Tuesday, December 30, 2008

The Obama Stimulus Plan: We need Policy Reforms as well as a Fiscal Stimulus

In his op-ed piece of last Sunday’s Washington Post, Larry Summers underscored that the Obama administration’s fiscal stimulus package is being designed not only to create “jobs and incomes essential for recovery,” but also to make “a down payment on our nation’s long-term financial health.” He illustrates this point by noting the importance of investments to build classrooms, laboratories, and libraries, spur renewable energy initiatives, modernize our health-care system, and rebuild our public infrastructure. Importantly, he notes “we must measure progress not by the agendas of interest groups, but by whether the American people experience results.*

As someone who has written on the importance of addressing long-term fiscal challenges, how can I be unhappy with this approach? Summers has correctly focused on one important element of long-term financial health, namely, the sources of our competitiveness and of long-term growth And yet a holiday of reading on the challenges facing us in the spheres of health care, energy, food, education, the environment, and infrastructure, convinces me that alone, this strategy might nevertheless be an enormously important, missed opportunity.

Don’t get me wrong. The thrust of the spending priorities that Summers has outlined are all sensible, and his emphasis on ensuring adequate returns appropriate. But what is missing from this characterization of the strategy is recognition that these are all sectors where the government’s role is already extensive and often misdirected, and where we will need a fundamental change in government policy if we are to address our major fiscal weaknesses as well as foster higher growth. Particularly in the spheres of health, agriculture, energy, and infrastructure, government lobbyists and interest groups have heavily influenced government policies. These policies have created enormous rents for particular industries and groups in the economy. Some of these rents have arisen from public spending decisions. Others have arisen from regulatory decisions that have sheltered certain industries, prevented the market from internalizing important negative externalities, or incentivised questionable production activities. Others have arisen by the deliberate underfunding of some important and legitimate and “formally recognized” government activities (see my blog of November 27).**

This is not the place to itemize all the ways, in these different sectors, where reforms in the whole approach to government policy might be needed. A few examples may suffice. Start by reading Eugene Steuerle’s recent blog on the “Breadth of Brokenness ***, where he lists the ways in which policies in a number of sectors are costly, inefficient, and not serving the public interest. Then read Michael Pollan’s brilliant op-ed of October 12, 2008 “Farmer in Chief, ”**** which underscores both the misdirection of government policy in the food sector and the damage such policies are causing in terms of poor health, energy dependence, and climate change. Certainly, you should also read the many recent op-eds by Tom Friedman as relates to the energy sector, and his call for the introduction of some form of carbon tax. In health care, Tom Daschle’s recent book, Critical: What We Can Do About the Health Care Crisis, outlines important first steps toward health care reform, though (as I will argue in a forthcoming blog) his proposals appear insufficient to reduce spiraling long-term health care costs, tackle the ways in which current government policies misdirect resources, or provide distorted incentives to the pharmaceutical industry.

In many of the vital spheres where a fundamental change in government policy is required, it will be far more difficult politically to execute a change in policy than to simply increase spending on meritorious investments. The latter are likely to be of the win-win variety. The former would inevitably involve “losses” to politically powerful groups in these sectors. But also, because the role of government has so shaped the market incentives in these sectors, many others in the economy would also feel the costs of reform (e.g., investors who have relied on government policies in considering their investment strategies across sectors).

I thus see the current financial crisis and the need for an ambitious fiscal stimulus package as an opportunity because there may be value in directing some of the fiscal stimulus to “grease the wheels” of policy reform, in effect, facilitating the transition to a more sensible set of policies. Pollan’s piece certainly suggests that the food sector is one where it might be necessary to provide financial assistance to redirect incentives away from the excessive focus on corn and soy-based products. Again, linking financial support for the auto industry to a program for its retooling for the production of more energy-efficient cars is another example of where fiscal grease might facilitate policy reform.

The President-elect ran on a campaign for a “change that we could believe in.” His policy proposals in many areas clearly underscore his recognition that a fundamental change in policy direction is required. The urgency of addressing the financial crisis argues for a strong and stimulative fiscal policy. But if the long-run financial health of the country is to be addressed and long-term growth reenergized, the focus on “change,” and importantly, the misdirected character of government policies in many sectors, must be tackled in the process. In closing, I recognize that perhaps much of the transformational policies that I hope will be forthcoming may already be on the agendas of the incoming Cabinet and its various transition teams. But what is critical is that such policy reforms are not seen as of secondary importance relative to the fiscal stimulus package.

* (http://www.washingtonpost.com/wp-dyn/content/article/2008/12/26/AR2008122601299.html)
** http://petersheller.blogspot.com/2008_11_01_archive.html
*** http://www.pgpf.org/newsroom/tgwd/27/
**** http://www.nytimes.com/2008/10/12/magazine/12policy-t.html?scp=2&sq=Michael Pollan&st=cse

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