Economists warn that the $85 billion in across-the-board cuts in federal spending set to start taking effect March 1 would stunt growth and slow hiring. Less clear is how long it would take to feel the benefits from the tough-love approach.
The betting is that there’ll be no compromise and the cuts, known as sequestration, will take effect as scheduled. Economists don’t think the reductions are bad enough to shove the nation back into recession. But they also don’t think it’s a rational way to go about reducing the budget deficit, and they fear that it would inflict harm on the economy unnecessarily.
In the simplest of economic terms, the debate is about the benefits or costs of taking the bitter medicine of spending cuts now or taking it later. The looming sequester would cut $1.2 trillion out of $48.3 trillion in spending over 10 years.
“There are benefits to going down the sequester path. But at this point, the negatives outweigh the positives,” said Mark Zandi, the chief economist for forecaster Moody’s Analytics and a frequent witness before congressional committees.
Gauging the near-term impact of the spending cuts is easy enough.
“You are taking purchasing power out of a weak economy, which means in the short term demand is going to decline. Output will decline. You are going to produce less stuff, because people will be less interested in buying it. And as a result of that, you will have lower employment,” said Joe Minarik, a former chief economist for the House Budget Committee and later the White House Office of Management and Budget.
High-profile economists whom McClatchy consulted expect the spending cuts to shave anywhere from four-tenths to seven-tenths of a percentage point from growth this year, most of it during the next six months. The effect on hiring, they said, would be 500,000 to 700,000 fewer jobs by the end of next year than there otherwise would have been.
“There’s no free lunch here,” said John Silvia, the chief economist for Wells Fargo Securities and a former adviser to the presidential campaign of Sen. John McCain, R-Ariz.. “Basically, you’ve gone for many years, long before President Obama came into office, where the federal government was allowed to overspend its budget. Basically we’re on a diet, and there’s no way you’re going to eat like you did before.”
The drag on growth would come on top of the tax increases that President Barack Obama and the Congress approved in a New Year’s deal. Combined, they mean an economy that might have grown this year at a rate of 3.5 percent to 4 percent would instead grow at a rate of 2 percent to 2.5 percent.
So does it follow that government can never cut spending because it would harm employment? No, and the medicine might not take that much time to turn a negative for the economy into a positive.
“From my perspective, that happens pretty soon. I think by 2015 it crosses (into positive). The sheer dollars and cents calculation, it becomes a net positive,” Zandi said. “But that doesn’t account for the fact that you are cutting programs that everyone argues are successful. The impact of that is very hard to measure. All those things that people generally like and feel are effective, you’re cutting them, too. There are a whole lot of intangibles that you cannot measure easily.”
The argument for tough spending cuts now is that they’d put the deficit, anticipated this fiscal year to be around $845 billion, on a path where it poses less of a threat to the U.S. economy. Bringing down the deficit’s ratio to the total U.S. economy reduces the chances that global investors may sour on U.S. government bonds and demand higher returns, which would further amplify the nation’s swelling public debt, now at $16.5 trillion.
Before the 2008 financial crisis and the Great Recession, budget analysts and the nonpartisan Congressional Budget Office advocated the kinds of spending cuts that Congress is fighting over now.
“CBO in the past has made the argument that you reduce the deficit today, and because the deficit is lower you have the potential for the increase in private-sector investment, which increases the economy’s stock of capital, which increases output in the future” and thus boosts growth and employment, said Minarik, who’s now the director of research for the Committee for Economic Development, an independent economic-policy research center.
But those arguments, he cautioned, were predicated on an economy that functioned more as it has over most of the period since World War II. Today’s subpar economy has all sorts of anomalies, ranging from an impaired housing market to the Federal Reserve snapping up U.S. bonds to force investors into the stock market.
The current economy, Minarik said, “is so underutilized that interest rates are already on the floor, can’t fall any further in practical terms. It will take longer to recover the short-term loss in economic output (from spending cuts) because you’ve already pulled money out of the economy through decreased government spending and increased taxes.”
Past pullbacks from spending generally involved military spending, and short-term pain was followed by strong growth – the so-called peace dividend. This was true after World War II, the Vietnam War and the Cold War.
But in all those cases the economy was on sounder footing than it is today.
“You reduce government spending, and that’s a direct hit to the economy. It means fewer government jobs and non-government jobs as it all ripples through the economy,” Zandi said. “Small businesses are hurt, there’s a pullback on hours worked, the government is buying fewer things that employ other people, and it all reverberates.”