by Robert Litan
6. Ibid. One of Intrade’s co-founders, Ron Bernstein, has since reentered the prediction market business, with the website Tradesports.com, which lets people bet on the outcomes of sports events.
7. Ibid., 16.
8. Gillian Tett provides an excellent history of how these deals began in her highly recommended account of the precursors of the financial crisis, Fools’ Gold: The Inside Story of J.P. Morgan and How Wall Street Greed Corrupted Its Bold Dream and Created a Financial Catastrophe (New York: Free Press, 2009).
9. Adam Davidson, “How AIG Fell Apart,” Reuters, September 18, 2008, www.reuters.com/article/2008/09/18/us-how-aig-fell-apart-idUSMAR85972720080918.
10. James Kwak, “The Profitable Bailout? The Real Cost of Saving AIG and Wall St.,” The Atlantic, September 12, 2012, www.theatlantic.com/business/archive/2012/09/the-profitable-bailout-inside-the-real-costs-of-the-saving-aig-and-wall-st/262281/.
11. Data from the Bank for International Settlements.
12. The market interest rate on a bond is simply its annual promised interest payment, or its coupon, divided by the market price of the bond at any given time.
13. The charge that CDS markets offer a means for speculation and therefore should be condemned is thus fundamentally misplaced, just as it would be if applied to stocks or commodities where speculators are essential to add liquidity and to take the other sides of trades that no one else may be willing to take.
14. See Robert J. Shiller, Finance and the Good Society (Princeton: Princeton University Press, 2012), and The New Financial Order: Risk in the 21st Century (Princeton, NJ: Princeton University Press, 2004).
15. See, e.g., Robert Z. Lawrence and Robert E. Litan, Saving Free Trade (Washington, DC: Brookings Institution, 1986); Martin N. Baily, Gary Burtless, and Robert E. Litan, Growth with Equity (Washington, DC: Brookings Institution, 1993); Gary Burtless, et al., Globaphobia (Washington, DC: Brookings Institution, 2001); Lori Kletzer and Robert E. Litan, “A Prescription for Worker Anxiety: Wage and Health Insurance for Displaced Workers,” Brookings Policy Brief 73, March 2001, www.brookings.edu/events/2001/03/06unemployment; and Lael Brainard, Robert E. Litan, and Nicholas Warren, “Insuring America’s Workers in a New Age of Offshoring,” Brookings Policy Brief 143, July 2005, www.brookings.edu/~/media/research/files/papers/2005/7/macroeconomics%20brainard/pb143.pdf.
16. Economic Report of the President, 2013, Table B-44, 376.
17. Robert J. Shiller, Macro Markets: Creating Institutions for Managing Society’s Largest Economic Risks (New York: Clarendon Press, 1993) and Stefano Athanasoulis, Robert Shiller, and Eric von Wincoup, in Tabarrok, Entrepreneurial Economics, 23–46.
18. See Jessica Leber, “Economist Proposes a $30 Billion Megafund for New Cancer Drugs,” MIT Technology Review, November 19, 2012, www.technologyreview.com/news/506916/economist-proposes-a-30-billion-megafund-for-new-cancer-drugs/. The idea is explained in a video by one of Lo’s colleagues, Roger Stein, www.ted.com/talks/roger_stein_a_bold_new_way_to_fund_drug_research.html.
19. Detailed technical information about Bitcoin is available on its official website, where its Frequently Asked Questions are most useful: http://bitcoin.org/en/faq#who-created-bitcoin.
20. The way in which Bitcoins are created and the fascinating industry that has grown up trying to collect them is described in detail in Ashlee Vance and Brad Stone, “Bitcoin Rush,” Bloomberg Businessweek, January 13–19 (2014): 46–51.
21. See, e.g., Brad Delong, “Watching Bitcoin, Dogecoin, Etc.,” Washington Center for Equitable Growth, December 28, 2013, http://equitablegrowth.org/2013/12/28/1466/watching-bitcoin-dogecoin-etc, and Paul Krugman, “Bitcoin Is Evil,” New York Times, December 28, 2013, http://krugman.blogs.nytimes.com/2013/12/28/bitcoin-is-evil/?_r=0.
22. This is based on an on-the-record interview with the foundation’s general counsel, Patrick Murck, January 29, 2014, with other Bloomberg analysts and reporters.
23. Robert J. Shiller, “In Search of a Stable Electronic Currency,” New York Times, March 1, 2014.
24. Bob Tita, “Slow Road to Recovery,” Wall Street Journal, October 14, 2013.
25. Edward Glaeser, Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier and Happier (New York: Penguin Books, 2012): 105.
26. See Ryan Dezember and Emily Glazer, “Drop in Traffic Takes Toll on Investors in Private Roads,” Wall Street Journal, November 21, 2013, and Nathan Koppel and Emily Glazer, “Fast Toll Road Struggles to Pick Up Drivers,” Wall Street Journal, January 3, 2014.
27. The Economist had a cover story in early 2014 on the potentially huge revenue gains governments around the world could realize by selling off state-owned assets, and in the process improving the efficiency of the assets and functions after privatization. See “Selling Out the Store,” The Economist, January 11–17, 2014.
28. Information for this paragraph provided by employees of Standard & Poor’s.
29. Clifford Winston, “On the Performance of the U.S. Transportation System: Caution Ahead,” Journal of Economic Literature 51, no. 3 (2013): 7773–7824. For an analysis of how technological advances will ultimately address at least the road congestion problem, see Clifford Winston and Fred Mannering, “Implementing Technology to Improve Public Highway Performance: A Leapfrog Technology from the Private Sector Is Going to Be Necessary,” Economics of Transportation (2014), http://dx.doi.org/10.1016/j.ecotra.2013.12.004.
Chapter 14
Economic Ideas and Challenges on the Policy Shelf: Business Implications
Economists who are in the profession because they want to influence policy makers, with some exceptions, typically have to wait some time for their ideas to be taken seriously, if at all, and perhaps even longer to be implemented. A prime example, discussed in Chapter 11, is the idea of auctioning off licenses to the electromagnetic spectrum, floated by Ronald Coase in 1959, but not put into effect until 1993. Coase, who lived to the age of 102, was lucky enough to be alive to see his idea become a reality. Most economists don’t get that pleasure, either because the time was never right while they were alive for a crisis or action-forcing event that could bring their ideas to policy makers’ attention, or because the ideas were impractical or even wrongheaded.
It is thus a bit hazardous for anyone to project which of the many possible economic policy ideas already out there on the proverbial policy shelf will be implemented by legislators, regulators, or possibly judges. Nonetheless, I believe three sound ideas long in the public domain have a reasonable chance of being adopted in some version at some point. I’m not going to predict when this might happen, like I didn’t do with the direct business ideas outlined in Chapter 13. But any one or all of the ideas discussed in this chapter could be adopted in the context of a successful effort addressing the long-term federal deficit, whenever that happens (hopefully sooner than later). I also highlight some potential business impacts if these ideas are implemented.
Federal Budget Deficits as Drivers of Policy Change
For over a decade, the nation’s official scorekeeper for federal budgets, the Congressional Budget Office, has projected that the federal deficit, at this writing in 2014 at about 3 percent of the nation’s output (GDP), will grow, in the absence of offsetting policy measures, to unsustainable levels over the next 30 to 50 years. The main reason: soaring health-care spending, driven in part by more baby boomers drawing on Medicare, and also by rising health-care costs. To a lesser extent, rising costs for Medicaid, the federal and state health-care program for low-income households, also are projected to contribute to the growth in deficits. None of this is new, of course, since budget experts for years have been warning of these problems. One of the earliest was Charles Schultze, President Johnson’s budget director, President Carter’s chief economist, and a longtime scholar at the Brookings Institution (see following box).
Charles Schultze: The Quintessential Economic Policy Expert
He often gets confused with the author of Peanuts—the
other Charles Schultz (without the e)—but no one who knows policy and how economics can be used to inform policy makers confuses the importance, humanity, and originality of Charles Schultze.
Schultze is a Washington, DC, native who went to Georgetown for college and to the University of Maryland for his PhD. He began his teaching career at the University of Indiana, moved to the University of Maryland, and then was tapped by the Kennedy administration to become an assistant director of the Bureau of the Budget (since renamed the Office of Management and Budget, or OMB). His quick mind and deep understanding of the mechanics of the budget were recognized by the budget bureau’s director, Kermit Gordon, who upon leaving to assume the presidency of the Brookings Institution in 1966, recommended Schultze as his replacement to President Johnson, who readily agreed.
The Johnson years were an exciting time for public policy, and especially to be OMB director. Schultze had to manage the competing demands for federal resources devoted to Johnson’s multiple Great Society programs (aimed at helping the disadvantaged), and to fund America’s escalating involvement in the Vietnam War, a venture that eventually contributed to Johnson’s decision not to run for reelection in 1968.
After the Johnson years, Schultze joined the Brookings Institution as a senior fellow where, off and on, he has spent the rest of his career, turning out a steady stream of books, professional papers, and popular articles on a wide range of public policy issues, including budget policy, economic growth, energy and environmental economics, and industrial policy (which he has vigorously opposed). His book Public Use of the Private Interest is essential reading for those who urge that regulators use market-like incentives rather than command-and-control detailed regulations to achieve social goals.1 Later, Schultze wrote a popular guide to macroeconomics, Memos to the President: A Guide through Macroeconomics for the Busy Policymaker,2 which in my view is the most readable and informed treatise on the subject ever written.
Charlie (as he was and is known to all his colleagues and the media) couldn’t stay out of the policy fray entirely, however. He knew too much and Democratic political leaders wanted his experience and advice. So he returned to public service after President Carter was elected, chairing the Council of Economic Advisers for all four years of that presidency (two of which I had the privilege to work for him and with Bill Nordhaus, another giant in the profession, whom you will meet later in this chapter).
After CEA, Charlie returned to Brookings, where for a time he directed the economic studies program, after the passing of the longtime director and tax expert Joseph Pechman (who is discussed in the next section). Upon his return to Brookings, Schultze was an early advocate of long-term deficit reduction, warning that continued high and rising deficits were more like “termites in the woodwork” eating away at the long-run growth prospects for the country, and less likely (at least at the time) to be the spark for a sudden run on the dollar or a recession-inducing spike in interest rates. Schultze’s concerns about the nation’s fiscal health predate the concerns expressed by leaders in both political parties since the Great Recession about the corrosive effects of long-term federal deficits.
Schultze’s economic prowess is also widely valued by many in the private sector. He served on a number of corporate advisory boards, and has given countless speeches and written numerous op-eds for newspaper and magazines, in addition to writing for his professional colleagues.
Charlie is and always will be Brookings personified. Brookings officers, directors, and staff constantly seek his counsel. To me, Charlie is a professional father figure (he even looks a bit like my own dad), whose advice and friendship I always will treasure.
During the Obama administration, a number of bipartisan panels issued reports and recommendations for a grand bargain to rein in long-run deficits—consisting of a combination of tax increases and cuts in the growth of spending of entitlement spending—but the president and the Congress (especially the Republican-controlled House) could not come to agreement. The failure to do so triggered across-the-board cuts in spending, known as the sequester, over 10 years in discretionary spending (that part of the budget that runs the government and does not transfer income, as do the three major entitlement programs, Medicare, Medicaid, and Social Security) in 2012, which was partially offset in 2014 to 2015 by a limited budget deal reached in January 2014. In addition, in January 2013, Congress enacted, at the president’s urging, tax legislation that canceled the cut in the top marginal tax bracket for very high-income individuals and families under the 2001 tax bill designed by the George W. Bush administration and enacted by the Congress in that year.
The combination of the tax increases and spending reductions, coupled with a slowdown in the rate of increase in health-care spending, brought some stability to the projections of the ratio of federal debt to GDP, one widely watched measure of debt sustainability. By late 2013, the Congressional Budget Office (CBO) was projecting that this ratio would remain in the mid-70 percent range through the early years of the 2020’s, much higher than the 35 to 40 percent range before the Great Recession, but at least not exploding.
Unfortunately, from the mid-2020s and beyond, the outlook is expected to darken. Rising health-care costs spread over an increasing beneficiary population (seniors and the indigent), coupled with rising interest costs on a mounting public debt, are eventually projected to drive both the deficit and the total federal debt burden as a share of national output to unprecedented peacetime levels. CBO’s forecast in late 2013 is that by 2038, the ratio of publicly held federal debt to GDP will hit 100 percent. The debt-to-GDP ratio could be almost twice as high under some more pessimistic budget assumptions.3
Economists continue to debate at what level or rate of increase this key ratio becomes unsustainable, though one thing is clear: At some point investors can lose confidence in the willingness and ability of policy makers to get the debt burden under control. When confidence goes, and it can do so suddenly, it can trigger a sharp rise in interest rates, perhaps even a seizure in financial markets. This is precisely what happened (for different reasons) during the financial crisis of September 2008. At the very least, high and rising federal deficits keep interest rates higher than they otherwise would be, discouraging private investment, which is one key to long-run economic growth—Schultze’s termites in the woodwork scenario played out over decades.
Each of the policy measures discussed in the balance of this chapter could directly, or indirectly, reduce deficits and debt and thus reduce the likelihood of their unwelcome effects. Each would also have private sector impacts, hurting some firms while helping others. In this sense, each of the measures described next represents a policy platform for business analogous to the deregulation platforms highlighted in Chapters 9 through 12.
But don’t expect any of these ideas to become reality anytime soon. If the federal deficit as a share of GDP remains in the 3 to 5 percent range for the next decade, as CBO has projected, then federal policy makers are likely to be complacent, and at least ten years away from making the kind of bold policy decisions described next and that have been in public circulation for some time.
Premium Support for Medicare and Medicaid
The main driver of increased federal deficits and debt over the long run, apart from rising interest costs on the mounting debt (combined with rising rates themselves as the economy gets back to normal), is the projected increase in federal costs for Medicare and Medicaid. Rising subsidy costs under the Affordable Care Act of 2010 will make things worse. CBO’s 2013 long-term budget outlook projects that total federal health-care spending, which was just short of 5 percent of GDP in 2010, should hit 9 percent in 2040, and 13 percent by 2080.4 In early 2014, CBO revised slightly downward the near-term Medicare cost growth projections,5 but this revision doesn’t fundamentally alter the organization’s prior pessimistic long-term outlook.
Some health-care cost optimists point to the decade-long slowdown (2002 to 2012) in the annual rate of U.S. heal
th-care spending growth as a potential game-changer. But even if annual U.S. health-care spending increases keep chugging along at 4 percent, down from about 10 percent a decade earlier—which is unlikely as the population ages and the millions enrolled under the ACA use health care more intensively—the CBO has calculated that aging alone will drive federal spending on health care as a percent of GDP steadily upward.
At any pace, the rise in federal costs for all federal health-care programs, including the ACA, will crowd out other federal spending or lead to steadily larger and unsustainable deficits. While this fact may not be appreciated widely until the 2020s, when it is, there will be a search for solutions, and my guess is that interest eventually will center on an idea that two liberal economists—Henry Aaron and Robert Reischauer—hatched in the 1990s called premium support.6
Carefully avoiding the politically sensitive word voucher (the public school education arena has not made it popular), Aaron and Reischauer suggested that each Medicare beneficiary be given a fixed amount, adjusted for medical-care inflation, to purchase private insurance. These premium supports also would be adjusted for preexisting physical conditions of beneficiaries and where they live, to take account of differential risks and medical costs across the country. The authors acknowledged that making these adjustments would be difficult (though one of them has become easier given one of the reforms in the Affordable Care Act, discussed shortly).
By effectively putting a cap on the growth in total Medicare expenditures, and letting individuals determine how best to live within their personal government-provided, health-care budgets (which could be supplemented with additional private insurance), Aaron and Reischauer argued that a premium-support program would harness market forces to slow the rate of increase of Medicare spending per beneficiary (the part that theoretically can be controlled, not the growth in the number of beneficiaries). The premium support idea theoretically also could be applied to Medicaid, the government support program for health care for low-income individuals of all ages, and also nursing care for seniors without any resources, but the authors did not go that far. (One interesting historical fact: Aaron and Reischauer note that Medicaid was a Republican idea, which Democrats who favored Medicare accepted in a kind of trade. The combination comprehensive law incorporating both ideas passed Congress and was signed into law by President Johnson in 1965.)
