Health and tax overwhelm the Republicans

The party should let the bill die and take a bipartisan approach to tax reform

by: Rana Foroohar

Healthcare reform is the Moby-Dick of American politics, a great white whale that can pull down anyone who takes it on. Former President Barack Obama encountered it, as did Hillary Clinton during her husband’s tenure in the White House. Republican senators returning this week from their July 4 holidays must surely be thinking about it, too, as they try again to push through a healthcare bill that has become the single most unpopular piece of legislation in three decades.

They should let it die, not only because 88 per cent of the public wants it to, but because the battle for the bill is putting Republicans and the Trump administration at risk of losing support from business, which is starting to believe that they simply cannot get anything done.

“It’s really tough to tackle both of these big and complicated issues [healthcare and tax reform] at the same time,” says Mark Weinberger, chairman and chief executive of EY Global, who sits on the president’s business advisory council. He warns that chief executives are worried about how little of the “business friendly” president’s agenda has moved forward. That’s not only because of infighting between the various power centres in the Trump administration, but also because the issues of healthcare and tax reform have become inexorably, and nonsensically, intertwined.

As anyone outside the US knows, the most cost-effective and humane way to provide healthcare is via a nationalised system that allows people to buy add-on options in the private market.

In the US, we have the opposite. The reason that nobody — not individuals, businesses or most policymakers — likes the Republican healthcare bill is that it adds more complications and less coverage to a market that is fundamentally broken and needs to be scrapped.

As OECD figures show, US healthcare spending is 15.3 per cent of gross domestic product, about 5 percentage points above France, the next most expensive country, and with worse outcomes. Like so much in the US economy, healthcare is bifurcated: we have concierge medicine for the wealthy and state-of-the-art pharmaceutical research but many people cannot afford to have their teeth fixed or have a baby without risking financial ruin. Given that the cost of healthcare is the number one reason for personal bankruptcy in the US, this is a big net loss economically.

Republicans are pushing a healthcare bill that would exacerbate those inequities by leaving 23m more people without insurance. They also hope to use the money generated by reversing Obamacare tax increases to cover the cost of their own proposed tax cuts. Amazingly, the administration still seems to believe in the magical thinking of the Laffer Curve, which posits that tax cuts always increase growth. Yet at the state level, conservative politicians are not only giving up on that idea, but are going the other way.

Just look at Kansas, a Republican state which cut top marginal individual rates and corporate taxes to the bone in 2012 and 2013. It has seen slower growth and ballooning deficits since, leading to major cutbacks in everything from education to infrastructure and social spending, making Kansas a less attractive place for business in general (the state’s bond rating has been downgraded twice in the past few years). Not only have Republican members of Congress supported tax increases since to provide basic services, but Jerry Moran, a Kansas senator, has become an obstacle to his party’s aspirations to reform healthcare at a national level.

He and a number of other senators from states with poor and rural populations argue that it is economically and socially wrong to roll back coverage just for the sake of overturning Mr Obama’s signature legislation.

They are right, and both Republicans and business people should think carefully about the lessons here. The election of Donald Trump has overturned much of what passed for political wisdom in Washington. But his election was partly a result of the fact that mainstream conservative economic thinking is stuck in the past.

Republicans and many of the business leaders who support the party have failed to move on from Reaganomics, which posits that government cannot do anything except cut taxes.

But voters have, rightly, lost faith in this message since it has not worked for the past 20 years. There are areas, such as healthcare, in which the government should be more involved. It would save money and help US corporations which are at a huge disadvantage relative to international competitors since they shoulder most of the burden of healthcare costs (60 per cent of Americans want government, not business, to run healthcare). And tax cuts of the sort being proposed by the Trump administration, which mirror much of what has failed in Kansas, are not going to help the economy.

My own white whale hope? That Republicans will let their healthcare bill die naturally, and take on tax reform in a more sensible, bipartisan way. This means cutting the corporate rate to international norms, not cutting the top marginal rate for individuals, and closing loopholes.

The administration could then show business that it has actually accomplished something — and something good for the economy to boot.

Central Banks Looking to Reduce Stimulus Face Quandary of Falling Inflation

Weak growth in prices questions traditional model of linking output and prices

By Paul Hannon and David Harrison

Mario Draghi, president of the European Central Bank, gave a speech last month that many investors viewed as signaling a readiness to remove some stimulus later this year or early next. Photo: PETI KOLLANYI/BLOOMBERG NEWS

Leading central banks plan to withdraw some of the stimulus measures they have put in place since the financial crisis. But their timing seems a little puzzling: Inflation, which is already below their targets, is falling world-wide.

The decline in inflation is a mystery since the global economy appears to be growing at a faster pace than during recent years, while unemployment rates continue to edge lower.

According to central bankers, inflation is generated by the gap between the demand for goods and services and the economy’s ability to supply them. When that output gap is wide, inflation is lower, and when it is narrow, prices grow more quickly. Low inflation is a symptom of a weak economy, something they want to avoid as much as high inflation, a sign of an overheated economy.

To boost inflation, central banks stimulate demand by lowering interest rates, encouraging households and businesses to borrow and spend. As the volume of goods and services that people want to buy nears the limit of the economy’s capacity to supply them, wages rise, as do prices, generating inflation.

But try as they might, central banks have been unable to reach their inflation targets over recent years, despite their success boosting growth and lowering jobless numbers. That has raised questions about the reliability of the traditional link between the output gap and prices.

“Central banks across the Western world are struggling to define that relationship,” said Bert Colijn, an economist at ING Bank.

Across the Group of 20 largest economies, which account for most of the world’s economic activity, annual inflation slumped in May to its lowest level since August 2016, according to the Organization for Economic Cooperation and Development.

Much of that decline was due to easing energy prices. But even excluding that volatile item, and similarly choppy food prices, “core” inflation is slowing in many places.

That isn’t a recent phenomenon. Core inflation in developed economies hasn’t changed much in the years since the financial crisis, never reaching the 2.5% rate it stood at in September 2008, when Lehman Brothers collapsed, or going below the 1.1% rate it hit in December 2010.

Central bankers are struggling to explain why inflation isn’t responding the way the textbooks say it should to an improving global economy and falling jobless rates. According to the OECD, the unemployment rate in developed economies fell to 5.9% in May from 6.3% a year earlier.

In the U.S., Federal Reserve Chairwoman Janet Yellen has shrugged off the past few months of low inflation numbers, saying they were caused by temporary domestic factors, such as cheaper new cellphone plans. But the global inflation slowdown calls that thesis into question.

Chicago Fed President Charles Evans suggested last month that poorly understood technological advances or aging populations could also be holding down inflation around the world.

“I sometimes wonder if there isn’t something more global, more technological that’s taking place that we don’t quite have our arms around very well,” he said.

Fed officials devoted part of their June 13-14 meeting to debating inflation’s surprising weakness. Some argued the link between the output gap and inflation had weakened over the past few years. Others worried letting the economy grow too fast would bring about a sudden burst of inflation that would be hard to control.

The picture is just as confusing in Europe.

In a June 27 speechthat was widely viewed by investors as signaling a readiness to remove some stimulus later this year or early next, European Central Bank President Mario Draghi said inflation has been weaker “than one would expect on the basis of output gap estimates and historical patterns.”

Mr. Draghi concluded that a narrowing output gap would eventually have its usual effect on prices. It would just take longer.

Other global factors may be at play. Because so many companies compete around the world, weaker economic growth and sluggish inflation in one country could keep a lid on prices in other countries, propagating low inflation across continents.

Another explanation could be lower inflation expectations around the world. After years of tepid price growth, workers may not push that hard for a raise and companies may not feel compelled to increase prices despite signs of improvement in the economy.

Whatever the cause, central bankers appear willing for now to look beyond the past few months of weak inflation numbers as they shift away from easy money policies. Faith in output gap theory is one driver. Some also are growing worried about other problems. For example, recent speeches from Fed officials and the minutes of the last meeting suggest a growing concern about financial stability as asset prices rise.

If consumer price trends don’t turn soon, however, central bank officials could find they have undermined the inflation mission they’ve established as their core objective.

The new old: Your money and your life

Financing longevity

As lives get longer, financial models will have to change
IN 1965 ANDRÉ-FRANÇOIS RAFFRAY, a 47-year-old lawyer in southern France, made the deal of a lifetime. Charmed by an apartment in Arles, he persuaded the widow living there that if he paid her 2,500 francs (then about $500) a month until she died, she would leave it to him in her will. Since she was already 90, it seemed like a safe bet. Thirty years later Mr Raffray was dead and the widow, Jeanne Louise Calment, was still going strong. When she eventually passed away at 122, having become the world’s oldest person, the Raffray family had paid her more than twice the value of the house.

Underestimating how long someone will live can be costly, as overgenerous governments and indebted private pension schemes have been discovering. They are struggling to meet promises made in easier times. Public pensions are still the main source of income for the over-65s across the OECD, but there are big differences between countries (see chart). In both America and Britain public provision replaces around 40% of previous earnings, but in some European countries it can be 80% or more. Where it makes up a big share of total pension income, as in Italy, Portugal and Greece, a shrinking workforce will increasingly struggle to finance a bulging group of pensioners.
Private pension schemes, which supplement state provision, have been shifting from defined-benefit plans, where workers are promised a fixed amount of income in retirement, to defined-contribution plans, where workers themselves take on the risk. Such schemes are good for employers but tricky for individuals, who become personally responsible for ensuring they do not outlive their savings.

The new stage of life now emerging between work and old age adds a further complication. To accommodate these changes, the financial industry needs an overhaul.
First, it has to update the rigid three-stage life-cycle model on which most of its products are based. Second, it needs to resolve two opposite but equally troubling problems: undersaving during working life and oversaving during retirement. The first puts pressure on public provision, the second leads to underconsumption as cash is left under the mattress. Third, a more creative approach is needed to the range of assets that pensioners can draw on, including their homes, which have so far played little part in provision for old age.

“In a multi-stage life, the idea of hitting a cliff-edge retirement at 65 and then living off an annuity is outdated,” says Alistair Byrne, from State Street Global Advisors, a money manager.

His clients, many of whom intend to work past normal retirement age, are asking for more flexibility to get at their savings at a younger age. They also want a secure income for the last phase of life. “It’s not at all obvious that the traditional pension industry, which still sees life as a three-stage event, will survive this transition,” says Andrew Scott of the London Business School.

Nothing in the kitty
Many people simply do not save enough. Roughly 40% of Americans approach retirement with no savings at all in widely used retirement accounts such as IRAs or 401(k)s. In Britain 20% of women and 12% of men between 55 and 65 have no retirement savings, according to Aegon.

Yet with the demise of defined-benefit schemes, the increase in the retirement age and the steady rise in life expectancy, most of today’s workers will need to save more than their parents did. Some of them do not earn enough to put money aside, but for many the problem is in the mind: they consistently underestimate how long they will live and overestimate how long their money will last. As more people become self-employed, getting them to save for their old age becomes ever more important.

One solution is to allow retirement funds to be used more flexibly, which may encourage people to save more. But nudges are unlikely to be enough. “People need a push,” says Myungki Cho, from Samsung Life’s Retirement Research Centre in Seoul. Some countries, such as Denmark and the Netherlands, provide such a push by making enrolment in pension schemes more or less mandatory.

Short of that, auto-enrolment, recently introduced in Britain, and auto-escalation (increasing contributions over time) can also make a difference.

At the same time many pensioners spend less than they can afford, which creates its own problems. Ronald Lee and Andrew Mason have found that in most rich countries the elderly are net savers. Since they cannot be sure how long they will live and what their state of health will be, and have no way of predicting inflation, interest rates and markets, some caution is clearly in order. But Chip Castille, from BlackRock, an asset manager, thinks oversaving is often unintentional. “It would be an extraordinary coincidence if you saved exactly enough for retirement,” he says.

This gets to the heart of why some economists are pessimistic about greying societies. In a phase when older people should be spending freely, many are accumulating wealth, says David Sinclair, of the ILC UK. He thinks the greater pension freedoms granted in Britain in 2015 are more likely to lead to frugality rather than spending sprees.

Such “accidental” oversaving will increase in a world of defined-contribution plans, predicts Tony Webb, an economist at the New School, in New York City. Given a choice, people will assemble their own kitties rather than buy annuities that provide an agreed lifetime income in exchange for a lump sum. If they die young, the money will be a windfall for their heirs. Similarly, since money locked up in homes is difficult to get at during the owner’s lifetime, much of this too will be passed on, Mr Webb adds. Raising inheritance-tax rates could make a difference, but better insurance is equally important. This dormant wealth, which is often neither invested nor spent, is stopping many of the younger old from realising their full economic potential. “Often people just need the confidence that we’ve run the numbers and that they really can afford to make that donation to a charity, or spend a little more on themselves,” says Kai Stinchcombe, from True Link, a financial-advice firm for pensioners.

Take care
Depending on where people live, how much they earn and whether they have family willing to care for them, one of the greatest financial risks of ageing can be end-of-life care expenditure. A 50-year-old American has a better-than-even chance of ending up in a nursing home, estimate Michael Hurd and colleagues from RAND, a research organisation in America. In Britain an official review in 2011 of long-term care reckoned that a quarter of older people in Britain needed very little care towards the end of life but 10% faced care costs in excess of £100,000.

Most countries will need to find a mix of public and private provision to pay for long-term care costs.

A well-functioning insurance market should be an important part of this, but care insurance has mostly failed to take off. American providers who piled in too enthusiastically in the 1990s got burnt when customers needed more care than expected, and are still haunted by the experience. Low rates of return on bonds have not helped.

Every country has its own peculiarities, but four common factors help explain the market failures.

First, the future of public care is uncertain. Second, despite or because of this, many people think they do not need insurance because the state or their family will look after them. Third, the market is subject to “adverse selection”—the likelihood that insurance will appeal only to those most at risk of needing care. And fourth, care costs are unpredictable and could spin out of control in the future. As a result, insurers either avoid the care market altogether, or charge exorbitant premiums and add lots of restrictions.

As with any big risk, pools need to be large to make protection products work. The easiest way to achieve this is to make insurance compulsory, as in Germany. One alternative is auto-enrolment in a public-private scheme with an opt-out, a method with which Singapore is experimenting. At a minimum, some government intervention—such as providing a backstop for the most catastrophic risks—seems to be required for the market to establish itself. But perhaps the biggest problem is that government policies chop and change far too often.

Insurers could help, not least by offering more hybrid products such as life insurance with the option of an advance on the payout if customers need care, or annuities that pay a lower-than-usual income but convert to a higher-than-usual rate if pre-agreed care levels become necessary. And there is a need for clearer guarantees against unexpected premium hikes. Most importantly, though, insurers will need to persuade people to enroll long before they are likely to require any care.

By far the most common reason for someone needing long-term care is that they are suffering from Alzheimer’s or some other form of dementia. Globally around 47m people have dementia.

Without a medical breakthrough this number could grow to 132m by 2050, according to the World Alzheimer’s Report. One study found that people suffering from dementia accounted for four-fifths of all those in care homes worldwide.

In the absence of other options, for many people the ultimate insurance is their home, though few homeowners see it that way. In the rich world much of the wealth of lower and middle-income households is tucked away in bricks and mortar. With house prices soaring in many countries, releasing some of this equity could greatly benefit asset-rich but cash-poor pensioners, as well as the wider economy.

The most obvious tool for this is a reverse mortgage, which lets homeowners exchange some of their home’s equity for a lump sum or a stream of income in retirement. But it is not widely used. In America fewer than 49,000 reverse mortgages were sold last year, most of them provided by only about ten banks. Mis-selling scandals in the early days now seem to have been resolved, says Jamie Hopkins, of the American College of Financial Services, but people find such mortgages scary and worry that they might lose their home. Because of the lack of competition, the products also remain expensive. Mainstream financiers could help expand the market.

In the meantime, entrepreneurial empty-nesters have found another way to sweat their assets: Airbnb.

The over-60s are the fastest-growing group of hosts on the home-sharing site and receive the highest ratings. Almost half of older hosts in Europe say the additional income helps them stay in their home.

The longer that people live, the more varied their life cycle will become. Workers will take breaks to look after children or go back to school; pensioners will take up a new job or start a business.

Financial providers need to recognise these changing needs and cater for them. That includes helping to fund technology that could vastly improve the final stage of life.

North Korea and the American Dilemma

By George Friedman

The United States is still in the negotiating stage over North Korea’s nuclear weapons programs, but it is also getting close to the point where it must make a decision about what to do. 
Last week, the Trump administration confirmed that North Korea launched an intercontinental ballistic missile. The launch of a two-stage missile that, according to some experts, reached an altitude of 1,700 miles might indicate that the North Koreans have a platform for a nuclear weapon that could reach the United States. But that conclusion is premature. Other things are needed, including a guidance system, material that can survive the extreme conditions on re-entering the atmosphere, and a nuclear weapon that can function after enduring the rigors of launch and re-entry. They may already have perfected those technologies, and U.S. intelligence may know the status. To an outsider, it appears that the North Koreans are getting closer to a deliverable system. At best, we can now only say that we are uncertain whether they have one or not, and that is a huge shift.

This picture taken on July 4, 2017 and released by North Korea’s official Korean Central News Agency on July 5, 2017 shows the successful test-fire of the intercontinental ballistic missile Hwasong-14 at an undisclosed location. AFP PHOTO/KCNA VIA KNS/Getty Images
The Chinese Can’t Entice the North
The Chinese have not yet induced the North Koreans to halt their program, and I don’t think they will. The North Koreans see nuclear weapons as essential to the regime’s survival, and the Chinese have little to threaten or entice North Korea with. Negotiations will be difficult, moreover, because the North Koreans have not trusted the Chinese since the Korean War, when the Chinese intervened not to save the North’s regime but to protect China’s borders.

The Chinese are content to let things develop as they will. If developed, North Korea’s nuclear weapons program it will pose a perpetual threat to the United States, limiting its room for maneuver in Asia. An American attack resulting in massive casualties in Seoul may destabilize South Korea, giving China an opening: If the attack goes well, China can accuse the U.S. of unnecessarily and recklessly attacking North Korea – just when China was “making progress” in negotiations. Ultimately, China has little interest in solving the American problem, as the only real issue for the Chinese – trade – is going to remain a challenge regardless of where the North Korean weapons program stands.

All of this brings the option of a U.S. strike on North Korea back on the table. But this option is also problematic. An American attack on the North could result in massive South Korean casualties. In addition, the North Koreans have dispersed apparent nuclear and missile development sites so that it is difficult to tell which are primary, redundant and decoy sites. Some of them are built into deep tunnels or into mountains. Conventional airstrikes will set back the program, but they may not stop it.

To increase the probability of success, special operations forces and other troops may need to be used. Failure to destroy the nuclear facilities with catastrophic civilian casualties is a real possibility. The campaign, even if successful, will be extended, complex and inevitably costly. This is why the U.S. is prepared to give China all the time it claims to need, even if success is dubious. The alternative is frightening.

Another dimension of this issue is proliferation. The North Koreans are in need of hard currency and see the proliferation of nuclear threats as diffusing American attention on Pyongyang. The sale of weapons, technology and expertise to other countries and subnational groups is a real threat.
The Acceptance Strategy
As the point where a decision needs to be made approaches, some have argued that the only viable strategy is to accept North Korea as a nuclear power. As the argument goes, other countries the U.S. regarded as unstable and unpredictable – China and Pakistan, for example – have developed nuclear weapons, and the acquisition of those weapons changed their behavior. Where previously they were insecure and, therefore, given to recklessness, the acquisition of those weapons made them more secure and less impulsive. Possessing nuclear weapons can make nations more prudent. The proof is that no nation, save the United States under radically different circumstances, has used nuclear weapons.

Another point in favor of the acceptance argument is that eliminating North Korea’s nuclear and missile programs would be difficult and costly, and the chance of success would be uncertain. One way to increase the likelihood of success would be to use at least tactical nuclear weapons against hardened sites and perhaps against North Korean artillery in the south. But that would also set a precedent for using nuclear weapons in cases that aren’t of existential importance. Therefore, this is not an option for the United States.

The counterargument – the strategy that was in place at the beginning of this crisis – is that this is in fact an existential crisis for the U.S. There is no reason to believe that North Korea will behave like other nuclear states because even prior to acquiring these weapons, North Korea did not behave like them. Nuclear weapons were not a critical element of regime survival for Pakistan or China. They were at most an enhancement. The North Koreans see themselves as surrounded on all sides by enemies, and in some sense, they are right. The belief that they will change their core behavior by possessing nuclear weapons may be comforting, but the U.S. can’t be confident that it is true. And if the proponents of the acceptance strategy are wrong, the costs will be far greater than the costs of launching an attack now.

It comes down to predicting North Korea’s behavior, something that it has deliberately made unpredictable. The North has pursued a policy of appearing to be erratic and dangerous in order to deter destabilization tactics. And the strategy has worked. The North Koreans have made a convincing case that they are unpredictable and dangerous. And if those making the case for acceptance are wrong, and Pyongyang doesn’t change its behavior after acquiring nuclear weapons, the price will be staggering.
Understanding the Command Structure
The issue also comes down to the number of casualties an attack would involve. This requires an understanding of North Korea’s command system and how it would respond to a U.S. attack on North Korean nuclear facilities. In the event of an attack, will the North Korean artillery complex in the south be ordered to open fire immediately? And perhaps more important, if the political and military command is destroyed or isolated by an attack and communications are disrupted, where will the artillery complex get its orders? In the absence of contact with higher command, are they instructed to open fire on their own initiative? If communication within the artillery complex breaks down, what are the orders to battery commanders? In other words, is it possible to paralyze the artillery complex? Given the nature of the North Korean regime, devolving authority to the levels of lieutenants and captains is hard to imagine, and initiative is not built into the culture.

It is inevitable that as the decision approaches, alternative strategies will appear. And it is in human nature to raise doubts about a strategy’s effectiveness once it’s decided on. Going to war overwhelmingly confident is dangerous; it causes you to minimize risks. That said, this debate cannot go on much longer, because if it does, those arguing for acceptance of North Korea as a nuclear power win by default.

A decision must be made, but it can’t be based on an assumption of how North Korea will behave. We just don’t know. But it can be made based on knowledge of how the command system for the artillery complex works, and a hundred other details that define vulnerability, and therefore risk, on both sides.