Professor links US fiscal woes, China-Unocal flap

Bob Tippee
Editor

China's unsuccessful bid for a US oil company last year bodes ominously for American fiscal health, argues Laurence J. Kotlikoff, a Boston University economics professor.

Without fiscal reform and large infusions of foreign capital, Kotlikoff writes in an article in the July/August issue of the Federal Reserve Bank of St. Louis Review, the US may be headed for bankruptcy.

Forget measurements of national debt and policies based on them. According to the professor, a country's solvency is better assessed in terms lifetime fiscal burdens faced by current and future generations relative to resources of those generations. If burdens exceed resources or even get high enough to prevent full collection, "the country's fiscal policy will be unsustainable and can constitute or lead to national bankruptcy."

From research by two former government economists, Kotlikoff puts the US "fiscal gap"—the present-value difference between all future government expenditures and all future receipts—at $65.9 trillion.

To close that "red hole," he says, the US might immediately and permanently double personal and corporate income taxes, cut Social Security and Medicare benefits by two thirds, or slash all federal discretionary spending by 143%.

None of those remedies seems likely. And Kotlikoff thinks immigration, often viewed as a cure for fiscal problems, can't do the job. Even productivity growth won't help much if federal expenditures rise with consequent wage increases. The trick is to break that link and find a reliable source of productivity improvement, such as external investment.

That's where China enters Kotlikoff's analysis. The country holds dollar-denominated financial reserves of nearly $500 billion and craves foreign investment opportunities. The US government, however, acted averse to Chinese direct investment when it resisted state-owned China National Offshore Oil Corp.'s bid for Unocal Corp. CNOOC withdrew the offer under political pressure 1 year ago (OGJ, Aug. 22, 2005, p. 32).

Besides assessing its fiscal health through "generational accounting" rather than debt, Kotlikoff proposes that the US government overhaul tax law, Social Security, and health care—and, of course, welcome foreign investment.

"Fear of Chinese investment in the United States," he says, "seems terribly misplaced."

(Online Aug. 18, 2006; author's e-mail: bobt@ogjonline.com)

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