Election Upheavals: What's the Significance for Business and Beyond?Published: November 10, 2010 in Knowledge@Wharton
The political landscape in Washington and around the country shifted considerably as a result of the midterm elections, with Republicans taking control of the House, gaining ground in the Senate and claiming several high-profile state offices against incumbent Democrats. What are the elections' implications for the economy and the stock market, health care reform, the Obama administration's leadership strategy and the future of both parties going forward? Knowledge@Wharton spoke with Wharton finance professor Jeremy Siegel, insurance and risk management professor Kent Smetters, management professor Michael Useem, and Penn political science professor Marc Meredith about these and other issues.
Edited transcripts of the interviews follow.
Jeremy Siegel on the Economy and Stock Market:
Knowledge@Wharton: What are the implications of this midterm election for the U.S. economy?
Jeremy Siegel: Well, certainly it appears the financial markets like it. Generally, the Republicans are considered to be more favorable towards business, particularly about lowering taxes. We see early signs the Obama Administration is willing to compromise on the taxes. That's going to be an exciting end to the lame duck session about how or to what extent they're going to extend the tax cuts. That's the most immediate question. But further down the road, clearly more regulation is not in the cards for business. That's one of the things voters objected to under the Obama Administration.
Knowledge@Wharton: When the Senate and the House are dominated by different parties, one concern is that gridlock might slow down the process of reform. How likely is that?
Siegel: Well, there's gridlock if the President is different than the Congress, and if the two Houses of the Congress are different. Of course, it's often been said that gridlock is good for the economy. A lot of the laws that are passed are not good for the economy -- so the fewer laws that are passed, the better. I'm not concerned about that. I mean, if there's a national emergency, all the parties are going to get together. Consider the response to 9/11. If something like that were to happen, everyone would come together. But when it comes to other contentious issues, a stalemate is not the worst situation.
Knowledge@Wharton: The day after the election, the Fed announced a $600 billion program, the second phase of quantitative easing. What will be the impact on interest rates and stock markets?
Siegel: I'm very much in favor of the Federal Reserve's $600 billion quantitative easing program. It's very positive. It will push banks into a position of being more willing to lend because basically the Federal Reserve is giving them $600 billion worth of reserves. They already have an awful lot of reserves but they need those to cover bad loan losses, regulations, et cetera. If they're offered more reserves on top of that, they'll be tempted to push those funds out into the lending market. The margins are very high for them right now, and I think this is the push that is needed. This is a very favorable policy by [Federal Reserve chairman] Ben Bernanke and the Fed.
Knowledge@Wharton: Overseas, several people have reacted negatively, especially in Asia. To what extent do you think those concerns are justified?
Siegel: Well, the problem is, how much will this depreciate the currency? That is the biggest concern. I think most of the depreciation, honestly, has already occurred, in anticipation of the quantitative easing by the Fed. I think that if it stimulates the economy, as I believe it will, we will see a stronger dollar in the future, particularly against Europe and Japan. So, I'm not too worried that it's going to cause continued depreciation. That should lessen some of the international concerns.
Knowledge@Wharton: In addition to concerns about the dollar, there seems to be some rethinking about capital controls. What's your view?
Siegel: Well, there's been a lot of volatility in exchange rates. Whenever you have volatility, you have talk about capital controls -- but I don't think we want to go down that route. The free flotation of capital is a critical ingredient to global trade, and emerging markets, and the success of the world economy. So, there'll be a lot of talk. If the dollar does strengthen, as I anticipate, in the future, I think a lot of that talk will die down and we won't have any restrictions on capital.
Knowledge@Wharton: Let's assume that the dollar, as you said, does grow stronger. As we know, President Obama has just traveled to India and now is visiting other Asian countries. One thing he has said is that he wants to make the case for more American imports to those markets. What will he need to do to persuade these countries to open their doors to U.S. goods and services, especially if the dollar goes up?
Siegel: Well, we want fewer restrictions on both sides. I'm not in favor of what the House had done, in trying to close down on China, or threaten China. I think that the free trade should go both ways. But even if the other countries don't respond -- which I hope they do, because I think they'll be better off -- it's still harmful for us to take a position of, "If you're not going to allow our goods, we won't allow your goods." I do think that the allowance of goods into our country is a big positive for us and world trade, and will ultimately lead to more demand for our products abroad. I'm glad President Obama is doing that. But he should not react, if they don't allow more trade. A unilateral reaction by the United States would be very detrimental.
Knowledge@Wharton: Given everything that's going on, what strategy would you recommend for investors in the next six to 12 months?
Siegel: I consider the past week to be a trifecta victory for stock investors. First, they got what they wanted, which was Republican control of the House on Tuesday. On Wednesday, the Federal Reserve announced a pretty aggressive quantitative easing program. I believe that liquidity is going to move, to a great extent, into risky assets, including stocks. And on Friday, we had the employment report, which was one of the best reports we've seen in a long time. All these three ingredients are going to set us up for a positive fourth quarter here for stocks that I think will probably extend into 2011.
Knowledge@Wharton: Are there any risk factors you're worried about?
Siegel: Not too much. What I am worried about is if there's a total stalemate on the tax issue, and we start getting higher withholding on taxes in January, because the old tax rates will take effect. That could be detrimental. So, I'm hoping that there's at least a degree of cooperation to temporarily freeze the taxes until a more permanent solution can be found. Outside of that, it looks quite favorable for year-end.
Kent Smetters on Health Care:
Knowledge@Wharton: Do you think the health care bill -- officially known as The Patient Protection and Affordable Care Act -- will be repealed?
Kent Smetters: I think the health care act will definitely survive the new Congress. The Republicans simply don't have the votes to do a full repeal. They don't have control of the Senate. They certainly don't have a filibuster majority, much less a simple majority. I think you're going to see House Republicans bring it up, in a symbolic act -- that's why a lot of them got elected -- but they just don't have the votes to repeal. Putting it in an historic context, we have seen this before. Under Truman and Johnson and other presidents, Republicans came in during the midterm elections with the idea that, 'We're going to repeal and undo.' They have almost never been successful.
Knowledge@Wharton: What parts of the bill have come in for the most criticism from Republicans?
Smetters: The provisions of the health care bill that Republicans dislike the most are the mandates. The mandates strike people as big government and the wrong thing to do, in terms of a free society and certainly in terms of free enterprise. The reason the mandates are there is because you don't want people dropping their health care and then just getting the cheap insurance when they get sick. So the mandates are really part of a larger package, [which means] the Republicans can't simply undo them. They don't have the votes. But if somehow they could, that would actually be disastrous, because it would create an enormous adverse selection problem -- people getting insurance only [at the moment] they need it -- and it would be incredibly costly. So the Republicans either would have to somehow undo the whole package, or do nothing. But they don't want to just touch the mandates.
What we mean by "mandates" is the requirement that people buy health care or face significant penalties if they don't. So for all practical purposes, people would be almost crazy not to buy health care, because it would be just too expensive. Or, of course, they get it through their employer. So the mandate is that they can either prove they got health care through their employer, or they have to buy it. Otherwise, they face a big tax.
Knowledge@Wharton: Can the newly reconfigured Congress nibble away at the health care act, even if it can't repeal it?
Smetters: Congress has a lot of tools [available] to it. To the extent that something is mandatory spending, Republicans can't really touch it unless they actually change the law. Social Security and Medicare are examples of mandatory spending, as is the health care law, for the most part. There is some of what they call discretionary spending -- things like roads and several education programs. Republicans could try to deny funding these. But this [applies to] very few parts of this program.
Knowledge@Wharton: What would Republicans want to see in a health care bill?
Smetters: In terms of the Republican's wish list regarding health care, I think, candidly, they would like to undo the whole thing ... just undo it. I don't think that there are many parts of the bill that they really support. And again, it would be dangerous to undo some parts of it and not others. And so it's either all or nothing. Some additions that they would like to see would certainly be curbs on malpractice. Traditionally, that has always been a very tough fight. The U.S. has very high malpractice rates, because lobbyists in favor of them are very powerful.
Knowledge@Wharton: Do you see any impact from the midterm election on unemployment, and on the Dodd-Frank Wall Street Reform and consumer Protection Act?
Smetters: With regards to employment, I don't think the elections will have a big impact either way. It's mainly a monetary policy issue, at this point. The impact of the federal government is going to be fairly minor because the debt that currently exists has already been produced. And there's not going to be much change going forward. In terms of entitlements, the Republicans, in theory, are supposed to be the people who say, '[We have] a massive problem. It used to be on the long horizon; now it's pretty soon.' They are going to try to curb the growth of those programs. If you can curb the growth rate, you could have a big impact. Quite frankly, I think that's going to be a very tough fight. And if Republicans push too hard, they are going to face a big backlash -- [especially if] there is the perception that they are taking away benefits targeted for old people....
As for the Dodd-Frank bill, I don't see a lot of it being reversed. But the Dodd-Frank bill is really just an apparatus for lots of additional regulation and discussion. It creates an outline. It doesn't impose a lot of the rules. I actually view the Republican control of the House as probably a negative thing -- and I say this as a former Republican political appointee. The reason why is because I think consumer protection rules, in the area of finance, are simply too weak. And I don't think the Republicans are going to [act] aggressively for these rules.
Michael Useem on Leadership:
Knowledge@Wharton: Given the negative midterm evaluation, what should the Obama administration's immediate steps be?
Michael Useem: In light of the dramatic results of this election, what should the Obama administration be doing? And in particular, what should the President take on? ... If I were sitting [with the President] in the Oval Office and he asked, "Mike, what's next?" I would say, "This Friday, let's do an after-action review. Let's look back on what happened over the last two years -- what went right and what, in your view, went wrong. And looking at the next two years, what can be done better going forward, in light of the fact that this set of election results said [that] things have not gone as well as you certainly had hoped they would.... Call it kind of a "reset button." Let's take a good look backwards, to be more clear-minded on how we should go forward the next two years.
Knowledge@Wharton: What would you identify as some communication mistakes Obama may have made during the first two years, and what could he do differently for the next two years?
Useem: ... I'll draw on a project I did the last couple of years with two colleagues, on what company CEOs said they did ... in getting through this huge financial crisis of 2008-2009. Two points stand out from that research [and] bear on what Obama might want to take on going forward. We talked to 15 chief executives who had gone through that wrenching period. And they said, number one, that they learned to be brutally clear about what is happening: to get at the reality of what's around them; to accept, and in fact identify, the huge problems that the country is facing, in the President's case, and to [communicate] that [to constituents]. So, a big dose of realism here is vital.
Number two, the chief executives said that in that crisis ... more frequent communication with the key groups upon whom they depended to get their job done [was] vital. For the chief executive of a company, [those groups would be] the board of directors, the big investors, the customers, the employees and the community. For Barack Obama, it's vital to be aggressively communicating going forward now with the voters, with country leaders outside the U.S. and certainly with the House and the Senate.
Knowledge@Wharton: What leadership challenges will the new House Speaker face? And how should he or she address those?
Useem: There are really, in my view, two main [tests]. When we say "leader," it means that the person now at the top of the House has to make things happen for the House, as part of our governance process. With an internally divided party, and big divisions within the opposition party, the new leader of the House is going to have to work really hard to build a common ground within his party, and then across the aisle. And number two, it's obvious as soon as I say it: Leadership is getting things done; it's having a vision, and then executing around that with a good strategy. To get anything done in the United States, as a House leader, you've got to work with the U.S. Senate. You've got to work with the White House. And so the new leader of the House has ... his work cut out for him in creating unity within the party, and then building consensus across the divide, within the Congress, within the House, then with the Senate, and then with the White House.
Knowledge@Wharton: How was the Tea Party able to galvanize voters so successfully? Is that form of leadership sustainable?
Useem: ...What comes to mind is research done, actually, many years ago, on social protest movements on the right. [The question was], what has driven the emergence of right wing or very conservative movements in American history? ... An analysis that I think is correct is that when people are feeling dislocated and not optimistic about their future, they are more prepared to go to -- not to extreme ideologies, but ideologies or thoughts that are often at one end of the spectrum. They move away from the center. And to me, anyway, I think the Tea Party is a reflection of the profound unease that so many people feel about where the U.S. is going in the world economy; profound unease about the fact that their real earning power has been flat for better than a decade now; and obviously, huge uncertainty about where our economy is going..... We may or may not agree with the way they articulate what they want done, but I think much of the energy of the Tea Party movement is coming out of the fact that our economy [is] very uncertain; it's very unclear where it's going to go. And for many people, it's been a very hard period.
Marc Meredith on Changes in the Political Landscape:
Knowledge@Wharton: How do you think the results of the midterm elections and the changes in Congress are going to affect the two parties' business platforms, or their plans as it relates to business?
Marc Meredith: The [debate over whether to continue the Bush era] tax cuts are on the horizon, and it's going to [come during the upcoming 'lame duck' session] before the new Congressional leaders come in.... It's pretty unclear to me what the Democrats are going to do about these expiring Bush tax cuts. I think that's probably what business is most in tune to, right now. Obama has said his preference is to keep the Bush tax cuts for people who make $250,000 or less. But we also know the Republicans want more than just that. We also have ... a 0% tax rate on the estate tax, which is going back up to its pre-Bush tax cut levels next year. You just have a lot of unknowns about what's going to happen with tax policy coming up, and I think the Democrats most likely may want to moderate their platform a little bit, and probably give a little bit more [in light of the election results]. But I think it remains to be seen, what happens in the next six weeks.
Knowledge@Wharton: Typically, it's expected that the political party in control of Congress will shift during a midterm election. In this election, one of the differentiating influences was that of the Tea Party. How is this shift of party different than those in the past -- than the Republican takeover of Congress in 1994, for example?
Meredith: I think the one major difference about this shift from what we saw in 1994 was we don't have both the House and the Senate going to the Republicans. The Democrats will still control the Senate. And that will probably work both ways for them. In some [respects], having control of a body is useful because you get to set the agenda. For things like Supreme Court nominations, this could be very important. On the other hand, the Republicans have some cover now, in the sense that they can do a lot of stuff in the House that has no real chance of ever going to the President. They can make the Democrats out to be the bad guy and Democrats can do the same thing to the Republicans somewhat, too. So, I think there's going to be a lot of bills that are pretty separate being passed by the Senate and the House. And then this makes what we call the conference committees very important, because this is where the Senate and the House have to come together and try to reconcile what the two are doing. I think you'll see a lot of power going to the people on these conference committees in the upcoming Congress.
Knowledge@Wharton: And how does the Tea Party influence play into this?
Meredith: The Tea Party's really interesting. Looking back on the exit polls that came out ... we asked people, "What do you think about the Tea Party?" ... Political scientists like to ask people, "What's your party ID?" and this is almost the exact same question. It turned out that Republicans, almost 90% of them, said they liked the Tea Party. Democrats, almost 90% of them, said they didn't. Independents were kind of down the middle. And so the Tea Party is still pretty ill-defined. It will be interesting coming up [to watch the results of] these Congressional leadership elections. The Republicans are going to elect their own leaders for the House in the upcoming weeks, and Michele Bachmann [of Minnesota], who is thought of as one of the standard-bearers of what many people think of as the Tea Party, is running for one of the leadership positions.... So far, it seems like her Conservative colleagues in the House are only lukewarm towards her candidacy, and are [supporting] a more traditional conservative candidate. What the Tea Party morphs into is going to be interesting to see -- whether it goes back into the Republican Party or has a life of its own. It will also be really interesting to watch whether candidates run as a third party, as Tea Party candidates, in the 2012 election.
Knowledge@Wharton: It seemed like some of the politicians who took the biggest hits in this midterm elections were political moderates. One example would be Mike Castle, a moderate Republican in Delaware who lost the primary to Tea Party candidate Christine O'Donnell. What do you think the "death of the political moderate" means? What's the significance of that?
Meredith: On one hand, there were a lot of political moderates who lost. Many of these were Democrats who were in districts where John McCain got a majority of the votes for President, but they managed to win the seat in 2008. And so in some ways, this is just reverting back to ... the way things should be -- Republicans holding seats in Republican-leaning districts. You also had, in Pennsylvania, in the Philadelphia area, a number of districts that are very much swing districts and can vote for either Democrat or Republican candidates. These are places where Democratic moderates -- not Blue Dog Democrats, but Democratic moderates -- did lose. What's interesting is that it seemed to be ... not [very] related to how they voted on the controversial legislation in the last Congress. Even Democrats who voted ... against the health care bill, or against cap and trade, were still paying a political price for being Democrats, despite their voting history. As a political scientist, we find this very interesting because there's past research [suggesting] that how you vote on bills relates back to how your constituents vote on you.
Does this mean the end of moderates? In some ways, if, in fact, people are going to punish the people from the party in charge, and not just [for] how they voted on bills, this could be a big problem for moderates because this makes it hard for moderate candidates to stick out from their party's platform. It remains to be seen what this means for moderates in the upcoming election [in 2012]. But certainly in this election, moderating your positions didn't seem to have a whole lot of electoral benefit, though we haven't had a whole lot of time to go through the data....
Knowledge@Wharton: It seemed like there were moderate Republicans who got blasted for trying to work across the aisle, which at least some segment of the American public says they want. And yet, it seemed like there was a significant group blasting politicians for doing just that.
Meredith: I guess that was more in the Republican primaries. You saw that ... in Alaska, where an incumbent moderate Senator lost to a so-called Tea Party candidate. You saw it with Mike Castle losing to Christine O'Donnell in Delaware. And so I think it'll be interesting to see whether this trend continues in the 2012 Republican primaries. Do you see the Republican Party taking on [its] more moderate members ... in the primary elections? Because I think had Mike Castle survived to the general election, he probably would have won the seat over the Democrat who eventually won. And in the Alaska election, we actually saw Lisa Murkowski still win the seat, even though she got beaten in her primary [Editor's note: Murkowski ran in the general election as a write-in candidate. Though she appeared to be the winner, the election results had not been finalized as of press time.] So, [the question is] how much influence these Republican primary voters, who tend to be much more conservative than Republicans overall, are going to have in the future of the Republican Party, and will having a presidential election bring more moderate Republican voters out to maybe weaken this effect? So, like we saw in Pennsylvania in 2004, when Pat Toomey, who now is our Senator, tried to take on Arlen Specter from the right, and he didn't win. And that may have been because [the Presidential election] mobilized enough moderate Republicans to come vote in the primary.
Knowledge@Wharton: What do you expect in terms of gridlock between Congress and the Obama Administration?
Meredith: I expect to see a lot of gridlock coming up in this next two-year cycle. I think the Republicans see this -- particularly with respect to health care and maybe tax policy -- as a way of really setting themselves up for the 2012 election.... We have Democratic Congressmen like Charlie Rangel [of New York], who had some ethical issues. In the past Congress, the House didn't take up investigations. I think you'll definitely see that Republicans now in the House have committees to investigate what they see as corrupt Democrats, which you didn't see because they didn't have control of the floor before. I think you'll see a lot of bills passed out of the House that [Republicans] think have no chance of ever becoming law. But they'll just be position-taking votes, where [Republicans] want to say, "We don't like health care. And even though this never has a chance of actually becoming law, this is going to be our way of showing our constituents we don't want health care."
And the one thing I think you might also see is that the House has the ability to control the appropriations process. And so to the extent they do want to try to cut back on the health care law, I think you'll see them try to use the appropriations process as the way they can do this, because this is where they have some agenda-setting power. I also think outside the Congress, you're going to see a lot of gridlock at the state level.... For example, if you have a Republican state Attorney General or a Republican state Governor, you may start trying to sue the federal government, saying that you don't want to have to be held up to certain parts of the health care law. You saw a similar thing done before with the Democrats with No Child Left Behind [which was passed during the Republican Bush administration]. So I think you'll see a lot of gridlock not only at the federal level, but you'll see a lot of contentious, partisan things coming out of the states that are directed towards the federal government, all with an eye on trying to get the Republicans back in office in 2012.