Since the AI’s inception, we’ve had the privilege of publishing some of the best minds in policy. With a new Administration taking over the White House in January, it’s not surprising that a number of these minds have found jobs in government. Now that they’ve had a chance to settle in at their new posts, we decided to go back into the archives to highlight the arguments they made in our pages. Below are some of our authors who are now in the Administration, their current posts, and links to the articles they penned for us. We’ll be watching to see whether they are able to enact any of the policies they prescribed.

Kurt Campbell, Assistant Secretary of State for East Asia and Pacific Affairs, Department of State: “McEmbassy,” May-June 2008.

Michael McFaul, Special Assistant to the President for National Security Affairs and Senior Director of Russian and Eurasian Affairs, National Security Council: “Liberal is as Liberal Does,” March-April 2007.

Dennis Ross, Special Advisor for the Persian Gulf and Southwest Asia, Department of State: “Iraq: Think Local,” March-April 2008.

James Steinberg, Deputy Secretary of State: with Ivo Daalder, “The Future of Preemption,” Winter 2006.

Todd Stern, Special Envoy on Climate Change, Department of State: with William Antholis, “Toolbox: Creating an E-8,” January-February 2007.

Stay tuned. We’ll update as more names become available.

Update:

Peter Ogden, staff, Special Envoy on Climate Change, Department of State: with Lawrence Korb, “Toolbox: Making the U.S.-India Civil Nuclear Deal Work,” Winter 2006; and with Lawrence Korb, “Toolbox: A Few More Good Men,” May-June 2007.

Update 2:

Ivo Daalder, U.S. Ambassador to NATO, Department of State: with James Steinberg, “The Future of Preemption,” Winter 2006; with James Lindsey, “Democracies of the World, Unite,” January-February 2007; with Mac Destler, “Toolbox: Advice for the Advisor,” January-February 2009.

One of the most obvious policy initiatives that the United States could undertake right now is is to seriously up the amount of help being given Mexico to bolster security along the US-Mexican border and to help to reform the Mexican judicial system.  We started this process last year with the Merida Initiative, but the latter needs to be expanded and better funded right now.  This is what they call a no-brainer.

The drug war in Mexico that has been in the news recently started due to the personal commitment undertaken by Mexican President Felipe Calderόn to eliminate the influence of narco-traffickers after his election in December 2006. The war has been fought in cities like Tijuana and Ciudad Juarez right on the American border, as well as in southern states like Sinaloa and Guerrero. Since the current war began in early 2007, nearly 10,000 people have been killed, 6,286 of them in 2008 alone.

The reason that Mexico has such a big problem with narco-traffickers, aside from the existence of a huge market for drugs to the north, is the weakness of certain basic Mexican institutions, and particularly its judicial system. Mexico like the United States is a federal state, and responsibility for dealing with drug trafficking is split between federal, state, and local jurisdictions. During the years when the dominant PRI was in power, many state governors and local officials came to have cozy relationships with drug lords. Mexican police are infamous for their corruption and the degree to which they have been penetrated by drug gangs. Mexican citizens have very jaundiced views of their own police, whom they tend to regard as part of the problem. Indeed, one of the most dangerous drug gangs was recruited from among an elite anti-drug strike force. Calderόn has brought in the army in places like Ciudad Juarez to replace the local police who are either corrupt or intimidated, but this risks corrupting the military as well.

It is hard to know how much progress has actually been made in this struggle. Part of the reason for the escalation in the number of killings recently is that the early stages of the war succeeded in removing many of the top leadership layers of the drug gangs. There is now an open struggle for power going on, with heavy gang-on-gang violence.

The Mexican government has started a number of reforms and needs to enact more if it is to win this struggle. It has sought to create clear national guidelines for the recruiting and training of local police. The federal government needs much stronger police powers and the ability to deploy something like the US FBI. The court systems are clogged and weak. A number of progressive Mexican states like Nuevo Léon have undertaken judicial reform experiments in recent years; these need to be expanded and further replicated elsewhere in Mexico.

As many observers have noted, the drug problem in Latin American countries like Mexico originates in the United States, with the high level of demand for illegal drugs on the part of American consumers. Over the past several decades, US drug policy has focused almost entirely on the supply rather than the demand side. Many economists looking at the drug problem have noted that supply side interdictions may temporarily raise the costs of illegal drugs in the US, but that markets respond by finding alternative routes and sources of supply. Cocoa eradication in Peru and Bolivia pushed the problem into Colombia; Colombian anti-drug efforts pushed the problem into Central America and Mexico. When the US closed supply routes through the Caribbean, Mexican traffickers picked up the slack, and also found alternative markets in Europe. There has been no serious diminution of either the total quantity of illegal drugs consumed, or their price (indeed, the price of cocaine has been dropping steadily in Europe since the early 1990s).

All of this suggests that without greater demand-side efforts, the United States will never make a serious dent in the drug trafficking problem. Virtually all of the social costs of the “war on drugs” is borne by producing or transshipment countries in Latin America, at the cost of political stability and economic development.¹

The most straightforward way to reduce demand, of course, would be legalization under a tightly regulated regime, much the way that alcohol and cigarettes are currently marketed.However, while legalization has been proposed by many people over the years, it has very little chance of being enacted by Congress, and therefore is not for the time being a realistic policy choice. Not only that, much of the world is locked into commitments not to legalized drugs, based on a trio of UN conventions passed with heavy support from the United States.Demand-side interventions like better drug education and treatment will not fundamentally lance the boil, but will bring demand down somewhat.

The reason why the US should undertake a comprehensive effort to improve security and bolster judicial reform in Mexico is therefore not because this will somehow “solve” America’s drug problem. Indeed, Mexico’s current war on drug gangs has already pushed a lot of their activity into smaller countries like Guatemala and El Salvador; a serious plan would have to be regional and not simply focused on Mexico.There are, instead, another set of considerations that would argue in favor of a new initiative:

Democracy and political stability in Mexico are very important to the United States. As a result of the recent drug wars, there has been a lot of loose talk about Mexico becoming a “failed state.” This rhetoric is much overblown, but it is the case that the drug trade is highly corrupting to Mexico’s basic political institutions. It will be impossible to deal with Mexico on immigration or any other problem if its government can’t govern, is pervaded by corruption, or is unable to enforce the law in border areas.

Mexico has a serious, pro-American president who has already invested a huge amount of political capital in the drug war.Felipe Calderόn of the center-right PAN nearly lost to the PRD populist Manuel Lopez Obrador in the last presidential election. Mexico’s poverty makes the populist alternative a continuing attraction for Mexican borders, and the United States needs to bolster the credibility of sensible democrats in its neighborhood. We do not need another Hugo Chávez right on our border.

Improving security against narco-traffickers is actually achievable through public policy. While beefed-up security measures cannot stop the drug trade, it is possible to defeat drug gangs and increase levels of security. The proof of this is Plan Colombia, which the Clinton administration initiated and the Bush administration continued, which has emerged as one of the most successful hemispheric initiatives of recent decades. While the effect of Plan Colombia on Colombian cocaine production may be temporary, the impact on the daily lives of citizens of that country has been enormous. Levels of everyday security in cities like Bogotá and Medellin have improved enormously over the past six years.

Under the Bush administration, the United States has launched the so-called Merida Initiative, which Congress reluctantly funded at a level of $1.4 billion. The Merida Initiative is explicitly patterned on Plan Colombia, but has not been funded at nearly as generous a level. Mexican nationalism has prevented Mexican governments from appearing to be too cooperative with the United States, but in the course of the recent drug war, 150 Mexicans have been deported for trial in the United States. Felipe Calderόn met with Barack Obama on Jan. 12 and proposed a “strategic partnership” with the United States on this issue, which the Obama administration has yet to take up. The 3½ remaining years of Pres. Calderόn’s term represent a big opportunity to move ahead with an expanded Merida Initiative.

An expanded initiative ought to focus not just on hardware and greater police cooperation, but on help to reform Mexico’s judicial system more broadly. The United States has participated in rule-of-law reform efforts in many parts of the world, and could launch similar programs in Mexico. We do not have the answers to fixing Mexico’s judicial system, but its federal structure allows for considerable experimentation.

One difficult issue will be the question of arms supply. As many recent news stories have made clear, Mexican drug gangs are able to buy assault rifles and heavy weapons in the United States, and use them to outgun the local police. Efforts to control this traffic will run afoul of guns rights advocates in the United States, but there may be ways in which we can bolster the ability to monitor the flow of arms across the border.

There are downsides of increased security cooperation with Mexico as well. Perhaps the most important is the danger that it poses to our own judicial system. The amount of money available to Mexican drug gangs is so enormous that greater involvement by US police and courts will ultimately lead to the danger of the corruption of American institutions. But there is no reason why the Mexicans alone should bear the costs and consequences of a problem that originates, after all, in the United States.

There is a pervasive sense of unreality in Washington about the nature and scale of the economic crisis facing the United States and the world. The Obama Administration seems to be proceeding on the assumption that the problem in the US financial sector is still one of illiquidity rather than insolvency, and that the task is to prop up US banks for the next few months until markets value their toxic assets more fairly. The growing consensus of many economists, on the other hand, is that they are insolvent. The rapid downturn in the real economy, accelerated by the financial meltdown last fall, is feeding back into the banking sector as higher quality home mortgages (like Alt-As), commercial real estate loans, and credit card debt start to go bad. It is easy to see why the administration doesn’t want to admit to itself that the banks are insolvent, because this would mean going back to Congress for another trillion or so dollars for further bailouts. It is this political logic that kept Japan from dealing with its non-performing loan problem in the 1990s, and means we may be headed down the same road.

The Republicans, for their part, are in total denial of what befell the country under their watch. Having presided over the growth of a half-trillion dollar deficit during the boom years of the 2000s, they have suddenly re-discovered the virtues of fiscal austerity at the one moment in the business cycle when deficit spending is desperately needed. In their efforts to think through what went wrong in their electoral defeat last year, many are saying that the problem was that they strayed from Reaganism. Very few Republicans have come to terms with the fact that it was some of the key tenets of Reaganism—in particular, its hostility to regulation and belief that tax cuts would be self-financing—that lie at the root of the country’s current problems. It is true that the Democrats were complicit in much of this—Bob Rubin and Larry Summers were as much believers in financial sector de-regulation as any Republican, while Congressional Democrats did a lot to protect the train wreck that was Fannie Mae and Freddie Mac.

But the fundamental ideas regarding the self-regulating capacity of the market and the deadening hand of government are Republican ones. Former Senator Phil Gramm, author of the 1999 Gramm-Leach-Bliley Act that repealed the Depression-era Glass-Steagal Act and weakened the ability of the US to regulate derivatives, is, along with Alan Greenspan, one of the individuals most responsible for laying the intellectual groundwork of the crisis. This didn’t prevent him from writing an astonishing op-ed in the Wall Street Journallaying major blame for the meltdown on the Democrats and their support for Fannie and Freddie. Fannie and Freddie without question contributed to the crisis. But these institutions didn’t induce AIG to recklessly issue credit default swaps, or Washington Mutual to sign up borrowers with no due diligence, or Merrill Lynch to create securitized mortgages that are impossible to value, or Moody’s to give these securities Triple-A ratings. As long as Republicans don’t admit to themselves that this enormous crisis emerged as a result of factors intrinsic to Reaganism, they will never find their way out of the desert.

Both Democrats and Republicans seem to be operating under the assumption that the recession will bottom out some time later this year, and that we will see a gradual recovery starting in 2010. Certainly Obama’s medium-term budget is based on the assumption that we will be growing briskly again in a couple of years and in a position to tackle long-term problems like entitlements and the deficit. My own view is much more pessimistic, for reasons related to the global economy.

The long-term conditions for the current crisis were set in train as a result of Asian, and especially Chinese, responses to the 1997-98 Asian financial crisis. As Martin Wolf of theFinancial Times pointed out in his book Fixing Global Finance, countries in the region decided to protect themselves from skittish global liquidity by reversing its flow and building up reserves of US dollars. This meant that from 2001 to 2008, more than US$ 5 trillion of foreign savings poured into the world’s richest economy, the US, fueling a credit boom and the overleveraging of both households and corporations. The level of debt that was subsequently built up was extraordinary; in contrast to the recession of the early 1980s, when US private debt was 123 percent of GDP, it had reached 290 percent by 2008. Of that, household debt moved from 48 percent to 100 percent of GDP. This is why the Fed’s efforts to flood the US with liquidity will have limited effect; households and businesses will be deleveraging for a much longer period than in earlier recessions. Americans are re-learning how to become savers; they need to do that, but their prudence leads to Keynes’ famous paradox of thrift where aggregate demand turns anemic.

There are many problems on the supply side of the economy; we have lost a lot of our manufacturing base, and the service economy that was supposed to supplant it is a mirage.Gretchen Morgenstern points out that Merrill Lynch lost more money in the past two years than it earned in the previous ten, even as its executives took home billions of dollars in pay and bonuses. At the peak of the boom, financial sector earnings were 40 percent of total US corporate profits, but we see in retrospect that these numbers didn’t reflect real value being added to the economy. When you look not just at bank balance sheets but at the negative externalities the sector imposed on the rest of the economy, the real productivity gains for the past decade are likely to be far lower than they seemed to be when the boom was still on. We didn’t recognize this at the time because it was being masked by the willingness of foreigners to hold US dollar assets.

But an equally great problem for the future is on the demand side. For all the talk of decoupling, the spread of the recession via falling US imports shows the extent to which the whole global economy was dependent on the US, and particularly US consumers, for its growth. The sharpest declines in fourth quarter 2008 GDP among industrialized countries were in Japan and Korea, not because they were fiscally imprudent like the US, but because of their high dependence on exports. China is falling off of a similar cliff, though not quite as fast. US consumers will not and should not return to their debt-driven overconsumption anytime soon; but Asia’s economies still do not promote domestic consumption. US households have seen their net worth plunge by some $11.2 trillion, or 18%, through the end of 2008, with further losses in the first quarter of 2009. The baby boomers in particular, whose net worth has fallen more dramatically because they held more assets than the general population, need to rebuild their savings for their impending retirements, and will not be reopening their wallets even if easy credit becomes available again. Asian countries recovered relatively quickly from the crisis of the late 1990s because global demand was still strong; where is it going to come from now? The only hope is public spending, like the much-reviled US stimulus bill; but outside the US there have been relatively few countries willing and able to step up to the plate.

All of this suggests a rather prolonged recession, or perhaps a prolonged period of flat to very modest growth. We may in fact be lucky to duplicate Japan’s performance of about 0-1 percent per annum growth during the 1990s.

We need to look at the crisis in a longer term perspective. The baby boom generation—of which I am a member—went through its life over-consuming and under-saving, all the while exempting themselves from taxation (except for a brief period in the Clinton years, when we succeeded in running a budget surplus). Getting out of the crisis they created will require significantly increasing the already high levels of public debt they incurred; not only will they will then pass these liabilities down to their children, but they will start incurring health care costs that will eat up a significant chunk of future GDP if not constrained.

All of this does not amount to a failure of capitalism, but to a failure of American public policy. It is inevitable, however, that the credibility of things that Americans hold near and dear—i.e., liberal democracy and a market economy—will suffer greatly as a result of the crisis. People from Latvia to Korea to Mexico are suffering from a global recession that started in the United States. It started in large measure because of the faith that Americans placed in the ability of free markets to regulate themselves, a key aspect both of Reaganism and of the so-called “Anglo-Saxon” model of capitalism. Alan Greenspan admitted last fall that he was astonished that the self-interest of the financial community did not prevent it from making huge mistakes. Now that the public sector is cleaning up behind them, we need to move from astonishment to a different model of capitalism if we are to fix our own economy, and regain a shred of credibility on the world stage.

I recently read Tom Daschle’s new book, “Critical: What We Can Do About the Health Care Crisis” (co-authored with Jeanne M. Lambrew and Scott S. Greenberger). This book has particular relevance since he will soon be the new czar of health care reform in the Obama administration. Arguing that it would be politically infeasible for the United States to move to a single payer, national health insurance scheme, Daschle and his colleagues argue for providing the option of an alternative health insurance scheme similar to that provided to Federal employees and the Congress. Such an approach would enhance competition with insurance provided by the private sector. They suggest that households unable to afford the purchase of federal insurance coverage might be made eligible for financial assistance through means-tested government subsidies. By extending the reach of the government beyond Medicaid, Medicare and the Veterans Administration, they believe that the combination of Federal insurance programs would also give the Federal government greater ability to influence how the private sector provides health care and its cost.  (1)

The authors also call for the creation of a Federal Health Board (FHB) that would have direct authority over Federal health care programs, shaping the framework—as a “standard-setter”–for decisions on coverage and benefits, and introducing an evidence-based approach in considering the cost-effectiveness of drugs, devices, and medical procedures. They call for this agency to be accorded independence similar to that given to  the Federal Reserve Board in the sphere of monetary policy (arguing that, as with monetary policy, Congress lacks the competence or flexibility to make micro decisions in the medical sector).

I have little doubt that adoption of Daschle’s proposals would be an important first step in reforming the provision and financing of health care in this country. Simply ensuring that individuals are able to obtain coverage at reasonable cost would be a dramatic step forward in ending the scandal of this rich country having so many of its citizens without medical insurance coverage. Competition will help to some extent in curbing the excessive administrative costs that characterize the private health insurance business in the United States. By moving closer towards universal coverage, the shifting of costs from uninsured to insured would be reduced, removing one source of the present pressure for rising costs. Daschle’s proposal also focuses on the potential for beneficial spillover effects from the Federal system on the approach taken by private insurers in terms of benefit coverage and in the application of cost-effectiveness standards in judging the efficacy or superiority of new drugs, sophisticated diagnostic tests, medical devices, and surgical procedures.

But any health care reform initiative in the U.S. must also address certain basic financial realities about the present situation (many of which are recognized by Daschle in his book), even before we consider an extension of coverage:

•    The U.S. spends far more on medical care—by a factor of roughly 1.5:1—than any other industrial country, with health care costs now approaching 17% of GDP;
•    All serious scholars suggest that it would be difficult to envisage containing spending at the current share of GDP; the most optimistic scenarios involve expenditures rising at a rate 1 percent faster than the growth of per capita GDP  and the more realistic scenarios suggest an even faster rate of growth (see the recent forecast of the Center on Budget and Policy Priorities (CBPP), which largely echoes similar earlier forecasts by the Congressional Budget Office);   (2) (3)
•    Such a growth in Federal spending would simply not be affordable without dramatic increases in taxes or cuts in spending;
•    Such growth in overall health care spending would also weaken the competitiveness of American business and further erode living standards of wage earners; and finally,
•    Perhaps even more frightening, despite this high level of spending on medical care, a substantial share of our population is uninsured and our performance on indicators of health are below those of our peer countries.

So this means that any serious reform proposal must provide an answer to the following key questions:

•    Will it ensure universal insurance coverage to all Americans?
•    Will it contribute to an improvement in basic health indicators in this country?
•    What would adoption of the proposal entail in terms of the growth of health care spending? Would it prevent the growth of spending as a share of GDP? Or would it continue to imply a rising share?
•    Would there be full transparency as to how any further increases in spending would be paid for? By higher taxes? Cutbacks in other spending? Higher borrowing?

When I read Daschle’s book, I worried about whether his proposed initiative would be sufficient to address the last two questions posed above. I believe that much remains to be determined in judging whether the Daschle proposal will be able to contain the variety of cost pressures. But what gives me some hope is that Daschle’s discussion clearly recognizes most of the key challenges that will need to be addressed if these cost-constraining imperatives are to be tackled. In particular, he comments on the high administrative costs in the insurance industry; the substantial level of spending on pharmaceuticals and medical devices, the significant costs associated with malpractice insurance; the problematic duplication of high cost technologies in many parts of the country; the undesirable incentive of medical practitioners to shift costs to third-party insurers; the substantial proportion of medical expenditures concentrated in the last year of life; the weakness of America’s efforts at prevention (illustrated most starkly by the epidemic of obesity among young Americans); and the relatively high cost of medical manpower relative to that prevailing in other industrial countries.

To give greater confidence that Daschle’s proposals would address the problem of rising medical outlays, I would make the following suggestion. In formulating the role and policy responsibilities of the Federal Health Board, I recommend that its explicit policy mandate should include—in addition to the objectives of universal coverage and a good standard of medical provision—the goal of constraining the trajectory of overall US medical outlays (as a share of GDP) to a given target path. This path would reflect both the dangers to fiscal solvency posed by the current health expenditure trajectory as well as the opportunity costs and competitiveness challenges posed by a rising share of medical outlays in GDP. Adoption of such an explicit policy mandate for the FHB would parallel the recognized need for a policy mandate to guide the difficult monetary policy tradeoffs faced by the Federal Reserve Board (viz., “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”).

Note, I argue that the FHB’s target would not simply be limited to constraining the growth of Federal spending. I share the conviction of the CBPP that reform that does not address the fundamental cost-increasing pressures in the entire medical care sector would be insufficient. The recent CBPP report cites both David Walker (former head of the GAO) and Peter Orszag (the incoming head of the OMB) making this argument. What would be important is that the FHB is in a position, over time, to take the requisite actions in its decisions on coverage and standards to influence the various pressure points underlying the current forecast cost trajectory. Note, I also do not rule out the possibility of some modest rise in the share of total medical spending in GDP. Such an increase might reflect the conscious choice of the American people that the gains afforded in better health would be worth the cost ( a point that has been made by David Cutler of Harvard University),  as long as the burden of bearing this cost is equitably and transparently borne. (4)

I should also underscore what I believe should be a final important part of the task of the FHB. Specifically, it should help develop a greater understanding of how other industrial countries—faced with exactly the same set of pressures in terms of the availability of new and more sophisticated technologies in the context of aging populations—have made decisions to keep medical outlays within bounds. It should also work with other US government and private agencies to ensure that there is full transparency to the American people as to how the costs of delivering results in terms of medical care are being borne by different groups within the society. We continue to need a more transparent discussion of what medical care costs, what results and benefits we are getting for our high spending, and what are the difficult decisions that we must confront as we examine the costs and benefits of the ever-improving availability of new technologies of medical care.

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(1) They suggest that a government-run insurance program modeled after Medicare could give such a program the “clout to bargain for the lowest prices from providers and push them to improve the quality of care.”
(2)Richard Kogan et all, The Long Term Fiscal Outlook is Bleak: Restoring Fiscal Sustainability Will Require Major Changes to Programs, Revenues, and the Nation’s Health Care System (Center on Budget and Policy Priorities, December 16, 2008)(see http://www.cbpp.org/12-16-08bud.htm). They note that for the past 30 years, costs per beneficiary throughout the health care system have been growing approximately 2 percentage points faster per year than per capita GDP.
(3) It is also important to emphasize that the very little of this growth would reflect the aging of America’s population
(4)   David Cutler, Your Money or Your Life  (2005).

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

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It is with great sadness that I note the passing on Christmas eve of Samuel Huntington, long-time teacher, friend, and editorial board member of The American Interest.  I knew Huntington from my final year in graduate school at Harvard, when he had just returned from service in the Carter administration to the Government Department.  He kept up with his former students better than most professors through annual meetings at the Wianno Club on Cape Cod every summer, and through seminars and meetings at the Center for International Affairs which he directed for many years at Harvard.

Huntington was easily the greatest political scientist of his generation.  What was remarkable about his scholarship was the range of topics on which he wrote, and the way that each of his books became a major point of reference within each sub-field:  The Soldier and State for civil-military relations; The Common Defense for defense policy; Political Order in Changing Societies and The Third Wave for comparative poitics; The Clash of Civilizations for international relations; American Politics:  The Promise of Disharmony and Who Are We? for American politics.  Through his own scholarship and through his students he virtually created the subfield of strategic studies, an area that was not seriously researched by most universities until he came along.

Since there are likely to be many testimonials to Sam in the coming days and weeks, I thought I would concentrate on one particular aspect of his scholarship, his work on comparative politics.  Political Order in Changing Societies, first published in 1968, was perhaps the last great effort to build a general theory of political development, and left a profound mark on the entire field.  In 1997, when I was a regular book reviewer for Foreign Affairs, I nominated Political Order as one of the top five books on international politics that had been published in the past 75 years.  Perhaps as a result of this, Sam asked me to write a preface to a new reprint of paperback edition of the book which appeared in 2006.  This was a great honor that I undertook gladly.  I will simply quote from what I said in that preface:

“In order to understand [Political Order]’s intellectual significance, it is necessary to place it in the context of the ideas that were dominant in the 1950s and early 1960s.  This was the heyday of “modernization theory,” probably the most ambitious American attempt to create an integrated, empirical theory of human social change.  Modernization theory had its origins in the works of late nineteenth century European social theorists like Henry Maine, Émile Durkheim, Karl Marx, Ferdinand Tönnies, and Max Weber.  The writings of these authors established a series of concepts (e.g., status/contract; mechanical/organic solidarity; Gemeinschaft/Gesellschaft; charismatic/bureaucratic-rational authority) that sought to describe the changes in social norms and relationships that took place as human societies made the transition from agricultural to industrial production.  While based primarily on the experiences of early modernizers like Britain or the United States, they sought to draw from them general laws of social development.
“European social theory was killed, literally and figuratively, by the two world wars; the ideas it generated migrated to the United States, and were taken up by a generation of American academics after the Second World War at places like Harvard’s Department of Comparative Politics, the MIT Center for International Studies, or the Social Science Research Council’s Committee on Comparative Politics.  The Harvard department, led by Weber’s protégé Talcott Parsons, hoped to create an integrated, interdisciplinary social science that would combine economics, sociology, political science, and anthropology.

“The period from the late 1940s to the early 1960s also corresponded to the dissolution of European colonial empires and the emergence of what became known as the third or developing world, newly independent countries with great aspirations to modernize and catch up with their former colonial masters.  Scholars like Edward Shils, Daniel Lerner, Lucian Pye, Gabriel Almond, David Apter, and Walt Whitman Rostow saw these momentous developments as a laboratory for social theory, as well as a great opportunity to help developing countries raise living standards and democratize their political systems.

“Modernization theorists placed a strong normative value on being modern, and in their view, the good things of modernity tended to go together.  Economic development, changing social relationships like urbanization and the breakdown of primary kinship groups, higher and more inclusive levels of education, normative shifts towards values like “achievement” and rationality, secularization, and the development of democratic political institutions, were all seen as an interdependent whole.  Economic development would fuel better education, which would lead to value change, which would promote modern politics, and so on in a virtuous circle.

“Political Order in Changing Societies appeared against this backdrop, and frontally challenged these assumptions.  First, Huntington argued that political decay was at least as likely as political development, and that the actual experience of newly independent countries was one of increasing social and political disorder.  Second, he suggested that the good things of modernity often operated at cross purposes.  In particular, if social mobilization outpaced the development of political institutions, there would be frustration as new social actors found themselves unable to participate in the political system.  This led to a condition he labeled praetorianism, and was the leading cause of insurgencies, military coups, and weak or disorganized governments.  Economic development and political development were not part of the same, seamless process of modernization; the latter had its own separate logic as institutions like political parties or legal systems were created or evolved into more complex forms.

“Huntington drew a practical implication from these observations, namely, that political order was a good thing in itself and would not automatically arise out of the modernization process.  Rather the contrary:  without political order, neither economic nor social development could proceed successfully.  The different components of modernization needed to be sequenced.  Premature increases in political participation – including things like early elections – could destabilize fragile political systems.  This laid the groundwork for a development strategy that came to be called the “authoritarian transition,” whereby a modernizing dictatorship provides political order, a rule of law, and the conditions for successful economic and social development.  Once these building blocks were in place, other aspects of modernity like democracy and civic participation could be added.  (Huntington’s student, Fareed Zakaria, would write a book in 2003, The Future of Freedom, making a somewhat updated variant of this argument.)

“The significance of Huntington’s book must be seen against the backdrop of what was happening in U.S. foreign policy at the time it was published.  The year 1968 marked a high water mark in the Vietnam War, when troop strength swelled to half a million and the Tet offensive undermined the U.S. public’s confidence.  Many modernization theorists hoped their academic work would have useful implications for American policy; Walt Rostow’s book The Stages of Economic Growth was a guide for the new U.S. Agency for International Development as it sought to buffer countries like South Vietnam and Indonesia against the appeals of communism.  But by the late 1960s, there were not a lot of success stories that Americans to which could point.  The competing communist and Western nation-building strategies in North and South Vietnam ended with the latter’s eventual defeat.

“Huntington suggested that there was another way forward, through modernizing authoritarianism, a point of view that brought considerable opprobrium on him in the highly polarized context of America in the late-1960s.  But is was exactly this kind of leader – Park Chung-Hee in Korea, Chiang Ching-Kuo in Taiwan, Lee Kwan Yew in Singapore, and Suharto in Indonesia – who brought about the so-called “Asian Miracle,” even as Vietnam was going communist.

“It is safe to say that Political Order finally killed off modernization theory.  It was part of a pincer attack, the other prong of which was the critique from the Left that said that modernization theorists enshrined an ethnocentric European or North American model of social development as a universal one for humanity to follow.  American social science found itself suddenly without an overarching theory, and began its subsequent slide into its current methodological Balkanization.”

Political Order in Changing Societies was one of Huntington’s earlier works, and one that established his stature as a political scientist, but it far from his last major contribution to comparative politics.  His work on democratic transition also became of a point of reference in the period after the end of the Cold War.  Ironically, this stream of writing began with a 1984 article in Political Science Quarterly entitled “Will More Countries Become Democratic?”  Surveying the situation following the Spanish, Portuguese, and Latin American democratic transitions of the 1970s and early 1980s, Huntington made the case that the world was not likely to see more shifts from authoritarianism in the near future given inauspicious structural and international conditions.  This was written, of course, a mere five years before the fall of the Berlin Wall.  He shifted gears quickly after the collapse of communism, however, and wrote The Third Wave, a book that gave the name to the entire period.

The Third Wave’s take on democratization was, however, different from many others in the field, who focused either on agency (as in the Schmitter-O’Donnell-Whitehead series) or on structural conditions for democratic stability (as in the tradition running from Lipset through Pzreworksi).  Sam noted that the vast bulk of Third Wave transitions had occurred in culturally Christian countries, and that there was a distinct religious underpinning to the pattern of democratization in the late 20th century.  The Catholic world, in particular, was catching up to the Protestant first movers, just as Catholic societies had come late to the capitalist revolution.  The Third Wave was not, however, a manifestation of a broader cross-cultural modernization process that would eventually encompass all societies, but one rooted in a particular set of cultural values inherited from Western Christianity.

Though it may not have been obvious at the time, The Third Wave anticipated by this argument many of the themes that would be reprised in much greater detail in The Clash of Civilizations and Who Are We?, as well as in the volume that he and Larry Harrison edited entitled Culture Matters.  In perhaps an even deeper rebuff to modernization theory than the one made famous in Political Order, Huntington believed deeply in the durability of cultural values and the primacy of religion as a shaper of both national political development and international relations.  In the face of this, globalization was a superficial force that created the thinnest veneer of cosmopolitan “Davos men,” and would not in the end guarantee peace or prosperity.  And the United States did not represent the vanguard of a universalizing democratic movement; rather, it was successful due to its origins as an “Anglo-Protestant” society.  His last scholarly efforts prior to his passing focused on the impact of religion on world politics.

I disagreed with Sam on many of these issues.  While I fully appreciate the power and durability of culture, and the way that modern liberal democracy was rooted in Christian cultural values, it has always seemed to me that culture was more useful in explaining the provenance than the durability of democracy as a political system.  Sam, in my view, underrated the universalism of the appeal of living in modern, free societies with accountable governments.  His argument rests heavily on the view that modernization and Westernization are two completely separate processes, something which I rather doubt.  The gloomy picture he paints of a world riven by cultural conflict is one favored by the Islamists and Russian nationalists, but is less helpful in explaining contemporary China or India, or indeed in explaining the motives of people in the Muslim world or Russia who are not Islamists or nationalists.  Nation-states and not civilizations remain the primary actors in world politics, and they are motivated by a host of interests and incentives that often override inherited cultural predispositions.

Be that as it may, Sam’s arguments were always made with great force, erudition, and persuasiveness.  Even if one disagreed with him, it was impossible to not take his arguments with the greatest seriousness.  They provided vocabulary and structure to all subsequent discussions of the topic, whether latter was American politics, defense policy, democratic transition, or American identity.  In addition to his written work, he was a great teacher, and produced an entire generation of students who have reshaped virtually all of the sub-fields of political science.  From his earliest writings to his last works, he has drawn vociferous critics, but that is the mark of a scholar who has important and fundamental things to say.  It is a safe bet that we won’t see his like for some time to come.

It is difficult not to wonder about this. When I discuss the matter with my friends, the inevitable point is made that it is really hard to spend $50 billion dollars, even over a 10-15 year period. So where did it all go and what does this have to do with our fiscal deficit? My son Nate, who is an MBA student at Yale, and I were recently discussing these questions and the following is our fairly arbitrary guess. Our estimates are, of course, just conjectures. At some point, investigators will probably be able to come up with a far better estimate, and it will be intriguing to really disentangle this complex scheme.

Several observations on the mechanics of such a scheme can be imagined. First, one must assume that some of the capital simply went to support Mr. Madoff and his life style of an apartment in Manhattan, fancy houses in Montauk and Palm Beach, and if I recollect from the news, a house or apartment in Europe. I also seem to recall yachts with the name of “Bull,” as well as country club memberships in Palm Beach and the Hamptons.  All of this does not come cheap, and one may assume that Mr. Madoff pocketed and spent, after tax, at least $25 million a year—or $35 million pretax– (my ignorance of this standard of living may mean that I have underestimated what such a life style costs by a factor of two or three even). But there is also significant overhead to the production of Ponzi income of this magnitude. Add three floors of rent in the so-called Lipstick building of Manhattan, as well as the overhead costs of the employees and other running costs of his legitimate securities transactions business (presumably including at least two well-paid sons and other relatives), and we can potentially account for another $40 million in expenses (again, my numbers are completely arbitrary). So this would imply that Madoff would have had to have annual inflows of capital to his operation of at least $75 million to cover these costs. Even over 10-15 years, this would have amounted to no more than $1-1.2 billion. But when the scheme collapsed, Madoff estimated that something like $50 billion was the amount of lost capital, leaving us with approximately $49 billion unaccounted for.

So what happened to the rest of the money?  Let’s look at how the scheme would have worked in a given year.  Let us imagine 2008, this last year of the scheme before it collapsed.  At the roughly 10 percent rate that Madoff was offering investors, he would have had to pay out about $5 billion in “dividends and interest” in order for his investors to continue as happy campers.  Simply as a guess, let us assume that 60% of the
$5 billion, or $3 billion, stayed with Madoff as a reinvestment and 40% was paid out and spent by his investors.  For the latter, this would have included the charitable foundations that paid their employees and made grants with the income; the universities that used this endowment income to pay their teachers and staff; and of course those who lived on their income from Madoff to support their retirement or their life style of consumption. Assuming that Madoff was running the operation with no liquid reserves, this implies that Madoff would have needed roughly $2 billion in capital inflows plus at least another $75 million, as noted above, to cover the payout to investors as well as his own “expenses.”

Including the inflows from new investors (which were added, on paper, to Madoff’s principal even though he was actually using the money to pay off existing investors) to the $3 billion Madoff was supposedly reinvesting, the capital value of the Madoff scheme would have risen by the full $5 billion in 2008, even with zero increase in actual value ($2.1bn in from new investors, $2.1bn out for expenses and payouts, $3bn of fictitious returns).  It is also worth noting that Madoff’s reported earnings attributable to investors would have been subject to taxes by their recipients.

Of course these are the figures at the end of the scheme. During all of the previous years, a similar type of operation was occurring, with some of the money being paid out and actually used for real purposes by Madoff’s clientele, and with an important part of the capital growing fictitiously. So in trying to guess where the money went, one might hazard the fairly arbitrary guess that a significant part (perhaps 65 percent) never went anywhere! It represented earnings on capital, reinvested, that never actually existed. It was as if the original money of investors had not been invested but spent, but nevertheless the original sum was kept on the books and a 10 percent return kept being added to it.  (Note that if you were to invest $100,000 and earn a 10 percent return that you reinvested every year, you would have roughly $260,000 accumulated at the end of 10 years). So one can easily imagine that if many investors had left their money in the investment scheme for many years, quite a significant fraction of the amount they supposedly held would have simply been the result of smoke and mirrors.

Another significant sum, let us say roughly 30-35 percent, was actually was paid out and used by legitimate people for presumably legitimate purposes. A small share, probably 1 percent, was earned as fees by the feeder funds that took a 1.5 percent management fee on the amounts that they channeled to the Madoff funds. Madoff and his enterprise probably skimmed off about 1-2 percent of the total over the years. As is inevitable with Ponzi schemes, those who invested late in the game were probably the largest losers, never having had the opportunity to avail themselves of the income that Madoff so regularly paid out.

And how does the fiscal deficit enter in? Well, as I noted above, for each $1000 reportedly earned by Madoff for his clientele, at least $150 was presumably paid to the Federal government in taxes (assuming all of it was declared as dividends and subject to the 15 percent tax rate on dividends). However, in many cases, even more was probably paid, since some earnings would have been declared as interest and taxed at the recipient’s marginal tax rate. Most likely, the Federal government received, on average, about 20 percent of Madoff’s fictitious reported earnings for his clients. So most likely, if roughly $47-50 billion was “earned” over the time frame of the Madoff scheme, and this was all declared as taxable income, the Federal Government was probably the beneficiary of about $10 billion. So one could say that this was Madoff’s implicit contribution to preventing the Federal deficit from being even higher over the period. Of course, now that the losses are revealed, it is likely that many of the losers will now be able to write off some of their losses, recouping some of their previous payments in lower tax liabilities in 2008 and 2009, and thus adding to the already high fiscal deficit!

None of this is very pretty as we begin the holiday season.

www.petersheller.blogspot.com

As the United States Government seeks to dig the economy out of a recession through a massive fiscal stimulus package, many voices continue to remind us that the larger challenge to be faced is the large and growing long-term fiscal debt. For example, the Center on Budget and Policy Priorities (CPBB) has just issued budgetary forecasts through 2050 (http://www.cbpp.org/). These highlight that under current policies and with historically reasonable assumptions, the federal debt will reach 279 percent of GDP in 2050. “The average amount of program reductions or revenue increases that would be needed over the next four decades to stabilize the debt at its 2009 level…equals 4.2 percent of projected GDP”, “the equivalent of an immediate and permanent 24 percent increase in tax revenues.” These warnings are not new. They follow similar alerts from the Congressional Budget Office, academics, and journalists over the last several years. The Peter G Peterson Foundation is also ramping up for a major initiative to raise the alarm, starting with the airing of its film on the long-term fiscal crisis, I.O.U.S.A (see http://www.iousathemovie.com/), early next year.

Perhaps the more challenging question is why there has been so little traction on this issue, particularly given that these facts are undisputed among America’s political leaders as well as by most economic analysts. There are two simple answers. The first is the most obvious. Addressing the long-term fiscal deficit will be politically painful, requiring significant increases in taxes or cuts in expenditure programs, and the political system does not do pain very well. The second is the difficulty of coming to grips with how to tame the major elephant in the room, that is the largest source of the looming fiscal gap—the rising costs of medical care.

What has been missing in this litany of fiscal warnings, and which perhaps best explains why there has been so little political groundswell for action (including in the recent Presidential campaign), is any significant discussion of how this fiscal mess will be resolved, and who will bear the burden of its resolution. And here the CBPP’s note does highlight one important observation, which was first made in a joint op-ed by former Treasury Secretary Robert Rubin, incoming OMB head Peter Orszag, and economist Allen Sinai. Long before we get to 2050, it is likely that the edifice will crumble—that the capacity of the US government to continue to run large fiscal deficits and to service its growing debt will implode. Interest rates will begin to rise, further aggravating the debt service burden, and foreign buyers of US debt obligations will begin to be wary of too large a portfolio exposure to the US government.

In effect, markets will force action sometime in the next decade or so—this might occur through tax increases, draconian cutbacks in government programs, or by cutbacks in coverage or benefit eligibility. It also might occur through inflation, if the government were to erode the real value of its debt by printing money (though it is doubtful that in today’s globalized financial markets that this can be a successful strategy for very long). But action will take place because there will be little alternative. This will be painful and will have real consequences. The need for action, when pushed by markets, will not occur at a time of our choosing; indeed, one could imagine scenarios where the timing is simply awful in terms of the global economy or national security interests.

The current financial crisis is illuminating in this regard. We have just experienced (during a Republican Administration no less) an enormous unexpected and untargeted wealth “tax” of roughly 20 percent, borne largely by homeowners and by those with portfolio wealth (that has sunk in value). Unlike a tax increase, where at least the government would receive the associated revenues, few (and certainly not the government) have benefited from this current loss of wealth. Others are feeling or will feel the ripple effects of this loss in the form of lost wage earnings, lower benefits at the State level, higher taxes and fees, and lower interest incomes. A year ago, few would have imagined the starkness of the crisis that we now face.

Who will bear the financial burden of how this larger long-term fiscal debt problem will be resolved remains to be determined. One can imagine a number of equally plausible scenarios. The most desirable would be one that arose from a well-thought out strategy entailing many “politically difficult” measures sequenced over time: with some increases in tax rates and revisions in the tax code (e.g., reducing some present tax subsidies), significant efforts at rationalizing how and what medical services are provided, adjustments in coverage and eligibility for medical benefits, cutbacks in inefficient or less meritorious government programs, adjustments in the social security system in the form of higher payroll taxes or delayed ages for benefit eligibility (see Eugene Steuerle’s recent blog for some obvious candidates for reform ttp://mail.google.com/mail/?shva=1#inbox/11e4b24bf419a3e9). Another scenario might entail a far more comprehensive revision of the way in which medical care is delivered and financed, coupled with some less dramatic revisions to taxes and expenditures. Still another might reflect a far less strategic approach, involving ad hoc tax increases, brutal expenditure cuts, and ad hoc adjustments in the Medicaid or Medicare system. And finally, of course, using inflation to reduce the real value of a government’s debt is an approach many governments have used in the past, with large and long-term harm, both to individual households and to the government’s financial credibility. Regrettably, these latter solutions have been the outcome too often in the past.

How individual American households—of different income groups, from different generations, and from different sectors—would be affected by these very different ways in which the problem might be resolved would need to be analyzed carefully. A major part of these effects would be reflected in higher taxes, lower benefit incomes, a higher cost of public services, and a need to defray some costs that had been previously been financed by the government. But another important part of the effect would be reflected, say, in diminished access to real and useful government services or reduced availability of some medical care that had heretofore been provided by the government. Some groups in society might be affected far more than others—for example, if there were a major restructuring of the medical care system. Equally, some approaches—such as an increase in inflation–would certainly affect creditors and, as we have long known, would disproportionately affect those with a more limited ability to adjust their assets to an inflationary environment. What is important to acknowledge and clarify is that different approaches would affect different households in different ways, but the effects would be real and substantial.

Perhaps the best way to motivate political action would be to explore a few alternative scenarios and to illustrate specifically and transparently who would bear what part of the burden. Let the American public come to grips with the stark reality of the possible consequences of a well-thought-out strategy as opposed to an ad hoc, unplanned approach or recourse to inflation. The chips will fall, but they do not have to fall in an unintended way. Equally, some policy solutions will involve far less harm to America’s long-run interests. Others will not only be costly, but inefficient and damaging to America’s security and long-term interests.

www.petersheller.blogspot.com

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* 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 “€œa series of processes—actual proposals for quick enactment in some cases, commissions and white papers in others, and complete departmental reviews in yet others.”**

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 www.petersheller.blogspot.com or www.fiscalspace.com .

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

** See http://www.pgpf.org/newsroom/tgwd/26/

In the January-February 2008 issue, I warned, in “Averting the Third Kosovo War”, that the Bush Administration should not recognize the independence of Kosovo until it first negotiated a deal to guarantee the autonomy of the ethnic Serbs who predominate in the province’s north. In the absence of such a deal, the article noted, independence could trigger three problems: violence in northern Kosovo, contagious secession elsewhere in the Balkans, and increased tension between Russia and the west. I summed up, “America’s current course of action risks renewing hostilities in the Balkans and stimulating Cold Warlike tensions with Russia.”

Less than a year later, each of those problems has materialized to some degree. In February, upon Kosovo’s recognition, Serbs rampaged and burned international facilities in the province’s north and in Belgrade. In August, partly in revenge for western recognition of Kosovo, Russia invaded and recognized the independence of Georgia’s secessionist republics of South Ossetia and Abkhazia. In October, the Washington Post reported that “Bosnian Serb lawmakers demanded the right to call a referendum on secession from Bosnia-Herzegovina,” putting at risk the 1995 Dayton Peace Accords that had ended more than three years of bloody war.

So now the United Nations and European Union are backpedaling furiously to grant autonomy retroactively to the Serbs of northern Kosovo. My article had suggested the Serbs should get their “own police force, control of local affairs and special association with Serbia.” According to press reports, the new UN plan would do just that, guaranteeing them separate “police, customs and justice systems.”

Unfortunately, it has become much harder to persuade Kosovo’s ethnic Albanian leaders to accept such concessions because when the west recognized Kosovo’s independence it surrendered its main leverage. As the speaker of Kosovo’s parliament, a former senior rebel of the Kosovo Liberation Army, stated flatly this week: “Any effort to change the provisions of the constitution is doomed to failure.”

To its credit, the international community is finally trying to do the right thing. But it may be too late. In politics, as in life, timing is everything.