The Coming Economic Growth Collapse

Mar 1, 2012Bo Cutter

Recovery winter? Not so fast. All signs point to political dysfunction that will wreck the economy.

We are about to see an abrupt slowdown in economic growth this year and next. It will be a policy-induced slowdown, not some mysterious event caused by aliens. We have delayed obvious policy actions for so long now that a slowdown is virtually inevitable. There is absolutely no room -- or inclination, so far as I can see -- for a compromise between the two parties that might conceivably change this outcome. We have pushed more and more major decisions into the post-election lame duck congressional session, making a policy "accident" (and there are no good accidents) more and more likely. This slowdown, which will begin in the second half of 2012 and extend through 2013, could happen rapidly enough to influence the 2012 presidential election. And it certainly won't help President Obama.

The story begins with a still fragile and low-level economic recovery. President Obama's budget projects 2.7 percent growth for 2012 and 3 percent for 2013. These are very low growth numbers after a recession as major as the one we just lived through. But I've always thought they were too high. As a comparison, the CBO, a public source of economic forecasts, and Merrill Lynch, a private source, are each projecting much lower growth. For example, in its most recent weekly research report, Merrill projects growth of 2 percent this year and 1.4 percent in 2013. The CBO is even lower. So our base economic picture is one of very low growth.

But despite this low growth, we've been lucky this year. The combination of stable energy prices and one of the two mildest winters in the last decade boosted the economy for the last quarter of 2011 and the current quarter. Stable energy prices have meant that people's real wages could improve. And they have. Warm weather has meant that more people are working -- between 50,000 and 100,000, according to Merrill. Helped by these factors and the last impacts of the 2009 stimulus program, we grew at about 2.5 to 2.6 percent in the last three months of last year, and we're set to grow at slightly above 2 percent for the first three months of this year.

But this anemic, only semi-happy economic situation is about to end. We will see growth slightly lower in the next three months, and then it is likely to collapse to around 1 percent for the rest of 2012, barely above stall speed. Growth will remain very low through all of 2013.

Part of this drop in growth will be due to a rise in energy prices. Oil prices have risen substantially in the last month, driven by widespread concerns about Iran. Higher gasoline prices will reduce real wages in the short run and raise unemployment in the long run (over half a year). But this is not the big story.

The big story is that the effects of austerity are about to hit home. We have programmed a fiscal tightening into our taxation and spending plans. A combination of tax increases and spending cuts will amount to 4.6 percent of GDP. This is the biggest one-year tightening in 50 years. For reference, the last big tightening of 3.1 percent in 1969 led to the 1970 recession. Merrill Lynch has an interesting graph showing the fiscal situation of European countries and their economic growth rates. Greece is currently experiencing a fiscal tightening of 6 percent and, not coincidently, a growth rate of negative 5 percent. We are vastly stronger than Greece and won't be hit that hard. But if we really go through the 4.6 percent tightening now projected, it's hard not to predict something very close to a recession.

Check out “The 99 Percent Plan,” a new Roosevelt Institute/Salon essay series on the progressive vision for the economy.

The first consequence of the coming growth collapse is that the congressional session after the election will be an absolute zoo. All major decisions -- and most minor ones -- are being shunted into this period. (We are planning to have a completely substance-free election.) Budget appropriations, major tax increases, the across the board budget cuts Congress "agreed" to last fall are supposed to be decided then.  An accident is virtually inevitable. Time will be compressed. It is likely that Congress will be as deadlocked after the election as it is now, so ideological fervor will be at a maximum. Any hope that a set of broad compromises could naturally emerge from this morass is craziness.  Absent a carefully planned approach to this session by President Obama, changes will very likely be at the margin, the fiscal tightening will be only slightly reduced, and 2013 will be a very, very tough year economically.

A second consequence is that tax policy will be in complete disarray. Tax rates will rise automatically unless both sides agree on a new policy, and at this moment President Obama has the political leverage. But as the growth collapse becomes apparent, this leverage will disappear and both sides will rush toward a tax cut.

(On the subject of taxes, one wonders what the tax policy people at Treasury were thinking when they convinced the president to propose raising taxes on dividends. Counting the fact that dividends are double taxed, this raises taxes on dividends from about 45 percent to 70 percent. At these levels, corporations would be close to irresponsible to pay dividends. So fewer dividends will be paid, corporations will raise more debt, the capital structure of the United States will be weaker, and nothing close to the amounts of revenue the Treasury forecasts will come as a result.)

But of course the real consequences won't be the zoo in Washington. They will be in the real world. There will be skimpy to non-existent growth, higher unemployment, more under-employment, another jobless environment for people leaving high school and college, worsening state finances, further stressed school budgets, and on and on.

The right policy is not a mystery. We need what I called "the pivot" three years ago. That means: (1) a much more expansionary policy now, one that spends rapidly (unlike the "shovel ready" big projects in 2009 that, predictably, failed), and (2) an explicit policy of deficit and debt reduction for the longer term. I know all the objections: the right demonizes one part of the pivot, the left the other. All compromises are deemed unacceptable. No "big bargain" is possible. So I'm quite certain that nothing even remotely close to what we actually need will happen. Meanwhile, a slow moving accident is about to engulf us.

Where are the grown ups? The answer is they are all leaving politics.

Roosevelt Institute Senior Fellow Bo Cutter is formerly a managing partner of Warburg Pincus, a major global private equity firm. Recently, he served as the leader of President Obama’s Office of Management and Budget (OMB) transition team. He has also served in senior roles in the White Houses of two Democratic presidents.

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