Thursday, November 27, 2008

What Will the Obama Administration Administer?

These first few weeks since the election have been enormously heartening. The Obama administration’s cabinet is beginning to take shape with nominees of high quality—well trained, pragmatic, with enormous experience, and good judgment. This signal that a sensible economic policy strategy will be put in place in the coming months is reassuring, given the extraordinarily important role that the government will play in the coming months, both in providing a stimulative boost to the economy and as a regulator (and even owner of parts) of the financial sector.

But these challenges come at a difficult time. The last eight years have seen a dramatic expansion of the government’s debt and future budgetary commitments, both explicit and implicit. Congressional Budget Office projections highlight the impact that this has had in undermining the nation’s long-term budget sustainability. The Peter G Peterson Foundation’s recent film, I.O.U.S.A, graphically illustrates the depth of the fiscal hole that we are in. Knowledgeable fiscal economists of all political stripes recognize the necessity to move swiftly to increase government revenues, reduce government expenditure commitments (particularly in the health care sector), and start the arduous process of restoring some degree of balance to the U.S. government’s long-term budget. Now the recession of 2008 and the implosion of both the financial and housing sectors has, within the space of a few months, further aggravated these long-term fiscal prospects and forced the incoming administration to consider a dramatic increase in fiscal spending in order to pull the US (and perhaps the global) economy out of recession. While there is little doubt that this fiscal stimulus is necessary if economic growth is to be restored, it will not make the challenge of addressing the fiscal challenges of the long-term any easier.

However, there is another element to this situation that has received far less attention, but which is relevant to any solution to both current and future problems. Even as the recession and financial crisis have forced the government to become a far more involved player in the US economy, and despite the large fiscal deficits previously created by the Bush Administration, many knowledgeable observers question the capacity of the US government to carry out its functions effectively!

Specifically, while military and entitlement spending commitments have soared and tax rates have been cut, the Bush administration (and to a lesser extent the Clinton administration) has sought to rein in other areas of spending through a slow starvation diet of those Federal agencies that deliver the real bread and butter of government goods and services. Across the board, operating budgets have been slashed, important offices delivering critical services have been eliminated or starved for funds, while contracting-out and privatization has become the norm. This has been coupled with an aggressive policy in recent years to infiltrate the senior layers of the civil service with many whose reigning ideology is to minimize the role and importance of government. The result has been a weakened federal bureaucracy that lacks the capacity to be adequately responsive in providing the basic stuff of public services required in this increasingly complex 21st century world. Of course, this also raises doubts as to whether the government has the operational capacity to deliver on the current pressing fiscal and regulatory policy agenda.

These are not random conjectures. The reduced ability of the government to regulate the financial sector is now well recognized. But informed observers and reports emanating from the policy literature and newspaper articles highlight that there has also been a systemic weakening in the government’s capacity to deliver on its mandate in many other spheres. For example, in recent lectures, Francis Fukuyama of The Johns Hopkins University’s School of Advanced International Studies* <#_ftn1> has highlighted the dramatic decline in the operating effectiveness of the US government’s aid agency, USAID. The politicization of the Justice Department has reached the status of front-page headlines. In the environmental community, concern has grown over the dramatic scaling back of EPA’s expertise and the turning over of the agency to those in the mining and energy industries who were supposed to be the regulated rather than the regulators. Witness the closure for lack of funds of the already small office in EPA responsible for providing critical data to poor countries around the world on indicators of the manifestations of climate change. Equally witness the cutbacks in the climate-change budget of NASA’s Earth Sciences program.

Even in those agencies responsible for disbursing entitlements, there has been deterioration in the capacity to disburse. One example would be the long delays by the Social Security Administration in determining eligibility for disability payments. The Bush administration’s efforts at financial starvation and ideological undercutting of the role of Federal agencies has been abetted by demographic trends. Many experienced senior servants of the baby boom generation are now retiring as they reach the required years of service for a pension.

So let me restate the difficulty of the situation. The incoming Obama administration finds itself with a need to expand the government’s role. It will be involved in regulating and even owning parts of the financial sector. It will be charged with acquiring financial assets derived from the housing and even the consumer finance sectors. It may be drawn into providing guidance or subsidies to the automobile sector. It will need to design policies that not only add to aggregate demand, notably in the infrastructure sector but which also energize the long-term growth potential of the U.S. economy. Additionally, it will be engaged in developing and implementing important but complex policy initiatives—for reduced energy dependence, a strengthened education system, and expanded coverage of health insurance. Yet it will take the reins of a government civil service that is short on the skills and administrative capacity to meet these challenges. And all this comes at a time when there is a continuing long-term fiscal imperative to move towards a restoration of fiscal sustainability in the government’s financial operations.

Thus, while the Obama transition team focuses on filling the roughly 6000 political appointments at the top of the US Government, it must also not lose sight of the need to develop a strategy to restore the capacity of the underlying bureaucracy to respond to the challenges ahead while delivering effectively the basic but critical public services of government. In a recent important blog, Gene Steuerle of the Peter G. Peterson Foundation has called for the new administration to address what he terms the “broken” nature of government. He calls for “a series of processes—actual proposals for quick enactment in some cases, commissions and white papers in others, and complete departmental reviews in yet others.”** <#_ftn2>

The process Steuerle recommends is indeed critical in order to ensure that the different programs and policies of the government are warranted in terms of their objectives, relevance, and their modalities. But it will also be important that the level of funding and the adequacy of staffing is appropriate for these programs to be effectively implemented and for government agencies to have the capacity to respond to the many new and difficult challenges they will face. For most major departments, this will require external program audits, with adequate participation from key client groups, OMB, and the US Government Accountability Office. Higher funding levels will be needed not only for the cost of operations but to ensure that salaries of civil servants are sufficient to attract high quality staff. Achieving these objectives will of course entail additional spending, but in relative terms, the amounts that would be required are far less than the amounts being contemplated in the current financial rescue package and in any case they are dwarfed by the spending cuts that will be necessary in entitlement spending over the long term. Rebuilding the civil service and adequately funding the operations of the federal government are of critical importance if it is to meet its challenges without having one hand tied behind its back.

Peter Heller’s blog “Thinking about Fiscal Policy” can be found at or .

* A recent book by Carol Lancaster of Georgetown University has also highlighted the deterioration in the capacity of USAID.

** See

Monday, November 10, 2008

The Current Financial Crisis is only the Tip of a Long-Term Financial Iceberg!

With financial markets in crisis worldwide, policy makers are rightly focused on actions to restore confidence and enable banks to feel comfortable in renewed lending. Without such actions, the risk of a recession spiraling into a depression would be great. While households worry about their jobs and their portfolios, they also are recognizing that their long-run financial plans have now been jeopardized.

For years, analysts have warned that the U.S. government’s fiscal future is bleak—that its long-run obligations to retirees in the form of social security and, even more, for Medicare and Medicaid, have far outstripped projected tax revenues. Current policy actions to shore up the financial system have only added to the US government’s debt burden, making the restoration of long-run fiscal solvency even more difficult. Other potential liabilities loom, for example, if the US might be on the hook for bankrupt private, municipal, or state pension schemes. But the issues involved in addressing this looming fiscal crisis have long been the third rail of American politics. The focus of both Republicans and Democrats has, if anything, been more on enlarging health coverage than on restoring solvency to government obligations for medical care or social security.

The current financial crisis highlights that the private pillar of financial support for America’s aging population is now also severely shaken. Workers are starting to understand the risks associated with relying on high returns from home and equity investments for the financing of their retirement. Wealth in the form of home equity and 401K-type investment nest eggs has plummeted. The retirement plans of aging baby-boomers are being reconsidered. Pensioners who have relied on their investment portfolios to supplement social security, are worrying about whether they might need to reenter the labor market. Employers, including many states and municipalities, are worried that their pension plans are now seriously underfunded. And the prospect that households can rely on the Federal government’s promises with respect to medical and social security is even more threatened as the government’s own debt rises in the current financial crisis.

What must be done? First, we need to address the major weaknesses in America’s long-run growth prospects—an educational system that ranks far behind its competitor nations, failing and outmoded infrastructure, excessive energy dependence, and falling outlays on research and development. Without buoyant economic growth, the size of America’s pie will be inadequate to provide for rising living standards and a comfortable retirement for its citizens. Second, we need to fundamentally rethink how the financial costs of retirement are to be shared as between the baby boomers and succeeding generations. All serious analysts recognize that there are limits to what can be expected in the form of higher taxes on future workers. The sooner a fair and equitable sharing of the burden of Social Security, Medicare, and Medicaid is resolved, the lower the pain that any solution will entail. Third, increased wealth cannot be bought on the cheap by an expectation of rising home or stock equity values. Households will need to work longer, consume less, and save more. Finally, once the crisis is over, we must move to restore fiscal solvency. This means a return to a balancing of the Federal budget deficit over the cycle.

America could benefit by looking at the experience of other countries in Europe and Japan. They appear to be addressing the challenge of an aging population and providing comprehensive health care in a fiscally responsible way. Some countries in Europe particularly appear to have constructed social insurance systems and fiscal policy rules that are more responsive to these challenges than those of the United States.

As a first step, the next President should convene a nonpartisan commission to develop, within a tight timetable, proposals for energizing growth and restoring both fiscal solvency and a balanced role for the private and government sectors in financing the longer life span of America’s workers.