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Debt numbers are big; the problem is less so

When Congress and its "supercommittee" failed to agree on how to cut the deficit, it was predictable that commentators would declare the fiscal house of the United States in disarray. The charge to the committee was actually a modest one: cut $1.2 trillion over 10 years. The public is concerned about the national debt because of its large size and the projection that it will continue to rise. Because these numbers are large, the claim is that it is out of control. Is it?

The gross domestic product (GDP) is the best measure of the nation's debt capacity. Currently, GDP is $14.5 trillion and growing. To calculate the total GDP that the economy will produce over the next 10 years, we must assume a reasonable growth rate for the economy over that same period. Using a conservative estimate of 2 percent — well below the expected rate — we arrive at $150 trillion, of which $1.2 trillion is only 0.8 percent.

Currently, the national debt owed to the public is approaching $12 trillion, projected to rise to $70 trillion in the next 75 years. Surely, these numbers spell disaster. Don't they? Once again, the answer depends on how fast America's GDP will grow in those 75 years.

What proportion is $70 trillion debt to the total GDP, or "national income," produced by the economy over those years? Using the same 2 percent estimate, GDP will accumulate $2.46 quadrillion. The projected $70 trillion of debt is a mere 2.84 percent of that amount — very small relative to our ability to repay.

Compound Growth Can Work For Us Or Against Us. Higher growth rates make a huge difference in the ability to repay borrowed money. In fact, if the borrowed money is invested wisely, the "debt" pays for itself. The best way to appreciate this is by another arithmetic example. Compare the cumulative GDP for two rates that differ by a mere one-tenth of 1 percent: 2 percent and 2.1 percent. Incredibly, the difference in total GDP is $116 trillion over those 75 years.

Not only is $70 trillion projected debt just a tiny fraction of the total GDP over 75 years, it can be more than fully paid for if the borrowed money is invested in ways that produce at least a tiny one-tenth of 1 percent increase in the growth rate. Compound growth works in reverse as well. If the nation reduces its investment in physical and human capital so that the growth rate falls by one-tenth of 1 percent, it will lose $116 trillion in GDP over those 75 years and be that much less able to pay its debts.

This simple calculation demonstrates that as much as we need to get control of the deficit, it is counterproductive to balance the budget by reducing growth-enhancing investments in math and science education, road and bridge repairs, or broadband capacity. This is not an invitation for complacency; rather, it is a case for investing in education and physical infrastructure which will enhance future growth rates.

Arithmetic Versus Rhetoric. Basic arithmetic can liberate us from silly rhetoric. There is an old canard that says "We cannot grow our way out of debt!" Basic arithmetic shows that investment is the only way to get out of debt. We often hear that "We have mortgaged the future!" Good for us: mortgages taken out to pay for growth-enhancing investments pay for themselves. Were we to borrow today to invest in physical and human infrastructure, we would greatly enhance our economic potential — producing permanent increases in the economic growth rate of the nation. Another canard: "We are spending money we don't have!" Of course we are: That is what borrowed money is. The important question is whether we are borrowing to consume or borrowing to invest.

Lessons For Budget Balancing. Budget arithmetic teaches valuable lessons. For instance, the earlier we address a financial problem, the smaller the adjustment required; small adjustments per person can amount to large adjustments in the budget; growth-enhancing investments can pay for themselves and growth-retarding cuts can cost more than they save.

Debt numbers are big; the problem is less so 01/09/12 [Last modified: Monday, January 9, 2012 1:36pm]

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