Part 1 in this series reinforced the financial and political challenges facing our country. The debt of over 15 trillion dollars combined with the unfunded liabilities of over 61 trillion dollars threaten not only individual security but also national security.
If we continue to do what we’ve been doing, i.e., spending that does not result in economic growth, we’re headed for a financial crisis. A financial crisis can lead to political crisis, and political crisis leads to social unrest. Greece is often cited as an example of a country where debt has led to social, economic and political turmoil.
For the United States, an early warning that debt is leading to a financial crisis would be the financial viability of the states. The Washington Post columnist George Will, in his article Illinois is running out of time and money, describes the effects of debt on that state. The article also references the study Freedom to Fail: The Keystone of American Federalism by Paul E. Peterson and Daniel Nadler in the University of Chicago Law Review.
Peterson and Nadler provide historical examples of states that defaulted on their debt but, under the principles of federalism, the federal government could not and did not intervene. However, defaults by states in the current political and economic climate could lead to an interest to “transform the country’s federal system.” Investor Warren Buffet, when asked on the likelihood of a federal bailout of state and municipal bond holders, remarked: “It’s a bet on how the federal government will act over time.”
Preventing the crisis and/or responding to what many consider being an inevitable crisis reinforces the need for civil servants to anticipate the effect of the debt on agency budgets. The challenge will be to continue to meet stakeholders’ expectations (i.e., provide effective and efficient services) with what will invariably be less resources. This requires a level of innovation and productivity that cannot be achieved with the leadership model used to create the problem. We need a new model that integrates an understanding that reducing variation is the key to excellent quality, i.e., doing the right things right.
John Kotter identified an 8-Step Process for Leading Change. The first step is to “establish a sense of urgency,” which is the purpose of this article. Part 3 in this series will identify proven strategies that can be applied by individuals and groups to support the type of change that will result in improvement.
The National Commission on Fiscal Responsibility and Reform, commonly referred to as the Debt Commission, was created by President Obama in 2010 to identify options for achieving fiscal sustainability.
In its report, The National Commission on Fiscal Responsibility and Reform: The Moment of Truth, the Commission provides an objective and bipartisan assessment of the challenges facing our country. Excerpts include the following:
“The problem is real, and the solution will be painful. We must stabilize and then reduce the national debt, or we could spend $1 trillion a year in interest alone by 2020. There is no easy way out of our debt problem, so everything must be on the table. A sensible, realistic plan requires shared sacrifice.”
“The federal government can and must adapt to the 21st century by transforming itself into a leaner and more efficient operation. Like its citizens, government must also be willing to do more with less and live within its means.”
“The Commission recommends a complete review of all budget scoring practices … Changes should aim to more accurately reflect the true cost of government liabilities, including by considering accrual accounting, risk-adjusted credit reforms, and similar concepts.” (Note that “accrual accounting” would include the 61 trillion in unfunded liabilities.)
In its report The Long-Term Budget Outlook, the Congressional Budget Office (CBO) makes the following observations about budget impacts:
“In fact, CBO’s projections understate the severity of the long-term budget problem because they do not incorporate the significant negative effects that accumulating substantial amounts of additional federal debt would have on the economy….”
“Large budget deficits would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment–which in turn would lower income growth in the United States.”
“Growing debt would also reduce lawmakers’ ability to respond to economic downturns and other challenges.”
“Over time, higher debt would increase the probability of a fiscal crisis in which investors would lose confidence in the government’s ability to manage its budget, and the government would be forced to pay much more to borrow money.”
Debt to GDP – How Will We Know If Things Are Getting Better or Worse?
One of the first challenges in understanding a proposed change is to define the problem and the indicators (facts) that will be used to determine if the change results in improvement. Debt as a percent of Gross Domestic Product (GDP) is a common indicator that is used to assess a country’s ability to manage its debt.
However, the “debt” part of the equation is open to interpretation. For example, the Government Accountability Office (GAO) uses the “debt held by the public” in its assessment Historical Events Affecting Federal Debt Held by the Public (1797-2010). The GAO also uses “debt held by the public” in the report A Citizen’s Guide to the 2010 Financial Report of the U.S. Government, where it concluded that: “… the debt-to-GDP ratio is projected to increase continually over the next 75 years and beyond if current policies are kept in place, which means current policies are not sustainable.”
In the report Federal Debt and the Risk of a Fiscal Crisis, the CBO is projecting that the “debt held by the public” could exceed the historical peak of about 110 percent of GDP by 2025 and could reach 180 percent in 2035. However, calculating the debt-to-GDP ratio using the “debt held by the public” as opposed to the “U.S. gross debt” understates the problem. Calculating the “U.S. gross debt” using information provided by the Office of Management and Budget to GDP ratio reveals that the historical peak was 122% in 1946.
Increasing inflation is often considered a strategy to reduce the severity of the debt. In Not Enough Inflation, New York Times columnist and Noble Prize winner in economics Paul Krugman wrote “… a bit more inflation would be a good thing, not a bad thing.” He considers a lower unemployment rate at the risk of higher inflation to be an appropriate trade-off. Inflation benefits those who owe money (the federal government) as opposed to those whom this money is owed – the American citizens who are ultimately responsible for the decisions of their government.
Debt, GDP and Credit Ratings
No matter how you define it, the debt-to-GDP ratio is important because of its correlation to a country’s credit rating. A lower rating indicates higher risk, and higher risk leads to higher interest rates. Higher interest rates can lead to higher inflation.
Budget projections indicate that interest payments on the debt by 2022 will exceed that year’s defense budget. Restated, we might get to the point where we’ll pay more in interest on past spending than we will on national defense. A weak military reduces the diplomatic leverage needed to support the trade policies and practices needed to support a competitive economic system.
The chart Comparing Debt Ratios provides a comparison of countries’ credit ratings and their debt-to-GDP ratios starting from 2006 and projected through 2016. The credit ratings are from Standard and Poor’s long-term credit and outlook data. The debt-to-GDP ratios are based on debt levels provided by the International Monetary Fund. For the first time, Standard and Poor downgraded the U.S. credit rating from AAA to AA+ in August 2011. It also indicated that another downgrade is possible in the next 12 to 18 months.
A Way Ahead
As mentioned previously, the “U.S. gross debt” to GDP ratio peaked to 122% in 1946—the year after WWII ended. In the years that followed, the U.S. began dominating the world’s market due to the destruction of the European and Asian economies. We could sell anything we could make, which helped to grow the economy and reduce the debt down to pre-war levels.
The re-discovery of quality management principles in the U.S started to emerge in the 1960s and 1970s as Japanese and European car manufactures began to capture more market share from American manufacturers.
Quality management principles and practices have now been accepted and applied worldwide. They’re embedded in standards such as ISO 9000 and in performance management criteria integrated in recognitions such as The Deming Prize, The Deming Grand Prize, Shingo Prize and Malcolm Baldrige National Quality Award. On an individual level, the equivalent to an award or recognition is the self-satisfaction that comes from getting better results by applying a more effective leadership framework.
In order for the U.S. to dominate the world’s market again, people need to realize that, in the words of W. Edwards Deming, “it all has to do with reducing variation.” Reducing variation results in what Deming described as a chain reaction: When organizations improve quality by reducing variation, they decrease costs, improve productivity, capture the market with better quality and lower price, stay in business and provide jobs and more jobs.
Part 3 in this series will provide examples on the how an improved leadership framework can be applied to support the needed changes. This framework was introduced in my October 2011 article Leading Effective Change: Working in the System and on the System and is referred to as the Foundations for Quality.