The U.S government is days away from the so-called Fiscal Cliff, the stakes are huge. Last week at HBR's 90th Anniversary event, Starbucks CEO Howard Schultz remarked three possible ways the crisis could play out: First, Congress will take no actions by Dec 31, which will be disastrous to the US and to the world. Second (and most likely), they come up with Band-Aid solutions, and the problem will no doubt resurface. Third, they take actions that will put the country back on sound footing for the long term. Schultz favored the third solution — and we agree — but how can we achieve viable long term fiscal health? A metaphor might help.
Imagine a plane heading from Boston to Phoenix. Now if that flight's trajectory were just a degree off, it would end up in the Grand Canyon. But the fact is that planes are more than a degree off 95% of the time, and most planes land where they are supposed to. (The baggage every now and then seems to end up in the canyon, but that is a blog post for another day).
How do they do it? There are four critical variables that the pilot manages effectively to reach Phoenix. We believe that the U.S. government needs these same critical variables to have a safe fiscal landing:
Starting Point. The pilot knows clearly that he is starting in Boston. There is nothing clouding his understanding of the current reality as it is, not as he would like it to be, not as it appears to be, not as his copilot describes it to be. Similarly, we need to clearly understand the fiscal reality as it is. Posturing works for campaigning, but is not so great for governing; as it clouds a clear understanding and results in a sense of complacency. "Healthcare" is another example, since in truth the industry is sicknesscare; Most time, attention, and money goes to treating sicknesses rather than preserving health and preventing sickness. This disconnect with reality will lead Americans down a path where our "healthcare" industry will grow to consume over 20% of GDP.
Destination. The pilot can't just land in a random location and declare, "You have arrived." He must make proactive choices to reach a predetermined destination. Similarly, we need to choose our fiscal destination and work towards landing there, rather than reporting where we have landed. From a fiscal standpoint, the destination has to include a trade surplus ($600 billion), a modest budget surplus ($600 billion), and low unemployment (< 2.5%). If we address these the right way, GDP growth will take care of itself. We believe going from an average trade deficit of $600 billion to a trade surplus of $600 billion is an implementable idea, and can result in adding 10 million jobs. The extra economic activity will result in increased tax revenues. In addition, effectively making the transition from sicknesscare to healthcare will help trim spending.
The Plan. The pilot doesn't take off until he has a clear flight plan, and he can understand how it will take him from the starting point to the destination. Similarly, the government needs a plan that will get us there. Unlimited quantitative easing until the economy improves is no plan. While monetary and fiscal policy instruments (interest rates, money supply) are necessary, they will not suffice. After all, trade surplus, budget surplus, and unemployment are greatly determined by the economic activity of individuals and corporations. So there must be economic activity policy variables available to influence them directly.
Course Correction. As we mentioned above, the pilot knows that he is going to be off 95% of the time. He expects variation from plan, and deals with it. There is a cockpit full of tools that tell him where he is, relative to where he should be. He has knowledge and judgment to bridge that gap. He then reads those measurements and uses this knowledge to course-correct throughout the journey. He is not waiting for some deadline (for example, the end of a quarter) to decide what to do. Similarly, our leaders need to expect fiscal variation, and not freeze in surprise each time there is a variation. Just like the pilot makes a calm assessment and operates the right levers, we need to make a calm assessment and fine-tune the right set of policy variables.
Unless systems are in place to address each of these critical variables, even if we escape this fiscal cliff, we will continue to face dangers of fiscal cliffs in the future. Further, the biggest legacy President Obama can leave behind is leaving such a system behind for all future Americans, rather than just crossing this fiscal cliff.