Monday, 1 April 2013

Water Water Everywhere; Let's all Have a Drink

Read The Rhyme of the Ancient Mariner more years ago than I care to remember, but still remember the so-called money shot from the story.

I was thinking of it as I read an editorial in Yesterday's NY Times, penned by the economist Greg Mankiw.  Mankiw, a professor of economics at Harvard, was an adviser to President George W Bush.

Much has been written about our current state of financial affairs; the yawning deficits.  The crushing debt.  Sequestration.  The sustainability (or lack of) for Medicare and Social Security.  Pensions.

All told, it's more a current state of financial disrepair.

But Professor Mankiw raises an interesting point, and one I think many ordinary Americans do not grasp.

Fundamentally, the DEBT (the accumulated amount of money our government - we, in a sense - owe) is somewhat beside the point.  Plainly, with public debts in the multiples of trillions of dollars, the debt as it now stands, of course will never be repaid.  Even the deficits, in absolute terms (simply put, the difference between the amount of money collected by the government and the amount of money spent) are of secondary concern.

Mankiw makes the point reasonably well, but perhaps a bit opaquely.

In my day job, I am responsible for creating economic and epidemiological models to simulate patient pathways from health to sickness and back to health (or, mortality).  In my science, one invaluable tool is the stock-flow model.

From these models, we derive what are called the "incidence" and "prevalence" of disease (among other things).  Incidence is, essentially, the number of people who newly are afflicted with a given illness.  People who last year did NOT have lung cancer, for example, but who now do have lung cancer.  Its cousin, prevalence, is the total number of people who right now have the disease.  This is all the people who had lung cancer last year, and have not died, PLUS the people who are incident this year (very, very few people are "cured" of lung cancer, but of course, in a broader sense, people who are cured of a disease move out of the prevalent pool).

Within the prevalent population, there may be different stages of disease, but that lesson can be left to the side for another day.

If we think of a stock-flow model as a sort of bath tub then, the water POURING INTO the tub (new patients with a condition) represents the incident patients.  Patients in the tub represent the prevalence.  Some patients may be escaping the bottom of the tub (death; cure).  The tub may come to represent a certain equilibrium if the number flowing in (incidence) is roughly equal to those flowing out.

In terms of economics, I feel that these concepts translate naturally thusly.

The bathtub is our national economy.  The water IN the tub is our debt.  Water pouring into the tub each year then represents annual spending.  The bottom of the tub, from which water is escaping, represents revenues (taxes).

If water is pouring into the tub faster than it is escaping, then the level of water in the tub rises - our government is running deficits and the debt is increased.  If water is escaping out of the drain faster, then the government are running surpluses, and our debt is shrinking.

We reach catastrophe if the tub overflows - if we default.

Now, the argument that Mankiw and others rise is this:  If the tub EXPANDS, then the amount of water pouring in can increase safely.  That isn 't necessarily good or bad, of course.  But simply running deficits is not in and of itself dangerous.

The tub, then, can be thought of as national GDP.  When it is growing, then our capacity to take on debt grows.  On this, Mankiw (and the president) are correct, as Dick Cheney before them were.

The problem that Mankiw (and President Obama and VP Cheney) miss is that the presumption that our GDP will ALWAYS grow is flawed.  If the tub stops growing - or worse, shrinks to the size of the bathroom sink - then we have a big problem.

During the past decade, the tub has not kept pace with historic growth and worse, the tap is now wide open and no one is thinking to put a hand on the spigot, let alone reduce the flow.
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