metrics, goals, and whatnot. How are the terms and words you use influencing the discussion and analysis?