February 27, 2013 7:17 pm
Obama planned big budget cuts all along
The president had a Faustian pact on tax and spending, says Jeffrey Sachs

To hear US President Barack Obama tell it this week, the budget sequestration – the automatic spending cuts that are due to commence on March 1 – will decimate the government. Each party is blaming the other, as if something new and unexpected was about to begin. Many of the cuts are indeed ill-advised – but the fact is that from the start of his presidency Mr Obama has planned a steep reduction in discretionary spending as a share of national income.

Each year he has put a budget on the table calling for a sharp decline in discretionary spending as a share of gross domestic product in 2012 and beyond. Most of his supporters have been unaware of the contradiction between this and his rhetoric about increasing public investments in America’s future.

The administration is now vigorously blaming the Republicans for the pending cuts. Yet the level of spending for fiscal year 2013 under the sequestration will be nearly the same as Mr Obama called for in the draft budget presented in mid-2012. So deep were the proposed cuts in discretionary spending that the budget narrative pointed out that the plan would “bring domestic discretionary spending to its lowest level as a share of the economy since the Eisenhower administration”.

The squeeze on domestic programmes dates to the start of Mr Obama’s first term. In July 2009, he presented the details of his 10-year budget framework. Discretionary outlays (defence and non-defence) would rise from 7.9 per cent of GDP in 2008, the final full year of George W. Bush’s presidency, to 8.8 per cent in 2009; and 9.8 per cent in 2010, mainly because of stimulus spending and the surge in Afghanistan. But then they would fall to 8.7 per cent in 2011, 7.8 per cent in 2012, 7.4 per cent in 2013, and to just 6.3 per cent in 2019, the final year of the 2009 10-year budget framework.

These cuts are now taking hold, and they will hurt. Mr Obama’s supporters will be puzzled; many will doubt that these cuts have long been ordained by the president, at least in general terms, though not exactly as they will now occur. Why would a progressive leader plan for deep cuts in discretionary spending relative to GDP even as he advocates larger investments in health, education, infrastructure, clean energy, science and technology, job training, early childhood development and more?

There is a simple answer that is the key to the federal politics of our time. Mr Obama ran in 2008 and 2012 promising to make permanent the Bush-era tax cuts for almost all Americans. These tax cuts were unaffordable from the start and were scheduled to expire in 2010. But to say so, while the Republicans were promising to make them permanent for everybody, would probably have cost Mr Obama both elections.

So he made a Faustian bargain. He would champion the permanent extension of the tax cuts except for a tiny number of rich Americans, and he would silently plan for deep cuts in discretionary outlays as a share of GDP to compensate for the lack of adequate budget revenues in later years. In effect, he would allow rising outlays on mandatory programmes such as Medicaid and Social Security and debt servicing to crowd out public investments vital for America’s long-term economic future. And indeed, on January 1, Mr Obama and the Congress agreed to make the tax cuts permanent for 99 per cent of households.

Mr Obama probably hoped that when the moment of truth arrived, when the spending cuts started to bite, the American people would support higher taxes rather than the spending cuts long called for in his own budget proposals. And perhaps they will still do so. Yet he has never presented an alternative with more robust tax revenues in order to fund a higher sustained level of public investments and services.

So the moment of truth has arrived: we are on the path of deep cuts in discretionary programmes relative to national income. The fact is that America needs higher public investments and more tax revenues to fund them. Mr Obama is finally saying some of these things, though still without specific tax proposals.

Yet it is very late in the day. Now the Bush tax cuts are permanent, Mr Obama lacks the political leverage to achieve a boost of revenues. After years of deflecting public attention from the coming budget squeeze, he will now preside over sharp cuts in public services and investments that are the opposite of his stated goals.

The writer is director of the Earth Institute at Columbia University

Copyright The Financial Times Limited 2013.

American Conservatism’s Crisis of Ideas

J. Bradford DeLong

27 February 2013

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BERKELEYOn the back left corner of my desk right now are three recent books: Arthur Brooks’ The Battle, Charles Murray’s Coming Apart, and Nicholas Eberstadt’s A Nation of Takers. Together, they constitute an important intellectual movement, which also happens to be a large part of the reason that American conservatism today has little that is constructive to say about managing the economy – and little purchase on the center of the American electorate.
But let’s back up historically, to the founding of what we might call modern conservatism in early nineteenth-century Britain and France. There were some Frédéric Bastiat and Jean-Baptiste Say come to mind – who believed that government should put the unemployed to work building infrastructure when markets or production were temporarily disrupted. But they were balanced by those like Nassau Senior, who spoke out against even famine relief: Although a million people would die in the Irish Potato Famine, “that would scarcely be enough.”
The main thrust of early conservatism was root-and-branch opposition to every form of social insurance: make the poor richer, and they would become more fertile. As a result, farm sizes would drop (as land was divided among ever more children), labor productivity would fall, and the poor would become even poorer. Social insurance was not just pointless; it was counterproductive.
The proper economic policy was to teach people to venerate the throne (so that they would respect property), the paternal hearth (so that they would not marry imprudently young), and the religious altar (so that they would fear pre-marital sex). Then, perhaps, with women chaste for half or more of their childbearing years, the surplus population would diminish and conditions for the poor would be as good as they could be.
Fast-forward 150 years to post-World War II America, and to the original Chicago School critique of the New Deal version of social insurance – that it creatednotches” that perverted economic incentives. The government, Milton Friedman and others argued, told the poor: make more money and we will take away your free housing, food stamps, and income support. People are rational, Friedman said, so they will not work for long if they get nothing or next to nothing for it.
The big difference between the Malthusian conservative critics of social insurance in the early nineteenth century and the Chicago critics of the 1970’s is that the Chicago critics had a point: Providing public support to the “worthy poor, and then removing it when they began to stand on their own feet, poisoned incentives and was unlikely to lead to good outcomes.
And so, from 1970 to 2000, a broad coalition of conservatives (who wanted to see the government stop encouraging immorality), centrists (who wanted government money spent effectively), and leftists (who wanted poverty alleviated) removed the “notches” from the social-insurance system. Presidents Jimmy Carter, Ronald Reagan, George H. W. Bush, Bill Clinton, and even George W. Bush and their supporters created the current system, in which tax rates and eligibility thresholds are not punitive disincentives to enterprise.
So what is the problem that America’s new generation of conservative critics of social insurance sees? It is not that raising poor people’s standard of living above bare subsistence produces Malthusian catastrophe, or that taxes and withdrawal of welfare benefits make people work, at the margin, for nothing.
For Eberstadt, the problem is that dependence on government is emasculating, and that too many people are dependent on government. For Brooks, it is that knowing that public programs make one’s life easier causes one to vote for non-Republican candidates. For Murray, it is that social insurance means that behaving badly does not lead to catastrophe – and we need bad behavior to lead to catastrophe in order to keep people from behaving badly.
The crucial point is that America’s conservative elites believe Brooks, Eberstadt, and Murray. To this day, Mitt Romney is convinced that he lost the presidency in 2012 because Barack Obama unfairly gave Latino-Americans subsidized health insurance; gave women free reproductive health coverage (excluding abortion); and gave other groups similargifts.” He could “never convince them that they should take personal responsibility and care for their lives.”
In fact, it would be a tough sell for any candidate to convince Americans who receive government benefits that they are dependent rather than empowered; that it is bad for people to vote for politicians who make their lives better; and that good public policy seeks to create human catastrophe rather than to avert it. The problem for American conservatives is not their choice of candidates or the tone of their rhetoric. It is that their ideas are not politically sustainable.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

Copyright Project Syndicate - www.project-syndicate.org

The Healthcare Blues

By John Mauldin

Feb 27, 2013

On Being a Professional Worrier

I should note that I am a professional worrier. I get paid to think about what can affect our economy, finances, and investments. Over the years I have become quite good at it. But the sheer volume of things to worry about has grown so much that there is not enough time to worry about everything, so I have had to prioritize.

For instance, there was a time in my life when I worried about what the markets did on any given day. But serious study showed me that worrying about the day-to-day movements of markets was pointless (at least for me, and probably for most of you), so now I let the media and traders do that for me.

Instead, I try to think about what could move markets longer term. And yes, I “worry” (as in ponder) what could make the markets go up as well as what could make them go down. It is enough to try to get the direction of the movement right, let alone the day-to-day gyrations.

Further, I do not worry (at least in terms of economics and investments, the beat of this letter) about things that I can either avoid or at least hedge against. I may pay close attention, but I do not spend time worrying.

I try to devote my actual professional worry time to things for which I don’t have a solution, and to ponder the likelihood of their happening and what we might do about them.

This prioritization helps my worry closet remain a closet and not expand into the living room. I must confess that my living room is crowded enough with worries about how my kids are doing that I simply have to close the worry closet door every now and then, as they remind me of the here-and-now problems of life. However, problems that they deal with do often find their way into my worry closet. Problems like, where will the jobs come from? (Which is the subject of a book I hope to have off my desk in a few months.) Another such problem is the subject of my central worry in this letter: health care.

I have written extensively in this letter about the unsustainability of the entitlement programs, especially Medicare and Medicaid. They are growing at a much faster rate than the economy. We simply cannot afford as a nation to maintain our current system without reform.

The Healthcare Blues

For this week’s issue of Time magazine, the cover story is Bitter Pill: Why Medical Bills Are Killing Us, by Steven Brill. I had to have something to read while the plane was taking off, and that turned out to be it. (Since I got my iPad I no longer carry books, so I make sure I have something to peruse while waiting to be able to use my electronics in the air.) I have read work by Steve Brill in the past and like his style, so even though I don’t usually read Time, I picked up this issue on health care.

I wish I could get every voter in America to read that article and then go to the Internet, Google the piece, and read the comments. I don’t agree with all he wrote, but he does a marvelous job of giving us the picture on just how broken the American healthcare system is in terms of costs. He goes into detail about how hospitals create those staggering bills. If you have private insurance or a government plan, you don’t have to pay those prices, but what if you don’t? The billing system is out of control: $1.50 for a 1.5-cent acetaminophen pill (Tylenol). A simple niacin tablet marked up 240 times.

Routine products like gauze marked up 10 times. Billing for a lamp shade? Are you serious? Double and triple billing for routine items that no insurance company or government agency will pay for, but that you will be billed for if you are on your own. You have read the stories or heard them from friends, but Brill makes it real.

We spend almost 20% of our gross domestic product on health care in the US, and that figure continues to climb. I could quote at length from the article, but let me just excerpt six paragraphs:

Taken as a whole, these powerful institutions and the bills they churn out dominate the nation’s economy and put demands on taxpayers to a degree unequaled anywhere else on earth. In the U.S., people spend almost 20% of the gross domestic product on health care, compared with about half that in most developed countries. Yet in every measurable way, the results our health care system produces are no better and often worse than the outcomes in those countries.

According to one of a series of exhaustive studies done by the McKinsey & Co. consulting firm, we spend more on health care than the next 10 biggest spenders combined: Japan, Germany, France, China, the U.K., Italy, Canada, Brazil, Spain and Australia. We may be shocked at the $60 billion price tag for cleaning up after Hurricane Sandy. We spent almost that much last week on health care. We spend more every year on artificial knees and hips than what Hollywood collects at the box office. We spend two or three times that much on durable medical devices like canes and wheelchairs, in part because a heavily lobbied Congress forces Medicare to pay 25% to 75% more for this equipment than it would cost at Walmart.

The Bureau of Labor Statistics projects that 10 of the 20 occupations that will grow the fastest in the U.S. by 2020 are related to health care. America’s largest city may be commonly thought of as the world’s financial-services capital, but of New York’s 18 largest private employers, eight are hospitals and four are banks. Employing all those people in the cause of curing the sick is, of course, not anything to be ashamed of. But the drag on our overall economy that comes with taxpayers, employers and consumers spending so much more than is spent in any other country for the same product is unsustainable. Health care is eating away at our economy and our treasury.

The health care industry seems to have the will and the means to keep it that way. According to the Center for Responsive Politics, the pharmaceutical and health-care-product industries, combined with organizations representing doctors, hospitals, nursing homes, health services and HMOs, have spent $5.36 billion since 1998 on lobbying in Washington. That dwarfs the $1.53 billion spent by the defense and aerospace industries and the $1.3 billion spent by oil and gas interests over the same period. That’s right: the health-care-industrial complex spends more than three times what the military-industrial complex spends in Washington.

When you crunch data compiled by McKinsey and other researchers, the big picture looks like this: We’re likely to spend $2.8 trillion this year on health care. That $2.8 trillion is likely to be $750 billion, or 27%, more than we would spend if we spent the same per capita as other developed countries, even after adjusting for the relatively high per capita income in the U.S. vs. those other countries. Of the total $2.8 trillion that will be spent on health care, about $800 billion will be paid by the federal government through the Medicare insurance program for the disabled and those 65 and older and the Medicaid program, which provides care for the poor.

That $800 billion, which keeps rising far faster than inflation and the gross domestic product, is what’s driving the federal deficit. The other $2 trillion will be paid mostly by private health-insurance companies and individuals who have no insurance or who will pay some portion of the bills covered by their insurance. This is what’s increasingly burdening businesses that pay for their employees’ health insurance and forcing individuals to pay so much in out-of-pocket expenses.

I know about those business healthcare burdens. At my very small business, the fastest-rising cost is health care. I have my staff get bids on health care every few years and try to hold down costs. I should note that after reading the Brill article I am actually going to go back and check a few items to make sure we have proper coverage. You think you do until…

Let’s be clear: the US has the best medical care on the planet. Expensive, yes, but our best is truly the best. As I get older and as my kids have issues, having access to good health care seems a very good idea. I want to live a very, very long time. Which is why I worry. I don’t want to see our healthcare system get sidetracked.

Now, we are getting ready to dramatically change how we pay for 20% of our economy. I fear Obamacare is going to be a bureaucratic nightmare. Before you consign me to some Neanderthal Republican hell, let me quickly state that any necessary reform is going to be disruptive and expensive. Even if we adopted Paul Ryan’s plan, it would be very disruptive. You simply can’t change the incentives and payment structures of 20% of the economy without creating macroeconomic problems. There are more unintended consequences than we can imagine lying hidden in the grass of healthcare reform, like hungry lions.

Having to cover pre-existing conditions is going to raise the costs of private insurers. In my business, we are getting reports that our cost will go up by as much as 50%. Individual rates may rise even more.

Under Obamacare, businesses may have sufficient incentive to drop insurance coverage and pay a $2,000-per-employee penalty. I am not certain where they came up with that number, but $2,000 is cheap insurance. Insurance companies are going to lose business customers as they raise prices. If your employees can get government health care (mine can’t, I hasten to add!), then from a financial perspective you are better off paying the penalty. When insurance costs rise, the pressure to drop coverage will rise as well, which will mean those still covered have to pay more. It will be an ugly trap until things get sorted out.

By the numbers, Medicare looks like a government program run amok. After President Lyndon B. Johnson signed Medicare into law in 1965, the House Ways and Means Committee predicted that the program would cost $12 billion in 1990. Its actual cost by then was $110 billion. It is likely to be nearly $600 billion this year. That’s due to the US’s aging population and the popular program’s expansion to cover more services, as well as the skyrocketing costs of medical services generally. (Time)

I fear that the Medicare budget will rise even further unless we get aggressive on holding down costs. But that will not be easy. The systemic and political incentives to effect change are just not there until there is a real crisis. And while Brill talks about the excess profit in the system, when you take that away, things will change. Some think they will change for the better, but I am afraid we are all indulging in wishful thinking.

Obamacare may have brought forward the crisis that we all knew was coming. Rather than runaway entitlement spending being a problem for the latter part of this decade, it may soon be a topic for your child’sshow and telltime at school. We either get a handle on the problem this year or things could quickly spiral out of control. Medicare and Medicaid costs could quickly rise by 5-10%, which would blow a hole a mile deep in our national budget. Yes, that would mean that costs that had been absorbed by emergency rooms and picked up by charities would now be paid for by the government, but while they might amount to the same total (unlikely), they would not be part of cost and budget projections.

Maybe the government does a better job at estimating future costs than it did in 1965, but I worry that it won’t. And the consequences of being wrong could be very disruptive to a healthcare system that is as vital as food and energy. Honestly, I do not get a good feeling when I think of Washington DC and crisis management. Call me silly, but I worry about that.

I don’t have an answer, or at least not an easy one. Should we treat health care as a utility? That is anathema to my free-market sensibilities. Should people be without basic health care? That is also not acceptable. Can we afford universal health care? Not as costs are currently structured.

Can we change? Sure, we will have to. But I expect a bumpy ride. I read and think a lot about health care because I am worried it is going to impact our economy in ways we simply don’t yet understand.

China, Japan, and a Few Rocks

I also read a lot of material written by other professional worriers – as opposed to amateurs who worry about everything simultaneously, or even worse, the tin-hat crowd that feels compelled to conjure problems and conspiracies that don’t exist in order to assign blame to some imagined cabal of bad guys.

(OK, let me generate a lot of negative comments with an example. I find the belief that there is a “Plunge Protection Team” simply bizarre. You know, the guys who are supposed to control the stock market? The “Working Group on Financial Markets”? If there is one somewhere, deep in the bowels of government, they are the most incompetent conspirators ever assembled. And no one has come forth and spilled the beans in a memoir after 25 years? Puh-leeze!)

But when I start to pick up similar themes from people I know and respect who don’t know each other, I start to pay attention. And one of those themes has been coming to me from people, including some at very high levels, who have deep knowledge and experience of Japan and China.

They are getting concerned that the level of rhetoric surrounding the Diaoyu/Senkaku Islands dispute is starting to get out of control. The real estate in question is a very small chain of five uninhabited islets and three rocks in the middle of the East China Sea. They are located roughly due east of mainland China, northeast of Taiwan, and west of Okinawa Island (the largest of the Ryukyu Islands), as shown in the map below.

China and Japan have had an on-again, off-again relationship for centuries. At times, it has not been very pretty. China suffered a great deal at Japanese hands during WWII. Just when you thought the old wounds were finally healing, the off-again phase has come back in full force. Japan nationalized what were to them the Senkaku Islands last September. (Technically, Japan bought them from the Kurihara family for 2 billion yen.)

The earliest historical records we have indicate that the Chinese discovered the islands in the 15th century. The Japanese nationalized them in 1895. After WWII, the US administered them but gave control back to Japan in 1971. Returning control to Japan angered both China and Taiwan, as both countries considered the islands as their own. China and Taiwan then began to officially declare ownership of the islands.

The rub is that these rocks may be perched in the middle of a rather large oil and gas field. The UN identified the petroleum potential in 1969, but no drilling has taken place.

The leaders of both China and Japan have made strong statements, and their citizens have expressed even stronger emotions. The Chinese are boycotting certain Japanese companies, and Japanese exports to China have dropped 14.5% (as of latest data). Recent meetings between the two countries have not been helpful. Recently, in what was supposed to be a speech to smooth things over, a top Japanese foreign policy advisor basically lectured the Chinese on their behavior in Hong Kong. Not the stuff of great diplomatic gestures.

And as I get ready to finish this letter, this timely note has come in from Stratfor:

Japanese Prime Minister Shinzo Abe has warned Beijing that Tokyo is losing patience with China’s assertive maritime behavior in the East and South China seas, suggesting China consider the economic and military consequences of its actions.

In an interview The Washington Post published just prior to Abe’s meeting with U.S. President Barack Obama in Washington, Abe said China’s actions around the disputed Senkaku/Diaoyu islands and its overall increasing military assertiveness have already resulted in a major increase in funding for the Japan Self-Defense Forces and coast guard. He also reiterated the centrality of the Japan-U.S. alliance for Asian security and warned that China could lose Japanese and other foreign investment if it continued to usecoercion or intimidation” toward its neighbors along the East and South China seas.

It is hard for the world to understand the national emotion surrounding a few barren rocks. But stranger things have happened. Remember the Falklands (although they were at least populated)? I bring this issue to your attention not as something to worry about, perhaps, but as something to which you might want to pay closer attention. Let’s hope cooler heads prevail; this is not something the world wants to choose sides over.

Stupid Sequestrations

The media and much of the political chattering class seem to think that the upcoming sequestration of certain government spending is going to bring down the republic. The actual reality is that we are talking about some $45 billion this year. In a $16 trillion economy, that is a rounding error. And with a $1 trillion+ deficit, it is not enough cutting.

Yes, across-the-board cuts are stupid. The Defense Department and, yes, even the other government departments should be given leeway to decide where to make the cuts, with proper Congressional oversight. But we need those cuts and more. We should be cutting the deficit by $100-150 billion a year every year until the budget is balanced (by which time we hopefully see some growth). If we simply held spending where it is, the problem would get solved with no cuts. Or if we cut the growth of spending in half, we could get close with some other adjustments.

I worry about a lot of things. But this sequestration is just simply not on the list.

Have a great week. Don’t sweat the small stuff. And remember: it’s mostly small stuff.

Your having too much fun to worry too much analyst,

John Mauldin

Copyright 2013 John Mauldin. All Rights Reserved.