from Global Economy in Crisis

Weighing Obama’s Packed Reform Agenda

CFR economic expert Sebastian Mallaby credits President Obama with highlighting the long-term structural reforms needed to repair the U.S. economy and competitiveness, but says the scope of reforms may be too ambitious.

February 25, 2009

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

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The director of CFR’s Center for Geoeconomic Studies, Sebastian Mallaby, says President Barack Obama’s first address to Congress correctly identified the structural problems facing the U.S. economy. But Mallaby says that the president’s apparent intent to press for simultaneous massive reforms in the country’s health, energy, and education sectors is fraught with challenges. He sees a tension between Obama’s vow to become more globally competitive while placing caps on carbon emissions. And health care reform, which he agrees is essential, must involve difficult choices on how to resolve the way medical bills get paid in the United States. Mallaby says the United States will have the ability to incur extra debt to pay for new programs but finding budget savings on areas from defense to agriculture payments will require enormous political skill.

President Obama gave a speech last night aimed at reassuring Americans that he would lead them out of the financial crisis, but also included aggressive plans to revamp health care, energy policy, and education policy. Do you see that as a risky combination?

It’s certainly very ambitious to try to do all of those things at once. He makes a decent case that the United States has put off for too long the structural challenges to its growth rate, and that exactly goes to these three issues of education, health care, and energy reform. So he’s substantively right that those three issues are important for long-term growth; he’s also right that you’ve got to stimulate the economy in the short term to get out of the collapse of demand that we’re seeing. Whether you can do both is more a political question than an economic one. In theory, economically you could incur the extra deficit, the extra debt, that it’s going to take to kick-start some of these reforms in education and figure its legitimate because it’s going to pay off over the long term. And the United States has a big ability to issue debt to do this because it has the reserve currency in the global economy.

So substantively it’s doable; what I worry about is whether the circuits, in terms of getting stuff through Congress, are going to be overloaded, some kind of fuse is going to blow, and then he will be left having promised more than he can deliver.

He couched a lot of his appeals in terms of global competitiveness, such as, "The country that invented cars is not going to walk away from the auto industry, the United States will restore its place as a leader in higher education," and so forth. People have heard these types of arguments before, but can this work now?

"Partly because of his popularity ratings, partly because of extraordinary economic times, there is a little bit more grounds for thinking that he can, at least at the margin, whittle away at some of these abuses."

One aside: Of course the United States did not invent the automobile; it was invented by a German. Henry Ford may have standardized the production of cars, but he didn’t invent cars. So that historical niggle aside, if you’re going to generate political energy around tough reforms that will be opposed by lots of interest groups or resisted on various grounds, you need to appeal to a sense of national urgency and competitive obligation to do these things. It works differently on different issues. For example, it’s clear to me that when you invest in education, you do build a more educated and productive workforce and that does have big effects on U.S. competitiveness going forward. Equally, [it’s shown that] health care is a massive burden on the U.S. economy, that we spend 16 percent of GDP [gross domestic product] or thereabouts on health care, which is almost double what the average is in rich countries. And yet we don’t have a longer life expectancy. We have almost nothing to show for that extra spending. It’s frankly just a lot of money out the window in pure inefficiency because of the structure of our health system. So, again, it’s legitimate to say that if you fixed health care you would be making the United States more competitive.

Where I have a bit more trouble is on energy. Because if by energy one means doing something about climate change, if you put a price on carbon domestically in the U.S. economy, that is going to raise energy costs. And you can talk all you like about green jobs that might be created as a side effect of that, but the economics is clear that if you raise input costs you’ll be less competitive in terms of your output. So if you raise energy costs, your industry and so forth will be less competitive and not more. He’s slightly in a trap on the energy point.

How closely should we look at the stimulus package in terms of how this could start to accomplish some of his goals? It includes money for digitalizing healthcare records, for example, and a great deal of scientific research into renewable energies and transportation infrastructure.

One point about the stimulus is that insofar as it addresses things like medical information technology, it’s not really stimulus, typically. These investments are going to take a while to roll out, and if you pick a thing to spend money on, on the grounds that it has a big impact on long-term U.S. economic growth, you’re going to be lucky if at the same time it happens to be something which allows you to funnel money into the economy quickly and have a stimulus [effect]. That’s why, in fact, if you do the analysis of the $787 billion, a lot of it won’t be spent this year, in 2009. It won’t be spent next year, in 2010. It will actually be spent beyond 2010, by which time most of us hope that we’ll be out of the worst of the economic trouble. So it’s fair to say that something like maybe one-fifth or one-quarter, depending on how you count it, of this spending, really is non-stimulus, and it’s been smuggled in under the label of stimulus when really it’s about a long-term economic/structural strengthening of the economy.

Clearly there’s a good case for the electronic records, but no one would argue that the key to bringing down U.S. healthcare costs to the same share of the economy that you would have in a European economy such as France, Germany, or Britain is in that electronic stuff. That’s going to make a contribution, but much more important is the fact that you have a third-party payer system, meaning that when a doctor meets with a patient and they discuss what kind of care that patient should have, the person who’s paying the bill is not in the room. It’s a third party, it’s either the government or some outside insurance company, which ultimately means the patient’s employer. And you need to muster the political will to somehow align those incentives to make the payer of the medical bill have more power over what medical bills get paid, either by giving HMOs [health maintenance organizations] more power to say no about certain kinds of treatment or by having the government do it and say no, or by shifting to the more conservative philosophy of saying the patient should pay out of their own pocket. You can take your pick out of that menu, and none of them is politically at all appealing, and it was nowhere in Obama’s speech that he mentioned any of this.

In moving forward on these massive reform proposals, does he do them in sequence, does he try to roll them out linking together some elements? What is the best way forward?

"[Y]ou can talk all you like about green jobs that might be created as a side effect of that, but the economics is clear that if you raise input costs you’ll be less competitive in terms of your output."

That’s a good question. If you remember back in 1993 when the Clinton administration was elected with high hopes for domestic policy reform, again, [it argued] then that, as the bumper sticker said, "It’s the economy, stupid." They felt at that time, in ’93, that they had to make a choice. Either they were going to move welfare reform to the Congress or they were going to do health care in ’93, and they went for health care. They felt they couldn’t do both at once, and they didn’t even get the one thing they tried to do. Obama thus far seems to be talking in terms of, "We’re going to do all these big structural things on education, health care, and energy, we’re going to do them at the same time as we do massive bank bailouts and stimulus, and we have a very loaded agenda, not to mention significant foreign policy challenges, and we can do it all at once, and I promise you we’ll do it in year one." I’ll believe it when I see it.

Looking at the financial sector again, he called for regulatory reform that "puts in place tough, new common sense rules of the road so our financial market rewards drive and innovation and punishes shortcuts and abuse." What kind of reforms do you think he’s talking about?

Frankly, he is reflecting an understandable popular revulsion against what the financial sector has wrought upon the U.S. economy: that people in the financial sector did pursue short-term profits, they did buy subprime securities which were going to yield a high interest rate in the short term that would go bust in the medium term, leaving taxpayers to pick up the bill and leaving the whole economy in a mess.

[W]hen you really go down the mouse hole of looking at how these proposals on financial reform would work, you end up not being particularly convinced that they’re going to make a big difference. It simply isn’t credible to say, "Oh, we’ll have better oversight, and that will fix the problem." The fact is we’ve run that experiment. In the past, there have been multiple different bodies--at the federal level, at the state level, in the United States, and abroad--all trying to oversee financial institutions to prevent them from taking excessive risk. It doesn’t matter whether you’re talking about European bank regulators, which had a system called Basel II and completely failed to prevent European banks from getting into trouble, or if you’re talking about the Federal Reserve in the United States.

Obama last night talked about going line by line through the budget, picking out areas of fat or waste or fraud. He talked about some areas where there was some congressional turf involved: the large agribusiness payments; reducing "Cold War-era defense spending;" and referring also to businesses that he says "send jobs overseas," and not allowing them to get any tax benefits from that. These are tough areas to navigate through--any sense that he’s going to be any more successful than his predecessors?

"[W]hat I worry about is whether the circuits, in terms of getting stuff through Congress, are going to be overloaded, some kind of fuse is going to blow, and then he will be left having promised more than he can deliver."

There are a couple of reasons to think he’ll be more successful than his predecessors. He still has very strong popularity ratings and a fantastic way of using the bully pulpit, and so any individual person in Congress who is on a committee and is tempted to use that committee power to funnel money to a constituent, a defense contractor, and so forth, has got to be somewhat worried that President Obama will show up in their district and give a prime-time speech in which he calls names and says, "This is not the patriotic thing to do; your money is being wasted in a time of economic need when people are unemployed and you have representatives who are simply throwing money." Now that’s a high-stakes thing for Obama to do; I’m not suggesting he would do it without some pretty intense political consultation with his advisers. But nonetheless it’s fair to say that partly because of his charisma, partly because of his popularity ratings, partly because of extraordinary economic times, there is a little bit more grounds for thinking that he can, at least at the margin, whittle away at some of these abuses.

Finally, Obama was at pains to say that despite all the government action he’s proposing, the government in the end will not supplant private enterprise but is aiming to catalyze it and thinks there’s a historical precedence for that. Do you agree?

Yes, I do agree. Nobody in the political debate in this country is wanting to nationalize things because they actually believe that government ownership works better than private enterprise. Any government in a massive financial crisis with a huge banking sector problem ends up pouring enormous amounts of taxpayer dollars into financial institutions and de facto owning some of them. You just can’t get away from that. And so it’s not that they do this with great zeal for public ownership; it’s just that there’s no alternative.