America Has Huge Holes In Its Pockets, Part 2

The super-committee in Congress is working on a plan to cut spending by several trillion dollars. It is likely that the final plan will prove too timid because most congressmen (and women) think their best chance to stay in power is by promising a future without sacrifice. Unfortunately, fixing the debt mess and improving the efficiency of the US economy will require the debate to go deeper and re-examine the very nature of major governmental expenditures.

If you agree with one or both sections of this article, then please send the part you agree with to your congressman.

This is part two of a longer article: "America Has Huge Holes In Its Pockets"

Part 2A of "America Has Huge Holes In Its Pockets"

The $862 billion stimulus from 2009 was so loaded with pork, that it has been called the "Porkulus" program. To that was added the $27 Billion Homebuyer tax credit and $3 Billion cash-for-clunkers. There's plenty of wasteful spending to be cut in these programs, but it is not going to be enough to close an annual budget deficit exceeding $1 Trillion. Larger parts of the US Budget, including some that have been hitherto considered untouchable will have to be examined. Two of the largest areas of government spending are the main focus of this article.

Holes in American Pockets: The biggest hole - Health care

I believe there are four big holes in the pockets of most Americans. Through these holes wealth is draining away, and that wealth drain is severely hampering the US economy, and preventing it from growing. Some of the holes are contained within the Federal budget, and some are in the personal expenditures of individual Americans. Hundreds of billions, or even trillions, of dollars are being lost each year in wasteful, non-productive expenditures. Fortunately, the drain represented by this malinvestment could be reduced if the nature of the excess spending problem was better understood and intelligently addressed. In fact, it will be nearly impossible to properly manage the US debt problem without simultaneously addressing the chronic wasteful spending which is making Americans poorer each year. Leadership on this vital challenge is a critical mission for the man (or woman) elected President in 2012 whomever that may be.

I fully appreciate that one man's expense is another man's income. But where the expenditure does little to add to the health or productive capacity of the American enterprise, it can weaken the overall economy. The same money spent elsewhere could have helped grow the productive part of the economy. As wealth is squandered, the seed corn of the nation can be squandered, or drained away into foreign hands.

Understanding the reasons why expenditures are out-of-control, and limiting the waste through discipline and a more purposeful long term approach is the best way to preserve US wealth, and help it to grow once again. The economists who have been advising the Presidents and the politicians within both parties are not serving them well. Nor are they serving America. They lack imagination and understanding. In some cases, they are compromised by their closeness to powerful vested interests. So they do not get to the root of the problem. This article contains a no-holds-barred account of spending issues we need to face as a country.

The largest single component of the Federal budget is health care. In fact, it is one of the heaviest expenditures within the economy as a whole. A sensible way to look at it is from the top down, by calculating total National Health Expenditure ("Nat'l Health Exp"), and looking at it as a percentage of US GDP:

Healthcare: It really does matter who pays!

Source : US Dept. of Health and Human Services

What these figures show is how Health care expenditures have out-paced growth in the economy. Taking 1980 as a starting point, NHE has grown 118% faster than the economy as a whole. And since 1990, NHE has grown 73% faster.

This growth comes in very big numbers. In 1980, health care was about 9% of the US economy, by 1990 it had risen to 12.5%. In 2009, it was pushing up towards 20%. That was twice the share that Health Expenditures were back in 1980. Meantime, Congress has been shifting more and more of that spending onto the Federal budget, first through Medicaid and Medicare, and more recently through Obamacare.

This impulsive rate of growth is truly unsustainable. And yet, with this history in mind, I can easily imagine that NHE will grow faster than any of the Congressional budget watchers have forecast if it is left alone. Why is this happening? I think the answer can be arrived at using common sense. Some of the growth is because new technologies are being employed to extend lives, and some of those technologies cost more. But I believe the main reason is even simpler than that.

It matters who pays for medical costs. If the patient pays the bills, he/she will exercise care in what they spend, and be cognizant of the cost of procedures and drugs that they are purchasing. We can see this inherent discipline in the slower rate of growth in "out of pocket" health care costs, which rose at 412% from the base year of 1980 and 116% since 1990. In the most recent 19-year period, the increase was less than the growth in the economy, which was 400% from 1980 and 140% in the later period. On the other hand, when the bills are passed to an insurance company, or (worse yet) to the government, there is little or no discipline. When somebody else pays, the cost balloons! And it balloons fastest when the government is paying. But there is no such thing as a government money tree, these costs will ultimately be borne by taxpayers, and that unhappy eventuality has become clearer during the budget debate.

Health care professionals know who pays. When they are aware that Medicare or Medicaid will pay, then they will be more willing to recommend expensive treatments, even though they may be unnecessary. Don't forget, from the doctor's perspective, the extra procedures may reduce the risk of expensive lawsuits. Lack of discipline is evident in the explosive growth of 356% and 408% respectively (see above) in these types of government-funded expenditures. Now under Obama's new healthcare programs, even more people are going to be passing their costs on to the taxpayer. No wonder the projected spending on healthcare is going to soar. Add to this retiring baby boomers moving in droves from their taxpaying years, towards their years of maximum health care. Instead of paying the bills themselves, they will be passing them on to their children and grandchildren, the future taxpayers.

If you accept my argument that costs run out of control when someone else pays, it is important to realize that only about 50% of Americans now pay income tax. If the US economy continues to stagnate, those overburdened tax payers are going to be asked to shoulder a truly massive burden of exploding health care costs. If the burden becomes too great, it will surely crimp growth in the economy. Some taxpayers will just give up and leave the country, while others may work well below their potential just to keep the tax burden down. These natural reactions to rising taxes will not help the US economy.

The alarming growth rates in the US are being noticed by others. And they have compared costs, with medical costs in other countries.

As Medscape, a medical website, puts it:

"The U.S. national health expenditure has risen from 5 to 17.7% of GDP since 1960 compared with a change from 3.8 to 9% of GDP in countries composing the rest of the developed world. Even if we choose to spend a substantial portion of our GDP on health care, its annual growth rate of 5.2% since 1960 is clearly unsustainable. Reining in the growth of health care expenditures is imperative for the continued prosperity of the American economy." (source)

Why does the US spend so much more on its health care?

In a few words: American doctors are paid more, they require more procedures for their patients, and they prescribe more expensive branded drugs. This happens partly because doctors are incentivized by drug companies and equipment manufacturers to behave this way. Generic drug makers spend little time and money promoting their cheaper drugs to physicians. Big pharma is constantly promoting the relative advantages of their branded drugs. Doctors naturally want to minimize possible lawsuits from litigious US patients. And if branded drugs appear to have fewer side effects, and more procedures reduce the risk of a mistaken diagnosis, then many doctors will take the easier path, without thinking a minute about how that increases costs for taxpayers. Congress does nothing to stop this reckless spending, because they too are beneficiaries of pharmaceutical company contributions, and are heavily visited by lobbyists from the drugs and insurance industries. And of course, the lawyers have their lobbyists too. Within Washington, there are 35,000 registered lobbyists, and that number has doubled in the last five years. As Bill Moyers has put it: "Amazingly, in Washington, there are approximately 65 lobbyists for each member of the House."

In the UK, where I have lived, health care is nationalized but it often reaches for a somewhat lower standard and relies heavily on rationing the most expensive treatments to keep the cost down. Moreover, very little of the spending is sucked dry by a complex and expensive insurance industry. Clearly, if America can no longer afford its expensive health care system, they have much to learn from the economies achieved in the rest of the developed world. America cannot afford "premium healthcare" when its own economy has fallen into a ditch.

Health care and Life Expectancy

Some will object to my comments, and say that lives are being prolonged by improved healthcare, and that advanced healthcare is inherently more expensive, as technology improves. Indeed, we have seen healthcare costs creep up as a share of GDP across the world, although to lower levels than in the US. The statistics show an improvement in the expected lifespan of individuals in the entire world, where the current world average life expectancy is 67.2 years, according to Wikipedia. In the US, the expected lifespan at birth has gone up from 68.2 years in 1950, to 73.7 years in 1980, and up to 78.3 years in 2010. That's a meaningful improvement, but if you look more deeply you will see that nearly all of that improvement is due to a reduction in mortality amongst infants and young children. More people make it 10, 20 or 30 years than they did in 1900, 1950 or 1980. But life expectancy beyond the age of 50 has improved very little*. In fact, we are more prone to fall prey to certain "modern" diseases, (such as cancer, diabetes, and HIV-AIDS.) The rise of these diseases have come with changes in our diet, lifestyle, and living arrangements. If expensive healthcare were rationed, as it is being done in other countries, people would need to take on more responsibility for their own wellness, and not expect the medical care system to bail them out from poor dietary and lifestyle choices.

You might expect that longevity would decline in hard times, but that has not been the case:

"The relationship between economic circumstance and life expectancy is not clear-cut, however. A study by José A. Tapia Granados and Ana Diez Roux at the University of Michigan found that life expectancy actually increased during the Great Depression, and during recessions and depressions in general. The authors suggest that when people are working extra hard during good economic times, they undergo more stress, exposure to pollution, and likelihood of injury among other longevity-limiting factors." (source)

Also, even with our advanced medical technology, and supposed top notch healthcare, the US is nowhere near the top in Life Expectancy at birth. According to the UN, that honor belongs to Japan at 82.6 years. Hong Kong is second (82.2 years), and Iceland is third (81.8 years.) In the UN data, the US comes in at number 36 (78.3 years.) And that's below the US Virgin Islands (#20, at 79.3 years), and Puerto Rico (#31. at 78.7 years.) Apparently, although Americans pay the most per capita for their healthcare, they are getting a much lesser result than countries that spend less.

The whole notion of healthcare needs to be changed in the US. The industry now gets paid when people fall ill and require treatment. This often means prescribing expensive branded drugs, because physicians have been "educated" about their benefits, rather than cheaper generic drugs, or herbal medicines which are little mentioned in medical education. There is little emphasis on prevention of disease. Americans eat a poor diet, get little exercise, and expect their doctors to prescribe a handful of pills when they are unwell. This is an expensive, wasteful and unsustainable health regime.

Whether they get there through enlightened choice or through enforced rationing, Americans will need to embrace a different system of health care. We need to accept that the most technology-intensive health care is likely to become less and less available. Fewer hospitals will have it, and those that do will have to ration it. The alternative is for individuals to accept more personal responsibility for their own wellness, with a focus on prevention and treatment by the patient himself. Some alternative forms of treatment, like Traditional Chinese Medicine, which are less expensive and less intrusive too, may have a role to play in US health care. The most expensive remedies recommended by highly paid health care professionals, will only be available to those who are willing to wait for it, or can pay extra to jump the queue. Truth be told, that is the way it works in other developed countries. Let's face up to these coming changes like adults, and focus more on our own wellness.

A sound prescription would be this: Politicians need to design a national healthcare system that shrinks the role of the doctors and pharmaceutical companies, and relies less on huge hospitals filled with expensive equipment, with a government not blindly covering the bills for all the care the present monstrous system sees fit to recommend. These changes will not be popular, since there will be complaints that only the healthy can make the change to a less hospital and doctor-driven form of health care. But historical growth rates are clearly unsustainable, so new models of treatment, and new ways of insuring health care will need to be entertained. For example, Paul Ryan's idea of allowing experimentation at the state level deserves careful consideration.

Footnotes:

• The gain from 1947 to today in life expectancy of those at 50 years, is only two years (source: Whale.to)

• Another source shows a gain of 3.9 years years in life expectancy at 65 years, since 1950: (source: EfMoody) That's even with all the new technology which keeps people going in hospital near the end of their lives.

• Another source talks about how men who exercise regularly from 50 years, can add 2.5 years: (source: Longevity.about.com)

Part 2B of "America Has Huge Holes in Its Pockets"

If Healthcare spending is a "sacred cow" for US politicians, then the Defense Budget is a "protected bull." The defense budget may need carving down to size, but it is a rare politician who is willing to talk about serious cuts. There are real conflicts for politicians. They like defense industry jobs in their districts, and they may also enjoy certain other benefits (like campaign contributions) from maintaining a good relationship with military contractors. It will take a big shift in the "public will" to get politicians to move away from their apparent willingness to protect the defense budget. Before they approve big cuts, they may need to see that failing to do so may cost them re-election. So American voters may need to get educated and get angry about the size of military budgets if they are going to see some long term relief from this unfair burden.

Holes in American Pockets:

Little protection from military overspending

One of the few major politicians willing to discuss the growing power of the military, was Ike Eisenhower, who probably had the best military credentials of any modern President. Even so, Ike left this touchy issue until his farewell speech, when he could do little but warn the country. He never "took the pentagon to the mat", even though he believed it needed doing. His speech was made 50 years ago, yet the words seem highly prophetic today:

"Our military organization today bears little relation to that known by any of my predecessors in peacetime, or indeed by the fighting men of World War II or Korea.

Until the latest of our world conflicts, the United States had no armaments industry. American makers of plowshares could, with time and as required, make swords as well. But now we can no longer risk emergency improvisation of national defense; we have been compelled to create a permanent armaments industry of vast proportions. Added to this, three and a half million men and women are directly engaged in the defense establishment. We annually spend on military security more than the net income of all United States corporations.

This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.

In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist." Eisenhower's Farewell speech

Stunning words, which almost no politician would dare to speak today. Amongst the current crop of presidential candidates, only Ron Paul speaks about the bloated size of the military, and asks the important question: Does the colossal military presence truly make the US safer? Ron Paul's assertion is that America's huge global military presence and its warlike activity actually threatens the safety of Americans because it creates enemies. Strangely, many veterans support Ron Paul's presidential ambitions, and yet the mainstream press fails to take Mr. Paul seriously. Questions are now being asked why this is the case, as we saw recently on Jon Stewart's program. Ron Paul nearly tied Michele Bachmann in the Iowa straw pool, and Stewart observed that he was treated as a distant also-ran. Are mainstream media outlets somehow being compelled to under-report Ron Paul's campaign? This is a question that needs asking. Perhaps the "unwarranted influence" that Eisenhower warned about has become so pervasive that it even plays a heavy-handed role even in US Presidential campaigns.

Certainly, the armaments industry of today is completely different from the "plowshares-to-swords" capability that Ike said once represented the US weapons capability. In fact, the American military apparatus is now unrivaled in every way compared to what exists in other countries on the planet. Its absolute size, its share of GDP, and its unmatched spending per capita leave the US defense industry in a class all its own.

Despite occupying most of a huge continent, and having friendly neighbors on both sides, the US spends more than two-times as much per capita, as any other major Western nation:

(Source)

Aggressive spending - is it really the best Defense?

With a population of 312 million, the US has 4.5% of the world's people, and they live on a huge continent, oceans away from serious enemies. At the same time, US military spending is about 43% of what the world spends on defense - Thus, the US spends about 10 times per capita what the world as a whole spends, and 16x per capita what the rest of the world (without the US) spends.

The United States is the ultimate safe haven country "protected" by vast oceans. Nevertheless, the US has somehow chosen to take upon itself the role of "global policeman". Perhaps this role is a residue of World War II, which left the US as the strongest man standing, and the US may have thought if it kept spending twice as high per capita as any other country, it could somehow maintain superpower status indefinitely.

This writer recalls attending a book launch about a decade ago with a well-known Neoconservative writer, who had identified three spheres of power: political, economic, and military. The Neocon philosophy of the time was that the US could remake the world to its own design, so long as the US maintained an unrivaled global military presence. I had the temerity to question that view, saying that eventually military power would accrue to the strongest economic power, and the US was in danger of losing its economic lead to China. I saw that the US economy was becoming increasing inefficient, and money was being wasted in many ways, including on a bloated military budget. The comment was brushed aside, as if the long term problems associated with a growing debt burden did not matter.

The US now has more than 350,000 troops in 150 countries overseas and is currently engaged in wars in Afghanistan and Libya, while struggling to "keep the peace" in Iraq. Is this spending really designed to keep Americans safe at home, or is there another agenda?

Who benefits from that spending? Who wins, when the US "projects its power globally", and gets involved in quixotic missions like removing unfriendly dictators, or protecting foreign oil fields? Obvious, it is not a farmer in the foothills of the Appalachians, nor an unemployed autoworker in Detroit. The average American probably sees little direct benefit from being a superlative military power. The most obvious impact of this global presence is that their children are asked to volunteer to fight in foreign wars. Indeed, more than a few patriotic Americans make the ultimate sacrifice to preserve this awesome power. Are they really any safer from that sacrifice?

An obvious indirect impact of the heavy spending is a much greater national debt level. Maybe, just maybe, the country has benefitted from the protection of their access to foreign oil. Another indirect benefit for the country may be that many countries have been more willing to hold the US currency as a reserve currency. Unfortunately, both of those "advantages" are proving, in the long run, to be wasting assets. Low oil prices have fed a dangerous addiction to foreign oil, as I will discuss later. And an overly strong currency has encouraged excessive US consumption- especially in the last decade, while making it more difficult to export products manufactured in the US. Now we have a schizoid dollar policy, where top US officials talk about the need to "maintain a strong dollar" while sticking to an ultra-low interest rate policy which seems designed to force the dollar down.

After acknowledging that most Americans have little benefit from the military behemoth, we can perform an Occam's Razor analysis, and see who does benefit. Surely, the key beneficiaries are those who sell goods, services, or equipment to the US military machine.

Star Trek's Ferengi had their own 34th Rule of Acquisition, which they might have borrowed from US defense contractors: "War is good for business."

It is not easy to trace all of the 0 billion or so that is spent in the US defense budget. In fact, there are rumors of huge additional sums being spent on things like "Black Ops", and building underground bases. Indeed, some observers like Paul Craig Roberts say that the annual military budget, including all the "special items" like two Wars, comes to .1 or .2 Trillion per annum.

One area where spending has been publicly reported, is the spending on military contracts, which in 2010 was reported to be about 0 billion. What we see is that these payments are highly concentrated. The top three companies: Boeing, Lockheed Martin, and Northrup-Grumman accounted for more than 75% of reported defense contracts in 2010. Without the benefit of these revenues, you have to wonder how healthy these companies would be. They have stock market capitalizations of billion, billion, and billion respectively

The US defense industry is huge and virtually recession proof, until now. Certainly, some contractors have been able to beat the inherent cyclicality of the US economy. As an example, here's one of the top 10 defense contractors: United Technologies (UTX) versus the S&P 500. Observe the outperformance since 2000 when US stock indices began a decade of stagnation. As many companies in the stock market struggled with the TMT and housing busts, the US fought wars in Iraq, Afghanistan, and now Libya. This assured handsome profit opportunities for those companies which had the US military as a major customer:

Click here for larger image

UTX has annual revenues of $57 billion, and some of its larger subsidiaries are Pratt & Whitney and Sikorsky Helicopters which sell to the US military. United Technologies provides the United States with aircraft, helicopters, and a fuel cells, elevators, and buildings. According to various press reports, UTX received $7.7 billion from the US for Defense-related contracts in 2010. That's 13.5% of UTX revenues, and in terms of absolute magnitude was 163% of 2010 net profits. No doubt, UTX has many big customers beyond the US government. But having a major customer with a huge appetite over a difficult decade, and a growing need for military equipment has been a big advantage. Within the defense sector can be found many other companies whose growth relies on the defense behemoth. When the pentagon remains a hungry customer, there is no need to shift business back to plowshares.

A second and less obvious beneficiary of the big spending are multinationals with foreign operations that want protecting. Many US companies have gone abroad in their search for customers. For instance, this includes the big US resource companies. Having a strong US military presence abroad helps them to keep mischievous foreign governments from abrogating contracts, or confiscating assets. I find it enormously ironic that some of those same big companies are now asking for lower corporate tax rates on the theory that this may increase jobs. Why do American voters keep falling for the trick that those who need big government as a customer, also seem to want others to pay for it?

As with the Healthcare system, those who benefit are shifting the costs to the US taxpayer. And Congress, excepting Ron Paul and maybe a handful of others, is less interested in providing oversight, than they are in climbing onto the gravy train.

A final beneficiary of US military spending which I want to mention are the foreign countries where the troops are based. And also, the many companies that sell goods and materials that the US military purchases overseas. For example, the annual oil consumption of the US military is approximately 120 million barrels of oil for fuel per annum - that's about 1.6% of total US consumption. Assuming an average price of $80 per barrel, that's nearly $10 Billion. These companies also look after their favorite congressmen. Meanwhile, this overseas spending is the ultimate hole in American pockets, since it leaks out without creating jobs or businesses at home.

Maybe it is time to take Ron Paul seriously. A surprising ally of Congressman Paul is Barney Frank, who has called for a 25% cut in military spending. Perhaps that could be a starting point. If the US brought home 75% of its troops, and cut back its overseas bases to what is really needed for genuine defense, as opposed to offense, then spending could be cut back dramatically. Alternatively, if the US had a goal of spending just $1,000 per capita, in line with what its allies spend, then defense spending could be cut in half, and it would fall from 4.7% of GDP, to 2.3% of GDP, permitting a savings of $350 billion per annum. Such a cut would greatly help reduce US debts.

In the next section, I will look at wasteful spending which is outside the US budget...