It’s Politics, Stupid

by Amal Varghese

SYDNEY- Before David Axelrod- one of the finest political strategists in modern American history- there was James Carville; the man who played a big hand in Bill Clinton’s rise to the White House. His greatest achievement was touted as devising the catchphrase for the campaign ‘The Economy, stupid’, which was modified after it caught on fire to ‘It’s the Economy, Stupid’. That mantra highly resonated with American voters who were gradually convinced by the Clinton campaign that George H.W Bush, despite ending the Cold war and coming out a victor in the Gulf War, was not the man who could turn the downward-spiralling economy around. The year was 1992, and in the decade that followed America grew at an average of 3.8% GDP and managed to balance its budget for the bulk of that time under Clinton. The divides that are a caricature of Washington today were present back then (though perhaps the climate was not nearly as polarized) but political leaders found a way to come together and carve a future path for growth. In the decade and a half that followed Clinton’s exit from Pennsylvania Avenue, America’s deficits have ballooned to over US$16 trillion, its growth prospects remain bleak nearly five years after the financial crisis and political paralysis has become the hallmark of Washington. But in stark contrast to the 1990s, America’s deepest problems today are rooted in politics, not economics.

Washington is not entirely broken, rather it can be said to be in a state of parlous fracture. Its inability to tackle the rising cost of healthcare, its broken immigration system, a stagnant economy, its aging infrastructure and ailing primary and secondary education systems have all been hostages to the political dysfunction in Washington for some time now. Only now the consequences of inaction are greater than ever before. Today the U.S Federal deficit stands at US$16 trillion and is expected to climb to over US$21 trillion by 2017[1]. The federal government needs to get its fiscal house in order in the medium-to-long-term, or else borrowing costs will cause significant damage to both government finances and the broader economy[2]. Servicing debt is unlikely to be a major problem in the short term, predominantly because the greenback is still perceived by investors as a safe haven (it helps that it is also the global currency). Economic conditions in Europe and Japan are not conducive to investment either, but there will come a time when investors will look to park their money elsewhere and interest on payments will cumulatively occupy a larger share of the budget- leaving less and less money for other spending.

America’s problems boil down to this: over the last three decades, the U.S government (both Republicans and Democrats alike) has been spending like a big government, but taxing like a small government. The present rate of revenue sits at about 18% of GDP (coincidentally also how much the U.S spends on healthcare, but more on that later), and the federal government now borrows a trillion dollars more each fiscal year than it takes in, about 5.3% of GDP- digging itself deeper into deficit[3]. The Congressional Budget Office (CBO), a non-partisan branch of Congress that delivers candid analysis of the federal budget and the state of the economy, has a variety of proposals on how to rein in the deficit without damaging short-term growth. It proposes a mixture of tax hikes and spending cuts in the medium-to-long term.  Equally important however, is the necessity of Americans to learn how to live with significantly less public services, (particularly entitlements) and they will also have to learn to contribute a lot more in taxes.  Specific ways that could be tapped to raise taxes include implementing a federal sales tax (like the GST in Australia) and a cap and trade system, akin to a tax on carbon. All of which spell political doom.

On the subject of entitlements, Medicare and Medicaid are the programs most in need of reform. The CBO states that “outlays for Social Security and the federal government’s major health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies offered through new health insurance exchanges and related spending) are projected to total over 10% of GDP in 2020”- an unsustainable fiscal path. Though the Affordable Health Care Act was designed to curb rising health care costs, in practice, it has failed to do so, largely because of a toxic political culture- that is often held hostage to special interest groups. Health care now saps the U.S economy 17.6% of its GDP-significantly higher than the OECD average of 9.5%. Political dysfunction again defeated sound economics.[4]

In the short-term, a number of measures should be taken by the federal government to stimulate growth. Firstly, Republicans and Democrats need to recognise this brief window of opportunity to work out a sustainable fiscal plan whilst jumpstarting the economy. Given that there isn’t a mid-term election until November 2014, political leaders should get together and work out a deal. Compromise will be necessary and short-term political ambitions need to be put at bay for the sake of the U.S economy and the global economy for that matter. I recently spoke with Mark Thirlwell, the Director of the International Economy program at the Lowy Institute, who suggested a number of policies that could solve both America’s deficit problem and boost growth. He proposed that the federal government should combine near-term stimulus with long-term fiscal measures, similar to those proposed by the CBO. In addition, despite the debate on the effectiveness of the Federal Reserve’s policy of aggressive monetary easing, the Fed should continue quantitative easing until economic growth picks up significantly. Lastly, both parties need to stop kicking the can down the road[5]. There will be plenty of opportunities for the Republican-controlled House and the White House to work out a sustainable fiscal path. The two main short-term challenges will be over the sequestration- the automatic cuts that took effect on March 1 and can still be reversed (the CBO has forecast that the cuts will shave off about 0.5% off GDP growth this year), and in May we can expect more political wrangling over the debt ceiling, which will have to be increased to allow the federal government to borrow more money so that it can meet its dues.

Despite my gloomy prognosis for America’s economic trajectory, there are a number of reasons for Americans to be optimistic. Firstly, if history is any guide, America has always come back stronger after a rough patch[6]. In the 1970s, economic growth was stagnant; hyper-inflation was hurting and the oil shocks sent share markets tumbling, yet only a few years later, the economy recovered. The story repeats itself with the recession of the early 1990s, with a new wave of growth, on the back of technology boosting the country’s GDP to historic highs. Secondly, according to a report released in December 2012 by the National Intelligence Council, America will be energy independent by 2030- dramatically altering its Balance of Payments and Current Account Deficit liabilities in the future and representing a long term supply side growth, which lacks the inflationary and exchange rate consequences of the demand side stimulation that monetary policy encourages[7]. Though it is still not entirely clear how the energy ‘revolution’ will pan out, the trend lines remain positive. Thirdly, America has a demographic dividend that is working vastly in its favour, with an overwhelmingly young population (unlike virtually every other developed country and China); giving the country an abundant labour force to draw on should it break through the current climate of political impasse.

I have outlined some of the key challenges that America faces, and make no mistake, the challenges are not insurmountable, but they are immense. If political brinkmanship in Washington continues to derail the prospect of an American revival, the consequences will be grave, both for its own domestic economy and for the global economy.

References:

Milton Friedman; Capitalism and Freedom; (Chicago: University of Chicago Press, 1962)

Choices for Deficit Reduction, Congress of the United States: Congressional Budget Office; November 2012;

http://www.cbo.gov/sites/default/files/cbofiles/attachments/43692-DeficitReduction_print.pdf

Deficit-reduction disorder; February 9 2013, The Economist

http://www.economist.com/news/united-states/21571456-austerity-and-economic-recovery-are-bringing-down-deficit-long-term-problem

Global Trends 2030: Alternative Words, Office of the Director of National Intelligence, National Intelligence Council, December 2012 http://www.dni.gov/files/documents/GlobalTrends_2030.pdf

Interview with Mark Thirlwell, International Economy Program Director at the Lowy Institute for International Policy, 13/02/2013

OECD Health Data 2012; http://www.oecd.org/unitedstates/BriefingNoteUSA2012.pdf

This time is different: A Panoramic View of Eight Centuries of Financial Crises; By Carmen M. Reinhart and Kenneth S. Rogoff; National Bureau of Economic Research, March 2008

Working paper at http://www.nber.org/papers/w138882