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NJ Daily / OFF TO THE RACES

Harmony Talks

A show of bipartisan cooperation in Washington could help shore up a fragile economic recovery.

On the edge: President Obama and Congress need unity to avoid fiscal cliff.(Carolyn Kaster/AP)

photo of Charlie Cook
April 16, 2012

The pace of the exceedingly fragile economic recovery over the 204 days between now and the Nov. 6 election is a lot more important than anything that either President Obama or Mitt Romney says over the course of the campaign. How fast the economy grows—measured by change in gross domestic product, in the unemployment rate, and in real personal disposable income, as well as in oil and gasoline prices—will be far more influential than rhetoric in determining whether voters renew Obama’s contract for another four years.  

If the economy grows, the jobless rate declines, real incomes increase, and gasoline prices drop, Obama’s economic policy would be validated. It would also heal some of the scar tissue of his first two years, when his approval numbers plummeted among independent voters and Democrats were ejected from their House majority. Conversely, if economic growth remains sluggish, the jobless rate stays about the same, voters’ personal finances don’t improve, and gas prices stay high, Obama’s situation would look considerably dimmer.

The struggles would reinforce lingering doubts from 2009 and 2010, when voters saw the president and the Democratic Congress as being more focused on health care reform than on a dramatically worsening economy. His reelection hopes would diminish.

 

To a certain extent, the level of the downward drag on the economy for the next six-plus months is beyond the control of mere mortals. Europe, which contributes 21 percent of global economic growth, is in a recession; the sovereign debt crisis in Southern Europe—with Spain and Portugal increasingly replacing Greece in the headlines—is a threat to world financial markets. China’s economy also has increasing difficulties, and economists debate over whether it is headed for a soft landing (slowing down, flattening, but avoiding a recession) or a hard landing (more violent, rougher, and possibly heading into a recession). Why do these events from around the world matter to us, beyond the spillover effect? If worldwide financial institutions become weakened, U.S. exports drop. This decline then hurts our domestic economy. Incredibly low natural-gas prices in the United States give many sectors of the nation’s manufacturing economy a boost. But if fertilizer, chemicals, and other goods can’t be sold abroad, that advantage evaporates.

Another element may further damage the economy as well: We are already starting to hear the drumbeat of concern among business leaders and the financial markets over the coming fiscal cliff. The concern is that Congress and Obama will not resolve the issue of the expiration of the Bush tax cuts (which expire on Dec. 31) and that they will not be able to reduce the size of the deficit by Jan. 2, forcing the budget sequestration process to kick in. Sequestration basically would make dramatic across-the-board spending cuts to the federal budget, exempting only Social Security and Medicare.

I heard one of the smartest guys on Wall Street this week say that the president and Congress will have about 29 working days for Congress to deal with the expiration of the Bush tax cuts and budget sequestration, which if allowed to run their courses, would equate to a 3.5 percent drop in GDP.

Some budget hawks might say that the end of the Bush tax cuts and the start of sequestration would be good developments. Eliminating the tax cuts would pull in an enormous amount of new revenue, and forced spending cuts would dramatically decrease federal spending. But economists warn that these two simultaneous hits on a very fragile economy could well trigger a double-dip recession. Add into that equation that the federal debt limit will likely be reached late this year or early next year, and you have the fiscal cliff that we are headed toward, if Obama and Congress don’t act to avoid it.

Corporate executives and the financial markets might begin to get spooked by the possibility of the U.S. economy going off a cliff for a second time in five years. They might begin scaling back spending plans, slowing down rehiring, selling stocks and bonds, and taking other defensive measures to protect their companies, institutions, and portfolios in case of a fiscal disaster. Those actions themselves would slow down economic growth.  

Economic decision-makers will be watching Washington increasingly closely over the next six months. They will look for signs as to whether policymakers can deal with the issues of raising the debt limit, extending some or all of the tax cuts, and achieving sufficient deficit reduction to avoid sequestration.

Evidence of continued hyper-partisanship will result in anxious business leaders taking prophylactic measures to protect against a sharp downturn. Evidence of cooperation and compromise will make them more likely to hire, invest, and expand.  

Words and actions in Washington always matter. But in an economy this fragile, they matter even more than usual.

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