JPMorgan Explains: The Problem Is The Inexorable Rise In Entitlement Payments

Via JPMorgan’s CIO Michael Cembalest,

Meanwhile, I visited New Orleans last month to see clients. One question that always comes up there: why can’t the US spend more on infrastructure? As I first wrote 5 years ago, preventive infrastructure spending can be effective: $120 billion was spent by the US government for relief and reconstruction in the wake of Hurricane Katrina. As is now believed in the geo-forensics community, for just $10 million, the Army Corps of Engineers could have conducted more detailed subsurface exploration beneath flood walls erected in the last 25 years. Instead, to save money, testing intervals were spaced too far apart. This led to faulty extrapolations and canal wall failures that caused 80% of the damage (and which preceded water rising over the levees). Given the dilapidated state of bridges, tunnels, rails, roads and the electricity grid in some places, why is US spending on this category falling? And how does the US avoid the kind of environmental problems facing China cited on page 4 as spending on superfund clean-up and other related programs declines?

Another question that comes up: why can’t the US spend more on worker retraining? The entry of China into the World Trade Organization in 2001 accelerated a massive decline in US manufacturing jobs, and after the housing bust, the country’s unemployed construction workers need new skills. As shown in the first chart on the next page, why is less money being spent on training, employment and related social services? The second chart on the next page is striking as well: given concerns around peak oil, fracking, climate change, etc., you would think that public sector spending on commuter rails, urbanized natural gas vehicles, carbon capture and storage, safer ways of operating nuclear power (light water reactors), more efficient internal combustion engines, battery/electricity storage R&D and renewable energy integration would be rising. So why is energy spending falling?

Some people ask if the US is prepared for a renewed cold war with Russia alongside its ongoing battles with other ideological enemies. One can debate whether the US has a national interest in getting militarily involved in Syria and Crimea (I don’t think it does), but that’s different from debating how low defense spending can go before it has repercussions in other ways. The first chart below shows spending on national defense.

The answer to all these questions is the same: these categories are declining since they are being squeezed out by the inexorable rise in entitlement payments. There may be negative consequences for productivity, job growth and national income over the short run and over the long run (the New Orleans infrastructure cost/benefit failure is one textbook example). Of course, some argue that there are sufficient incentives for the private sector to solve the transportation, natural resource, infrastructure, job retraining, energy and urbanization challenges facing the US, so that the above trends aren’t a problem. I wouldn’t.


Read the full Michael Cembalest note below:

Cembalest – 03-31-2014 – The 15% Solution


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