In Search of an Agenda for Obama’s Second Term

Recent history has not been kind to Presidential second terms.  Lyndon Johnson got mired in Vietnam.  Richard Nixon was forced to resign because of his role in Watergate.  Ronald Reagan faced the Iran-Contra scandal.  Bill Clinton was hobbled by the investigation of the Monica Lewinsky affair.  And George W. Bush spun his wheels as the public turned against the Iraq War.

Based on the low standards of the last five decades, the second Obama term will be judged a success if the President simply avoids a major scandal.  And, sorry, Republicans: What the Administration knew or said when about the Benghazi attack does not count as major or scandalous.

Obama ran for re-election mostly by telling the American people that Mitt Romney and the Republicans would undo the considerable policy achievements of the first Obama term: the Affordable Care Act; Dodd-Frank; saving the auto industry; winding down the Iraq and Afghanistan wars; and persuading Congress to enact a depression-averting economic stimulus.  Americans rewarded President Obama with a second term so that his first-term policies could be given more time to blossom into further concrete results.

But presumably the President wants to do something more in the next four years than simply fight a rear-guard action to preserve his first-term accomplishments.  If so, he needs an affirmative agenda.  What should it be?

After explaining why a “grand bargain” on the federal deficit does not fit the bill, I shall offer a framework for a second-term agenda: Cost internalization.

Why a “Grand Bargain” Should Not Frame a Second-Term Agenda

As the President huddles with Congressional leaders from both parties in the hope of finding a compromise to avert the “fiscal cliff,” it may be tempting to think that the second-term agenda should be framed by whatever agreement comes out of that process.  After all, in the summer of 2011, President Obama and House Speaker John Boehner came very close to reaching a “grand bargain” to reduce spending and increase taxes, but ultimately Boehner could not deliver the necessary Republican votes in Congress.  But perhaps, readers may speculate, the political capital that the President earned in the recent election has sufficiently strengthened his bargaining position that he can now win the concessions that are needed to seal the deal.

Don’t count on it.  As I noted in my column last week, the same forces that led to the unraveling of the proposed grand bargain in 2011 remain in place today.  More importantly, the grand bargain that is on offer would likely be harmful in the short run, and inadequate in the long run.

In the short run, making premature spending cuts could very well repeat Franklin Roosevelt’s 1937 mistake: He began his second term with a premature effort to balance the federal budget, and ended up intensifying the Great Depression.

The U.S. economy actually experienced much stronger growth during the period from 1934 through 1937 than it has experienced in the last several years.  Nonetheless, most economists believe that Roosevelt erred in concluding that recovery was self-sustaining when he pursued a deficit-reduction program that sent the economy back into recession.  Premature federal spending cuts could have the same effect today.

Nor is the ballyhooed grand bargain likely to address the fundamental long-term problems facing the country, even if it does not have a harmful short-term effect.  Supporters of the grand bargain assume that the government’s basic problem is that it spends too much, relative to the revenues it collects.  The solution, according to Congressional Republicans, is to spend less.  President Obama, by contrast, advocates a “balanced approach” under which the government spends somewhat less and increases taxes on wealthier Americans.  The ongoing negotiations seek some middle ground between these two approaches that is acceptable to both sides and their political supporters.

But over the long run, the core driver of federal deficits is health-care-cost inflation.  Budgetary negotiations focus partly on how much money the government will spend on Medicare (for the aged), Medicaid (for the poor), and Obamacare (for workers without employer-based insurance).  Unless the actual underlying health care costs are contained, however, the only way to spend less on these programs is to provide Americans with health insurance that is manifestly inadequate to cover costs.

Put differently, until we find some way to contain health- care-cost inflation, negotiations over other budget items and tax rates will have only a marginal impact on the country’s fiscal health.

Finding Common Ground on Health Care

The prospects for containing health care costs appear mixed.  Obamacare contains some measures that are designed to limit spending on ineffective treatments, but these have not been successfully promoted to the public.  Indeed, during his widely-praised first debate performance, Mitt Romney scored significant points by misleadingly attacking one of these measures: the Independent Payment Advisory Board, which proposes cost-savings for Medicare.  By falsely claiming that the Board would substitute bureaucratic judgment for medical judgment, Romney stoked fears that even modest cost-containment measures would be bad for Americans.

To be sure, Republicans have their own plan to contain medical costs: Unleash the magic of the market by making people better consumers of medical care.  According to this thinking, Americans do not have enough “skin in the game,” and so they spend too much on health care.  Faced with a $20 co-pay rather than the full cost of a $200 visit to the doctor, the thinking goes, Americans buy too much health care.

While there undoubtedly are some real instances of patient-driven over-utilization of healthcare benefits, the Republican view ignores the information asymmetries that health-care consumers face.  Most of us have no idea whether some particular medical test or procedure is in our interest, and so we place our trust in doctors.  And that’s where the more serious economic distortion comes in: Doctors have generally been paid by patients and insurance companies on a fee-per-service basis; thus, they have financial incentives to order more, rather than fewer, tests and procedures; and they can readily rationalize such over-treatment on the ground that it is in the patient’s best interest, because it is better to be safe than sorry.

Thus, the Republicans are right that our current system leaves people with incentives to spend too much on medical interventions that are of questionable utility.  But they tend to focus on the wrong people: patients, rather than doctors.  What we need is a health-care system in which costs are internalized—that is, one in which the people who profit from health-care measures also bear the cost of those measures.

Fortunately, recent and ongoing changes in the medical profession appear to be moving in the right direction.  As Atul Gawande noted in a recent New Yorker article, most doctors are now employees of health-care networks, rather than being self-employed—and within that structure, increasingly many doctors now receive an annual salary, rather than having their income depend on the expense of the treatments they administer.  The best-run of such organizations, like the Cleveland Clinic, implement additional procedures to contain costs—for example, by placing price tags on medical equipment to make doctors aware of the cost of particular interventions.

The jury is still out on whether these trends will substantially slow medical-care-cost inflation, but they point the way towards a policy agenda for Obama’s second term: Create regulatory frameworks in which the interests of individual actors (such as doctors and patients) are aligned with the public interest.

Towards a Cost-Internalization Agenda

More broadly, President Obama might frame the agenda of his second term around cost internalization.  For years, Republicans have attempted to portray Democrats as interested in enacting excessive regulations that stifle business.  Democrats typically respond by pointing out that greedy, self-interested actors will do great harm to others if not reined in by government.  That is a fair response, as far as it goes, but there is more.  Often regulations aim to make the market work better as a market, not merely to control bad actors.

Regulation of health-care markets to ensure that doctors have the right incentives is one example, but there are others as well.  For instance, much financial regulation aims to prevent corporate officers and executives from making wild gambles with other people’s money.

Environmental protection probably provides the best example of regulation that aims at ensuring cost internalization.  Suppose that a factory produces widgets for a dollar each, but also does a dollar’s worth of damage to the air and water around it each time it makes a widget.  Absent regulation, widgets would sell for a dollar each, even though their real cost (production cost plus environmental damage) is two dollars.  But half of that cost is “externalized” to the public, and so the widget-maker in effect receives a subsidy from the public.  Regulation aims to make the price of the widget reflect its full, two-dollar cost.

The principle of cost internalization has long been part of the academic discourse of regulation, but it is not much visible in public debate.  The Obama Administration would do well to try to change that, because cost internalization can be a big part of the response to our biggest national challenges—containing health-care costs, preventing future economic meltdowns, and dealing with the existential threat of global climate change and ecological disaster more broadly.  Now all the Administration needs is a less wonky term than “cost internalization” to use in packaging its regulatory agenda.

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