Obama's challenges remain; fix healthcare to cut fisc: INET

Robert Johnson, executive director, Institute for New Economic Thinking (INET) explains to CNBC-TV18 that the challenges for Obama remain the same in his second Presidential term. Johnson adds that the government could lower healthcare costs, by diminishing the impact of pharmaceutical and hospitalisation lobbies, to address the fiscal challenges.

Below is an edited transcript of the analysis on CNBC-TV18 Q: What are the various challenges for President Obama in the second term?
A: I think President Obama's second term has challenges similar to the first such as a House dominated by Republicans and a relatively conservative Democratic Senate and the increasing pressure of fiscal consolidation forcing him to cut entitlements such as social security and the healthcare budget for years in the future when the baby-boom ages. Q: Why have the markets have sold off so sharply? Is it because Congress continues to be in a gridlock which means that any political negotiation to arrive at an amenable solution to the fiscal cliff problem is going to be a nail-biting one?
A: I think there are number of factors. One, it is possible under President Obama if he develops a strong backbone in these negotiations that the capital gains tax and the tax on dividend income will rise. So, many people maybe booking profit at this stage in order to prepare for that event.
Secondly, the anxiety and the uncertainty that you mentioned regarding gridlock may be a factor. But I also think there is a third factor operating today and the clue is that the dollar is strengthening against the euro and that suggests that there are problems emanating from Europe.
Many of the European and the American officials cooperated to keep things calm before the election. But now here we are, one day after and Europe is down, in turmoil and that has nothing to do with the uncertainty in the US fiscal cliff per se though all stock markets are very highly correlated. Q: According to Congressional Budget Office (CBO) statement on the fiscal cliff issue, 'If the fiscal cliff does in fact occur, which means the tax cuts are allowed to expire, the fiscal tightening that will take place will probably be considered or will lead to economic conditions that will be considered a recession with real GDP declining by about half a percent between Q4 of this year and Q4 of 2013'. The CBO also says that the unemployment could rise to about 9 percent in the second half of calendar year 2013. Do you share this rather dismal view of what will happen if the fiscal cliff were to come to pass?
A: I think if the entire situation is unattended to, the US economy will suffer both from the uncertainty involved in the negotiations and from, what we might call - fiscal drag of the policy tightening that sequestration would imply. But I do not think that situation will arise. I think that is less than one-third chance that that would be the case.
I also think what is very misguided in this entire debate is that the United States has health policies which are ranked 37th in the world in terms of their quality and yet more than double the OECD average in cost.
The only thing I think we need to do to put out budget on a stable trajectory into the indefinite future, is to address pharmaceutical, insurance, and I mean medical insurance and hospitalisation lobbies in the healthcare sector to bring our cost in line with the other major industrial countries. In which case Medicare and Medicaid do not have to be curtailed in terms of the quality of service and our fiscal challenges will essentially disappear.
_PAGEBREAK_ Q: Do you think the government is going to be able to do what it takes to avert this disaster that the markets are looking at and what are the options do you think President Obama's government is most likely to pick in order to effectively scale this fiscal cliff issue with minimal damage?
A: I would tend to focus more on the Congress and the Senate and the tremendously dysfunctional system of money politics in America rather than on Obama's intentions or preferences. I think it is very clear, from the exit poll data , that most Americans would like to see taxes raised particularly on wealthy individuals and corporations.
I do not think that is going to be a large part of the programme. I think whatever will happen, will affect the lower half of the income range, the people who are not part of political fundraisers in this era of money-politics. Q: If the tax reform doesn’t take place, I think then the CBO has, under the Alternate Fiscal Scenario, predicted deficit over the 2014-2022 period for the USA, to be much higher and they have also said the debt held by public would climb to 90 percent of GDP by 2022. In short, what the CBO is saying is if politicians get together and manage to avert the tax hikes and the spending-cuts and postpone all of this over the course of the next few years, then we are going to look at debt of almost 90 percent of GDP by 2022. This is a Hobson's Choice, how do you think politicians are going to navigate this?
A: First of all, I think what the CBO is saying is absolute nonsense. The British Empire carried debt-to-GDP ratios of upto 240 percent for 50 or 60 years and did just fine. The Americans came out of World War II with debt-to-GDP ratio of 120-130 percent.
The United States is not experiencing a credit market crisis. People are clamoring to buy the debt right now so I think that is a scare story, but to answer your question that scare story will be addressed by frightened politicians who are running for the money of fund-raising and they will work very hard to maintain a very strong discipline on the powerless- meaning the people who are senior citizens and the people receiving social security. I think it's a dreadful result based on a fear that's unfounded.
_PAGEBREAK_  Q: Why do you say it's unfounded? Because of the course of ever since last year's downgrade we have had people talk about America's indebtedness at some point, likening it to Europe's indebtedness. I know the magnitude is very different, but will 90 percent of GDP- to-debt not be a serious problem if all the tax hikes and spending cuts are postponed?
A: I don’t think it will be a serious problem; not if the dollar is still the reserve currency of the world. That’s where I differ with that perspective. Since that downgrade, US bond yields are lower than before, so that downgrade didn’t seem to have much effect on market sentiment. My view right now is that the 90 percent debt-to-GDP ratio in the United States is not an extreme danger and it should not be used to raise the threat of extreme danger.
I think the biggest problems in America are of the runaway kind in the financial sector’s regulation which leads to the kind of prolonged recession that we are in, problems in the medical-industrial complex and problems with the military-industrial complex. The inefficiency of those later two sectors and the inability to regulate finance has created much more problemS than the imbalances in social security or overuse of healthcare by senior citizens. Q: If politicians in the US don't heed your advice how big a recession do you think we are likely to see over the course of the next year in the US?
A: I don't think it's a question whether they seek my advice or not. If they either allow us to go to sequestration or they make draconian cuts on the lower-half of the population and further undermine the confidence of American people, we will be faced with political instability for a great deal of time and a stagnant economy.
I think there are very healthy ways in which to distribute the burden of closing this deficit and I actually think one of the ways to do that is to borrow money in the short-term because I know resources do not pay taxes.
Putting people back to work, rebuilding the productivity through science, education and infrastructure would allow the American debt-to-GDP ratio to come down over 10 years because the growth and productivity would accelerate. So, I don't think austerity is the only answer to this problem. But I am quite afraid that that’s where the American elites are headed and it will create suffering and stagnation.