Busting the budget

Sequestration is upon us, in the form of blunt, across-the-board spending cuts to government agencies that will limit many programs and services unless President Barack Obama and Congress reach a budget deal to keep them running. Gazette staff writer Colleen Walsh spoke with Harvard analysts in a question-and-answer format about how sequestration is likely to play out politically and fiscally, including for research universities that rely on government funding. Here are their thoughts.

William W. Chin is the executive dean for research at Harvard Medical School and Bertarelli Professor of Translational Medical Science.

GAZETTE: The National Institutes of Health (NIH) budget will undergo substantial cuts if the sequester goes through. What will that mean for America’s research universities?

CHIN: There are just a lot of things we still don’t understand. We don’t understand what causes disease, and how one disease shows up in different manifestations. A lot of the funding [we receive] is important for basic research. It’s not the only thing. Obviously, there’s also translational and clinical research that the NIH and NSF [National Science Foundation] funds. But, really, it’s basic research that provides the foundation for our knowledge that allows us to answer the important questions.

The sequester really has a number of effects. It would likely force some decreases in funding of current grants, but it also would mean that a percentage, and maybe a good percentage, of potential new grants would not be funded. So if you think about the importance of basic research, then a lot of these efforts would be curtailed somewhat, if not totally stopped. We think it’s important to allow basic research and the sciences to continue to explore what I call “the fringes of science,” the fringes being very important areas because those are the areas that lead to new ideas and innovation. [In addition,] I find that many of our scientists are spending a lot more time writing grants. Nowadays it doesn’t take an A to get you a grant, you need an A-plus.

There is also the impact the sequester would have on the research infrastructure. The funding is important to keep a base of activities that allow these scientists, when they have new ideas, to be able to pursue them. And that is also a very important part of NIH funding that is probably not as well recognized. The combination of this is that the flow of new medicines that potentially come out from this basic knowledge, will diminish.

GAZETTE: When will the cuts be felt?

CHIN: Some people think that if funding decreases a little bit, “What difference will this make?” This may be the same thing with the effect of sequester on things like public services … I think the effect of sequester is probably going to be relatively slow, but it will have a cumulative effect that will impact all of us. In research, it’s the same idea. It might have a small effect within the next days, weeks, and months, but will have a grave effect with years of sequester, and will have a great effect on a generation of research. I think that if it continues like this, we jeopardize this research, which allows us to innovate, allows us to be a leader in the world in these areas.

GAZETTE: How do you foresee these cuts potentially affecting people thinking about becoming scientists and researchers?

CHIN: I think the sequester would have important and maybe even dire consequences for future scientists because it’s unclear where the cuts will come. But certainly from a psychological perspective, it means that choosing a career in science might mean that you’ve chosen a much harder path now. And the future of understanding these diseases and finding potential cures is in these young people. I worry about that part of it — the people, the human capital part.

GAZETTE: What will these cuts mean to project collaborations? Will there be competition between organizations for funding going forward?

CHIN: I don’t know how this is going to work out. You could say, on one hand, if there are fewer dollars for individuals, perhaps that might actually encourage more collaboration, so that might be a good thing. However, I would emphasize that a lot of our greatest ideas come from allowing diverse individuals doing this basic research to follow their nose, so to speak. In the words of Ralph Waldo Emerson, “Curiosity is lying in wait for every secret.” So if you think of the mystery of what causes disease as a secret, you have to allow the curiosity to roam free. This is what science is ultimately all about.

 ● ● ●

Daniel Carpenter is Allie S. Freed Professor of Government and director of the Center for American Political Studies in the Faculty of Arts and Sciences.

GAZETTE: It seems that the sequester has devolved into a game of political chicken. Do you think there will be a clear winner and loser?

CARPENTER: There are going to be so many intervening events between now and November 2014 that it’s difficult to believe that the resolution of this particular sequester fight is going to affect those [election] midterms any more than the fights already have. The immediate loser in the polls is probably the Republican Party on net. The polls seem to show that Obama has backing on a lot of these issues. And in the short term, at least, the public at present seems ready to blame the Republicans more than the Democrats for the sequester. But I think a lot of Republicans are calculating that they are not elected or unelected on the basis of polls and that they’ve got more than enough time to recover. They also see it as a chance to cut spending, and some Republicans are calculating that, to the extent this dampens growth or the state of the economy over the next year, it could actually help them a year from now.

GAZETTE: Do you think the pundits underestimate the degree to which the electorate is getting fed up with both parties?

CARPENTER: You have got a lot of people who are very turned off by politics in Washington right now, and they perceive a lot of what they would consider dysfunction. And to the extent that both sides are blamed, then neither side really loses because we’ve got largely a two-party system. Despite all the talk about a third party arising, I don’t see anything like that in the wings. There are a number of structural conditions that nearly guarantee we are going to have a two-party system for the foreseeable future. Again, the polls right now suggest the public is fed up with both parties, but they seem to suggest they are fed up more with Republicans than with Democrats.

GAZETTE: How does or will this political stalemate affect the continuing resolution [to provide other funding] that is set to expire at the end of March?

CARPENTER: It’s tough to say. I think we are going to see the sequester and spending issues being separated from the debt limit a little bit more. Obama kind of called the Republicans’ bluff on the debt limit in January and said, “OK, we just need an across-the-board raise.” And then they did, they voted an extension of the debt limit without any conditions attached. That kind of sets a precedent, not a binding one, but my sense is it will probably be observed in the future, or at least in the months and years to come.

A critical difference here is the differing time scale of the sequester versus a debt limit breach. A lot of these cuts are going to come in a very slow, kind of rolling manner … because a lot of federal spending isn’t cut overnight. Just as federal spending and outlays filter through a bunch of administrative processes, so too do the budget cuts. The outlays are planned to be undertaken over time, and therefore the cuts will be felt over time. If the debt limit is breached, on the other hand, that is felt immediately.

One could see the kind of economic carnage that we saw in September 2008 and the months afterwards, perhaps much worse. At some level, that is the kind of thing the Republicans could be more blamed for, if the House didn’t vote to increase the debt limit, because it’s such a quick and vivid example or event that is clearly tied to the vote. I think the Republicans may be gambling that the slow pace of many of these cuts is not something that they will necessarily be blamed for.

GAZETTE: Are there parallels to be drawn between the President Bill Clinton and Speaker Newt Gingrich standoff and the government shutdown in the ’90s?

CARPENTER: Back then, Republicans were rushing headlong into it and didn’t have a lot of experience on their side. The conventional wisdom is it kind of backfired on them and made Clinton look better. I think this is somewhat of a different setup. I think the Republicans have wised up somewhat. The Republicans then were kind of new in office after four decades in the wilderness that comes with being the House minority party, and the American people were just learning about Newt Gingrich and all the things he stood for. The current Republican majority has been around for three or four years, and so it’s not clear that there is necessarily going to be as much damage. They are smarter and are going to play their cards more wisely than Gingrich did at the time.

GAZETTE: Do you think that President Obama is emboldened by his reelection, and more willing to take on the Republicans?

CARPENTER: I think it’s clear that he’s emboldened, and I think he is probably going to stay that way. I think he believes that the public has given him, if not a mandate, at least legitimization to continue his policies. And I think he is going to continue to try to put pressure on them. The other thing to keep in mind about the Republicans is that they are kind of a party in disarray right now. It’s not clear that they have a central leader, which at some level actually hurts the ability of Obama to bargain with them, because there is not one unified spokesperson. There are congressional leaders like John Boehner and [senators like] Mitch McConnell, critical legislators, but it’s very difficult for them to round up votes among their own caucus, and the party is going through a lot of infighting right now, as often happens in the wake of an election defeat.

 ● ● ●

Robert Kaplan is the Martin Marshall Professor of Management Practice in Business Administration
and senior associate dean for external relations at Harvard Business School.

GAZETTE: What will happen with the economy moving forward?

KAPLAN: The best estimates I have heard from economists is that the sequester will likely take as much as a half point from GNP growth.

Despite the fact that this is not the most intelligent way to cut spending, we should recognize that there does need to be some combination of spending cuts, entitlement reform, and additional revenue measures. Any of the choices for cutting the deficit will have some negative impact on GNP growth.

Lastly remember that, even with this sequester, we will still spend more this year than we did last year. Spending is still growing. The challenge is to take action that will slow the rate of government debt growth as a percentage of GNP. The financial markets would react positively to actions that will help improve the fiscal situation in the U.S. I believe this is one reason why markets are not reacting negatively to sequester — they know that some type of deficit reduction is necessary. They would rather it not be done this way, but I think they want to see some type of deficit reduction.

GAZETTE: Will we be able to avoid this in the future?

KAPLAN: Deleveraging is difficult, ugly, and forces politicians to make choices that they are not accustomed to making. Tax increases are unpopular, entitlement reform is unpopular, spending cuts are unpopular, and yet to reduce the deficit and the rate of debt increase, politicians have to choose from these unpopular options. So as awful as this feels, as embarrassing as this feels, it’s possible that this is what deleveraging and deficit reduction are going to look like.

GAZETTE: Will a potential drop in the GNP hurt the economy?

KAPLAN: With GNP growth this sluggish, you hate to see any sudden fiscal moves that will slow it further. However, the Federal Reserve is pursuing an aggressively “easy” monetary policy that should somewhat ease the impact of tightening fiscal policy. I think the business community and public are also mentally prepared for deficit reduction. One reason people in the business community and the public are not quite as apoplectic as you might think is because they know we have got to make moves to reduce the deficit. It either has to be spending cuts, entitlement reform, or increasing taxes; it has to be one or a combination of those three.

GAZETTE: Are there positive lessons to take from this?

KAPLAN: All these events are occurring in the context of a general consensus that we need to reduce our deficit — before it creates a significant crisis. I think the public wants the government to make choices, understanding that any choice they make will be unpopular. The good news from this is at least we are starting to confront this situation — while not pretty to watch, I think the public is starting to get used to the idea that deficit reduction has to happen.

 ● ● ●

Jeffrey A. Frankel is James W. Harpel Professor of Capital Formation and Growth at Harvard Kennedy School. He directs the International Finance and Macroeconomics Program at the National Bureau of Economic Research.

GAZETTE: Will the sequester make it harder to reduce the deficit and hurt economic growth?

FRANKEL: It will certainly hurt economic growth. Nevertheless, cutting spending, even in such a crazy way, will reduce the deficit in an immediate sense. But it won’t help with the longer fiscal problem. The only sensible solution involves legislation locking in modifications to entitlements — Social Security and Medicare — to bend down their rate of cost increase over the next 40 years, coupled with some smaller measures to increase tax revenues, such as curtailing income tax loopholes and perhaps adding something like a consumption tax or carbon tax. This requires the Republicans giving way on taxes and the Democrats giving way on entitlements. The sequester doesn’t help in this process in itself. But if the political backlash from the public is strong enough, it might help. The political analysts tell us that the public will mostly blame the Republicans for effects of the sequester. The way this might work, if we are lucky, is that the Republicans respond by proposing something specific on entitlements together with some implied willingness to consider tax revenue, Obama then takes them up on their offer, and they work out a deal.

GAZETTE: Could the sequester lead us into a recession?

FRANKEL: If the sequester had hit at the same time as an expiration of all tax cuts, as almost happened Jan. 1, that would almost certainly have sent the U.S. economy into a new recession. But the January 1 resolution included a renewal of most of the Bush tax cuts; only a few tax-cuts-for-the-wealthy were allowed to expire. If the sequester is never reversed, it will slow the economy down; but in itself, that probably would not be enough to cause a recession. If other adverse developments come along, such as a government shutdown March 27, or a return of the euro crisis, it could push us over the edge.

GAZETTE: Does this impact our standing on the global economic stage?

FRANKEL: Yes. The rest of the world has continued to have great faith in U.S. treasury securities, surprising as that may be. So far the U.S. Treasury bill market is still the global safe haven and the dollar is still the favored reserve currency. But that could change at some point. Already over the last 10 years we have lost a lot of moral high ground in the sense of setting an example for the rest of the world. Other countries wanted to be like us, on so many different dimensions, and we have thrown that away. With respect to fiscal policy, our debt got downgraded from AAA for the first time in our history, as a result of the showdown over the debt ceiling in mid-2011. Our political deadlock over all aspects of fiscal policy is a continuation of that trend. Everyone sees that we don’t have our act together.