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Thursday, November 15, 2012

“Fiscal Cliff” in U.S.: Real or Hyped?

As the U.S. economy slogged through a recession following the credit crisis in 2008 and the E.U. was weighed down by the ballast of austerity in the most indebted states, developing economies, including those of China and India, kept the world economy afloat. As a group, those economies grew 7.4% in 2010, 6.2% in 2011, and 5.5% in 2012. In keeping with this trend, the Global Economic Outlook of the Conference Board predicted 4.7% for 2013. Fortunately, the Board also predicted a pick-up in consumer demand in the U.S. to pick up the slack. “The only really short-term positive impact that we can have is that we can see a faster return of demand, particularly in the U.S.,” the Board’s chief economist said. As of 2012, such a return was not necessarily “in the cards.” The pessimism can be seen in the projected world economic growth of 3 percent, which is lower than the 3.2% expected in 2012 and the 3.8% achieved in 2011. That the projected growth rate of only 1.8% for the U.S. in 2013 is less than the projected 2.1% for 2012 indicates that increased demand in the U.S. was not expected to fully pick up the slack for the slowing-down of the developing economies. Here I want to point to a major factor in the U.S.: the possibly impending “fiscal cliff” of cuts in the federal budget and the end of the Bush tax breaks  that were scheduled to begin on January 1, 2013 unless Congress and the White House could come to a legislative agreement beforehand on an alternative way of holding down the deficits. Presumably that way would have a less recessionary effect.
 
In doing political risk analysis, one might be tempted to weigh in on predictions of a grand deal. I submit that predicting whether one comes together, as well as its differential economic impact would be, is not merely difficult, but also nearly impossible—unless one has “inside information” from the key players in Washington. Political risk analysis is not a sort of crystal-ball operation. Predicting the future is notoriously difficult for us mere mortals. However, we can assess how the prospect of a possible event, such as the “fiscal cliff,” is being played out in real-time. In other words, it is possible to determine whether the “fear-mongers” are exaggerating the probably economic impact (and why!). Assessing the severity of the worst-case scenario can thus be recalibrated, with implications for strategic planning.
 
Should the automatic cuts in the U.S. federal budget and end of the Bush tax cuts begin on January 1, 2013—a combined hit of over $500 million in that year alone—a “recessionary toll” was generally held to be the result. That is to say, the domestic demand made possible by increasing discretionary spending would be reduced as government spending decreases and federal income taxes increase. The Global Economic Outlook pointed to the prospect of Congressional and White House negotiations potentially obviating the sequestration as bearing on the global economic growth. Even though Congressional leaders could be counted on to rise to the occasion in delivering on sufficient dramatics at the last minute, the general public could not be sure that the denouement would involve a quick swerve away from “fiscal cliff” as though in some 1940s film noir.
 
Just by the numbers—around $500 million in 2013—the Conference Board may have been overstating the recessionary impact of the sequestration in an economy whose GDP was over $16 trillion. For one thing, the momentum in 2012 was in the direction of increasing demand. Also, corporate planning may have already “hedged their bets” so “going over the cliff” would not actually involve much change, at least initially, on their part.
 
I must add here the caveat that I not an economist. Hence, I do not have the quantitative expertise necessary to "run the numbers" on how much GNP would decline from the sequestration. However, I have run economic regressions, so I have some sense that the actual variables in a political economy are not as formulaic as those in a regression equation. The inherrent uncertainty in the political dimension in particular renders suspect the “empirical social science” approach of modern economics as determinative in political economy. Put another way, the political-risk-analysis dimension of an economic growth projection introduces considerable uncertainty in an otherwise quantitative economic numbers game, which might itself be overly deterministic or "exact." Even if we could untangle the myriad political factors going into political negotiations beforehand, we would still have to accept the uncertainty that is inherent in predicting the future, especially where human decisions are in the mix. That is to say, the future cannot be known for certain, given the respective natures of time and human beings.
 
I suspect the differential economic impact between a possible deal and sequestration was being exaggerated, particularly by the media but also by officials in government and CEOs—all of whom had subterranean reasons for doing so.  The media’s “fiscal cliff” label alone illustrates the proclivity to exaggerate. It is not as though a deal would have absolutely no drag on the economy, even if significantly less than that of sequestration. However, in distinguishing between “some” and “more” in terms of a drag on consumer demand in the U.S., the impact on the overall global economic output may be less than the “fiscal cliff” rhetoric implies because the world is much more than the American union. In other words, if the “differential” in terms of economic impact between a deal to cut the deficit and sequestration turns out to be less than portrayed in 2012, the resulting impact on the larger global economy would also be less.
 
In terms of a prognosis for 2013 from the vantage-point of late 2012, my best guess was that it would be largely similar to 2012 globally—the U.S. and E.U. continuing to climb out of deep recessions while struggling to inflict austerity on themselves for their own good, and the developing economies continuing to cooling their heels from growth rates that were probably unsustainable anyway. In terms of international business prospects, “continued languid” rather than “fiscal cliff” would be my headline.
 

Source:

Matthew Walter, “U.S. Seen Propelling Growth of Global Economy in 2013,” The Wall Street Journal, November 13, 2012.