Date created: 15/06/09 3:02 PM
Last modified:15/06/0 3:02 PM
Maintained by: John Quiggin
John Quiggin

Stepping into a maelstrom

John Quiggin Australian Financial Review

6 November 2008

Following his convincing election victory, Barack Obama will have only a brief moment to relax, before preparing to face some truly daunting challenges. The financial crisis is the most immediate, but it is merely a symptom of unsustainable economic, social and environmental trends that have built up over decades, and accelerated greatly under Bush.

As regards the banking system, the immediate liquidity crisis has eased a little, as the banks have been bribed and bullied by their new public part-owners into extending at least some credit to each other, and to the finance markets on which the ordinary operations of business depend.

But the implications for the broader economy are only just beginning to emerge, and here the news is almost uniformly bad. Car sales have crashed, business investment is grinding to a halt, and the housing market shows no sign of a recovery. With many other countries entering a slowdown or recession, the few bright spots in the economy, such as exports, are turning dark.

With ten weeks until his inauguration it is hard to tell how far the economic situation will deteriorate in the interim. But Obama will have to be ready to take immediate and radical action.

First, the government will almost certainly need to extend further help to, and further control over, the financial system. While the bad news about mortgages has largely been received by now, there are looming disasters in credit card defaults, and the prospect of large-scale defaults by businesses hit by the recession. More public equity, and more encouragement to maintain lending to creditworthy borrowers will be needed immediately.

The new global financial architecture that is already emerging, more or less by default, needs some serious thought too. The old architecture rested on the implicit premise that the US system at its centre would never fail, and this in turn created a huge moral hazard problem. The institutions at the core of the system need to be separated much more sharply from the areas of high-risk innovation where rewards need to be matched by the absence of any public safety net.

In fiscal terms, the new Administration must act immediately to stimulate demand, both through aid to those hit hardest by the crisis, notably the unemployed, and through direct public expenditure. At the same time, Obama cannot afford to backslide on his core policy commitments, most importantly on health care.

The existing system of employer-provided health insurance, already in dire straits, is unlikely to survive the current crisis in its present form. Obama proposes subsidies, including public reinsurance for catastrophic claims. The result will be a big expansion in coverage and in costs, leading to a need for more effective public control over health costs, including initiatives similar to our own Pharmaceutical Benefit Scheme.

And looming over all of this is climate change. Obama has promised a cap-and-trade scheme, and a return to world leadership at Copenhagen. But, as in Australia, there will be powerful voices calling for a continuation of the Bush policy of delay and denial, and putting the financial crisis forward as a pretext. Neither the world nor the position of the US as a world leader can afford this.

And there will be bills to pay. The US national debt, is already over $10 trillion thanks to the incompetence and extravagance of the Bush Administration, with its ruinous wars and lavish tax cuts for the rich. The cost of the bailout, and of the deficits that will be necessary to soften the recession and stimulate a recovery, will add trillions more to that figure.

Ultimately that means higher taxes. Obama has already promised to let the Bush tax cuts expire for those earning more than $250 000, but this won’t raise a huge amount. The burden of cleaning up the mess left by Bush, and paying for a more equitable future, must be borne primarily by households in the top 20 per cent of the income distribution. This is the only group that saw consistent gains during the three decades of neoliberalism that began in the late 1970s.

Republicans from John McCain down have called the election ‘a referendum on socialism’. That’s nonsense, of course, but Obama’s victory should mark a revival of the progressive politics of the New Deal, in retreat ever since the 1970s. If Obama can combine an economic recovery with a new commitment to social equity, his election victory could prove more significant than any since that of Roosevelt in 1932.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

Read more articles from John Quiggin's home page

Go to John Quiggin's Weblog