Recently I have been thinking about The 4% Solution: Unleashing the Economic Growth America Needs advocated by the Bush Institute, the CALPERS report that said that they had 1-year return of only 1%, sequestration, and Mitchell’s Golden Rule. For those unfamiliar with Mitchell’s Golden Rule it states that “the private sector should grow faster than the government”. In this discussion I will use the stronger form which states the private sector should grow faster than the growth in government debt if we want to grow out of our mess.
The 4 percent solution is wonderful idea that appeals to both parties. It states that we should focus our economic planning on those plans that help us achieve a 4 percent growth in real GDP. The problem with this plan is that it is primarily aspirational and is not significantly different than the plans of our last four presidents. In fact it does not address the problem that has plagued our last two presidents, we spent money like we already had the 4 percent growth money in the bank. This has been readily apparent with the economies under the last two presidents. Two different plans were used, some political objectives were achieved but both plans failed to generate the job or GDP growth. We did achieve a fairly spectacular increase in public debt.
CALPERS is the poster child for pension problems in the United States. Like most pension plans they expect their portfolio to achieve a 7.25% return. This seems reasonable since they earned a 7.7% return over the last twenty years. The problem is that their 1-year return was 1%, their 10-year return is 5.7%, and they are spending about 6.4% of their portfolio on benefits. This doesn’t work. They look like they desperately need the government to be successful with their 4 percent growth plans or they might have to resort to Plan B.
Sequestration is not a plan but a veiled threat that becomes more unveiled as we get closer and closer to the spending cuts. The idea of sequestration is not to subtle hint that we would like to chain our legislators to the bargaining table until they made a budget deal that cuts spending. So far the threat has not worked. The Simpson-Bowles and Ryan Path to Prosperity plans are much better than sequestration. Both plans are much better at growing the economy while structurally reforming the spending than sequestration. In fact I think the end game is a budget deal will likely be some variation of one of those plans that partially satisfies both parties. I think it is interesting to speculate what the presidents over the last 100 years would do with the situation that President Obama has in front of him. I suspect all of them would see a budget deal as one of the most significant accomplishments of their administration. I can almost guarantee that the last four presidents would have done a deal before the end of the first term. In my life time all of the presidents except for the current president have been willing to reach across the aisle to get a deal done to pass major legislation.
The key to any successful budget plan will be how to grow the private sector faster than the government debt. This is really simple math. You get a better bang for your tax buck with an increased number of private sector employees. The less these employees are dependent on government spending, the greater the cash flow goes to the government. Adding private sector employees is more efficient at increasing tax revenues then via an equal number of number government employees. For at least the last twelve years growing the government debt does not appear to be helping the GDP or the private sector very much. Here is a graph I created to show that relationship. I am using the S&P 500 as a proxy for the wealth and health of the private sector. To paraphrase the old GM line, what is good for the private sector is good for the country and our pension plans, too. In this graph I deflated the S&P 500 and Total Public debt using the GDP Price deflator so that all three indicators reflect inflation adjusted values using the same deflator. In the graph it looks like the Total Public debt helped the S&P 500 in the 1980’s and 1990’s and significantly hurt it after 2000. I was somewhat surprised to see that an increased Total Public debt does not seem to have helped the GDP at any time on the graph. The GDP kept trucking along at the same pace with only a minor blip during the recessions. Here is an interesting question, “How did government spending let alone debt financed government spending became the preferred vehicle for growing the economy?”