Tip of the Week #121                   Tip Index

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Advances in Decision Analysis from Foundations to Applications
Go to       Tip 123
  Generational Accounting also by Laurence Kotlikoff
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The Clash of Generations:
Saving Ourselves, Our Kids, and Our Economy

by Laurence J. Kotlikoff and Scott Burns

2012, MIT Press, 275 p., hardcover, US$30.00 list.
ISBN  978-0-262-01672-8

I've been concerned about government debt since high school. I thought surely the U.S. government cannot continue to borrowcitizens won't stand for it! And creditors won't allow it.  I've been wrong on both counts.

Citizens Don't Understand, and Maybe Don't Want To

The Clash of Generations does an excellent job of sounding the fiscal alarm. The authors' recent calculation pegs

$249T, and growing approximately $6T per year. While these numbers are perhaps double others I've seen elsewhere, even half is enormous.

 My calculations of the federal gap is over $3T per year, using Government Accounting Office projections plus a few reasonable-seeming assumptions.

What's the gap? The difference between present value (PV) long-term obligations versus PV receipts to pay for them.

Kotlikoff and Burns say that government debt is a meaningless concept due to a labeling problem. For example "taxes" can be called "borrowing" if that feels better. Government accountants have proven adept at reclassifying and relabeling things. The authors say that the only rigorous way to to represent the gap is to forecast net cashflows in minus net cashflows out.

An earlier book by these same authors, The Coming Generational Storm: What You Need to Know about America's Economic Future (MIT Press, 2004) , provides more detail on the calculations.

I'm convinced that Kotlikoff and Burns are right, though we might quibble about the discount rate and a few other assumptions.

Three Major Themes

1. The situation assessment, well-done though I think the magnitude is a bit exaggerated.

2. Their prescriptions in four areas. these are called "Purple Plans" (a mix of blue and red, representing the two major political parties, and presumably acceptable to both).

These and three others are posted at http://www.thepurpleplans.org. They report that many luminaries, including several Novel laureats, have endorsed heir plans.

Noticeably missing, I think, is a Jobs Plan (which I've started crafting ... "Watch this space.")

There are many good features in the Purple Plans, and Kotlikoff (an economics professor) and Burns (a financial writer) have obviously thought long about their prescriptions for changes. (Personally, I would prefer that the changes feature much more individual responsibility.)

3. What an individual should do. This involves lifestyle and investment choices. The end chapters provide many ideas for the reader to consider.

Continuing Borrowing--Creditors Won't Allow It

I thought the government borrowing would end ... decades ago. At some point it surely will.

The Coming Generational Storm begins with a scenario. A major crude oil seller decides that he would rather settle in Chinese yuan rather than U.S. dollars. This pushes the U.S. over the tipping point. Confidence in the dollar crashes.  High inflation and recession follow.

Kotlikoff is an econometric modeler, and mentions (perhaps in the earlier book) that the models have multiple equilibria. Thus usually means a system is unstable and can easily be perturbed into a different state. A big change can come suddenly and without warning.

 

I recommend the book. It will surely provide you with many useful ideas and topics for discussion with friends and colleagues.

See also Tip 123 Generational Accounting also by Laurence Kotlikoff, which encompasses three related books.


—John Schuyler, July 2012, rev. Sep 2012

Copyright 2012 by John R. Schuyler. All rights reserved. Permission to copy with reproduction of this notice.