Photo: Preikstolen by Helico

There are likely fewer catalysts that will accelerate economic change as fast as either the US fiscal cliff or the Euro financial crisis. The US fiscal cliff is the expiry of certain spending programs set up by the George W. Bush administration that end in December of 2012. There are some significant ideological differences between the Obama administration and the Republican-controlled Congress. However, this is likely the greater of the two evils, but less likely to occur. The Euro financial crisis on the other hand, according to world leading economists, is inevitable.

First let’s address the US fiscal cliff. Dr. Larry Summers recently spoke at the Chateau Laurier two days after the US election on the impending US fiscal cliff. The fiscal cliff hinges on essentially three problem categories: ensuring recovery, sustainable finances and economic structural changes. The third problem category is economic structural changes which are long-run solutions and beyond the scope of this blog post. This blog post will address the first two categories of ensuring recovery and sustainable finances which are the key short-run fiscal cliff challenges.

If you consider the scope of the fiscal cliff, it is bounded on either end by increasing revenue by 1/6 or cutting entitlements by 25% … the final solution lies somewhere in between, separated by the political ideologies of Democrats and Republicans. Therefore, short-term budget action requires a combination of revenue increase and reduction of entitlements. The solution to the fiscal cliff involves broadening the tax base with such measures as increasing taxation on the wealthiest segment of the US population. In 1965 the top 1% of the wealthiest people in the US earned 10% of the total national wealth … today the top 1% earn 25% of the national wealth.

Rising health care costs are the largest single contributor to the burgeoning cost of entitlements. Expect to see reductions in planned increases in this sector. This is a market vertical ripe for efficiency improvements and technology; however, healthcare is a laggard market and very difficult to change due to the highly bureaucratic nature and complex administrative and approval process. The economic crisis may be the necessary impetus for reform to gain traction.

In my opinion the US fiscal cliff has the potential for greater impact on the global economic recovery, however, is far less likely to occur than the Euro Financial crisis.

About a year ago I wrote a post “Who is Afraid of the Big Bad Wolf” regarding Martin Wolf’s speech on the Euro crisis. We are a year further ahead, no significant decisions of consequence have been made and the runway to avert a Euro financial crisis is shortening. In my opinion, the Euro financial crisis will likely be the most significant news story of 2013.

Ian Graham