Analysis: Washington becomes the biggest risk to the U.S. economy

By Andy Sullivan

WASHINGTON | Thu Oct 17, 2013 6:05am EDT
 

(Reuters) - Consensus may be hard to find in Washington these days, but many corporate executives and economists seem to agree on one point: the biggest risk to the world's largest economy may be its own elected representatives.

 

Down-to-the-wire budget and debt crises, indiscriminate spending cuts and a 16-day government shutdown may not be enough to push the U.S. economy back into recession.

But Washington's policy blunders in recent years have significantly slowed economic growth and kept roughly 2 million people out of work, according to recent estimates.

Steep spending cuts are a big reason. But the governance-by-crisis also may be prompting businesses to sit on their cash rather than building new factories, buying more equipment and hiring more workers, some economists say.

"Increasingly I'm of the view that the reason why our economy can't kick into a higher gear is because of the uncertainty created by Washington," said Mark Zandi, chief economist of Moody's Analytics.

Congress on Wednesday voted to re-open the government and extend its borrowing authority through February of next year. But the deal did nothing to resolve the underlying disputes that led to the crisis in the first place - leading many to fear that the standoff may play out again in a few months. The plan sets up a forum to try to forge a more permanent budget deal, but few expect it to succeed.

"We have crisis after crisis after crisis and it has a corrosive impact on the economy," said Greg Valliere, an analyst with Potomac Research Group. "If you're a business, how do you make plans in this environment?"



Leading chief executives agree.

"Most CEOs I speak to in the United States say they're seeing a slowdown in business because of this," said Laurence Fink, the CEO of giant asset manager BlackRock Inc, in an interview on Wednesday. "I was on a conference call with many of them, and I heard across the board, a slowdown from the American consumer because of this narrative, so it's having an impact on our economy already - and it's going to have an impact on job creation at a time when we need more job creation."

Not all economists agree that the political circus in Washington is hurting the economy in a measurable sense. While worries over the debt ceiling have pushed up the government's borrowing costs over the past week, those increases are minimal, and the S&P 500 stock index remains near its all-time high.

SLOW RECOVERY
But the pace of recovery since the 2008-2009 recession has been unusually slow.

While America's total economic output is now higher than it was before the recession, the level of private investment remains lower than it was in 2007. Employers also continue to hire workers at a slower pace than before the recession.

Since the financial crisis eased, Washington has sent out one jolt after another. Democrats passed sweeping reforms of the healthcare system and the financial sector in 2010 which, whatever their merits, imposed wrenching changes on two pillars of the United States' post-industrial economy.

Public unease with the healthcare law helped Republicans win control of the House of Representatives in 2010, ushering in an era of divided government that has led to repeated standoffs over taxes and spending. A near-shutdown in April 2011 led to the debt-ceiling impasse in July and August of that year, which took the country to the edge of default and prompted the country's first-ever debt downgrade.

Like this most recent crisis, Congress averted disaster at the last possible moment. But the brinkmanship pushed consumer confidence to rock-bottom levels, where it remained for months. The S&P 500 tumbled 17 percent and took more than six months to recover its gains.

That debt-ceiling deal called for steep cuts to national defense, highway construction, scientific research and other forms of discretionary spending that Congress must approve annually.

Another budget deal, reached in January of this year after another round of brinkmanship, included tax increases to help narrow budget deficits further.

Neither of those deals addressed the health and retirement spending that poses the greatest threat to the country's long-term fiscal health. A failure to cut back these programs or find savings elsewhere prompted a round of deliberately disruptive across-the-board spending cuts - the so-called "sequester" - to take effect in March.

Along with an improving economy, those steps helped U.S. budget deficits fall from 8.7 percent of GDP in the 2011 fiscal year to an anticipated 3.9 percent of GDP for the fiscal year that ended on September 30.
But this has all come at a steep cost.

JOBS NOT CREATED
In a report released on Monday, Macroeconomic Advisers estimated that 1.2 million more Americans would be working today if Congress had kept discretionary spending at the levels that were in place in 2010.

The forecasting firm estimated that Washington's erratic behavior had also driven up unemployment by a further 900,000 jobs.

Zandi estimates the fiscal austerity has cost 2.25 million jobs. Without those measures, the unemployment rate would stand at 6.3 percent now rather than 7.7 percent, he says.

Even many of those who disagree with the notion that policy uncertainty has hurt the economy agree that the spending cuts and tax increases should have been phased in more gradually.

"Fiscal consolidation has been a big drag on the economy," said Paul Ashworth, an economist with Capital Economics.

The International Monetary Fund called the United States' deficit-reduction efforts "excessively rapid and ill-designed" in June and said the sequester cuts would nearly halve U.S. economic growth this year.
Meanwhile, Congress has punted on other important legislation like immigration reform that could boost the economy.

Construction firms have seen federal work plummet over the past several years. With the government shut down, they have been unable to use the federal E-Verify system to check workers' immigration status or get permits to build in environmentally sensitive areas, said Ken Simonson, chief economist of the Associated General Contractors of America.

The delays could be more than an inconvenience for builders trying to line up financing for a new project, he said.

"You never know when the market's going to turn and ... for some reason you may have missed the boat," he said.

There's more turbulence on the horizon. Simonson said lawmakers may not have the stomach to avoid further cuts on transportation spending when they take up the issue next year.
Though Washington may be responsible for lackluster business on Main Street, it may not have much of an impact on Wall Street.

Many economists had expected the Federal Reserve to begin scaling back its massive monetary stimulus program last month. The chaos in Congress means it now probably won't begin pulling back its bond purchases until next year.


"I think the markets are beginning to learn how to live with Washington dysfunction," said Valliere.


(Additional reporting by Jason Lange; Editing by Eric Walsh)