The credibility of US economic policymaking is in shreds
This package of measures will compromise growth and push the US economy back into recession.
Sanity prevailed at last in the United States, as the Treasury secretary, Timothy Geithner, had insisted it would. After a period of extreme political theatre, a default was avoided. The House of Representatives passed the bill to raise the debt ceiling by a vote of 269-161, with Tea Party Republicans and left-leaning Democrats voting against. The highlight was when Representative Gabrielle Giffords came on to the floor to cast her first vote since being shot in the head during a meeting with constituents in January.
It remains unclear whether the passage of this bill will prevent the US from losing its AAA credit rating. The bond markets have kept faith and US bond yields fell recently, implying that the markets did not expect a default.
The deal raises the debt ceiling into 2013 by $2.4trn, in two stages, from $14.3trn. The new framework also cuts $917bn in spending over a decade, raises the debt limit initially by $900bn and creates a congressional committee tasked with finding another $1.5trn in deficit savings by late November, to be enacted by Christmas. The cuts will be a drag on the US economy at a time when growth is anaemic - a further risk to the UK. During the negotiations, the publication of the Institute for Supply Management's manufacturing report showed slower-than-expected growth in the sector and stocks tumbled. The new orders and employment indices had fallen into contractionary territory.
On 29 July, the US department of commerce produced shocking new estimates of gross domestic product (GDP) growth. The first was that GDP grew by 1.3 per cent, annualised, in the second quarter of this year (divide by four to compare it with the quarterly growth that we publish in the UK). This was well below market expectations. In economics, it is sometimes hard to work out where you are and where you have been, because data is often subject to revision. This GDP release contained two major downward revisions to the back GDP growth data, which suggests that the recession was deeper than previously thought and the recovery less strong. Shockingly, GDP growth for the first quarter of this year, which had been reported as 1.9 per cent, annualised, was revised down to 0.4 per cent. Due to revisions further back into the recession, the figure for the drop in output has been increased from an earlier estimate of 4.1 per cent to 5.1 per cent.
The latest growth data for the US is reported in the first column of the table (below). These revisions help to solve the great puzzle of why the US had such a large increase in unemployment during the recession (+101 per cent compared to +50 per cent in the UK), given its much smaller fall in output compared to the UK (-5.1 per cent and -6.4 per cent, respectively). It's clear that the US, in contrast to the UK, has recovered most of the lost output levels during the recession (+5.0 per cent and +2.8 per cent, respectively). Over the past three quarters, the UK grew at a fifth of the rate of the US (+1 per cent and +0.2 per cent, respectively).
Why have the experiences of the two countries been so different? First, the scale of the fiscal stimulus in the US was much smaller than in the UK; spending by the federal government merely negated the big fiscal drag of state and local governments. In the latest data release, real federal consumption and investment were up 2.2 per cent, compared to a decline of 3.2 per cent in the equivalent for state and local government. Between May 2008 and June 2011, employment in the federal government rose by 67,000, whereas employment in state and local government fell by 490,000. Second, homeowners in the UK have not experienced such a large drop in incomes, because approximately 70 per cent have variable-rate mortgages and have had their monthly repayments fall. In the US, fixed-rate mortgages are much more common. Third, employment in the US construction industry has fallen by 25 per cent, or nearly two million. The unemployment rate for construction workers is 18.3 per cent, approximately double the national rate. In the UK, construction employment has fallen by roughly 10 per cent only.
There's something strange going on here and I suspect it is to do with the large numbers of workers from European Union accession countries who were working legally in the UK as self-employed construction workers. They were not counted in good times, because they weren't migrants, and are not being counted as unemployed now, even though their output and spending have gone with them. The scale of job losses has likely been understated in the UK.
Fourth, the US may well have taken the hit early and recover more strongly than the UK; there is some evidence to support such a contention from the table.
When the deal goes down
So what will all of this mean for the US and the world? In the short term, a catastrophic default has been avoided but the credibility of US economic policymaking is in shreds. How can anyone be reassured that this Congress will make an appropriate and timely decision when the next crisis comes along, as it surely will? Because this package of measures will compromise growth and push the US economy back into recession.
Almost inevitably, unemployment will start to rise again and there is no provision in the agreement to extend unemployment benefits into 2012. Plus, all the costs fall on the poorest: there are huge spending cuts and, so far, no tax increases. As the Nobel laureate Joseph Stiglitz has noted, over the past ten years, the income of the top 1 per cent has risen by 18 per cent while that of blue-collar workers has fallen by 12 per cent. Mark my words, this is not a deal that is going to generate peace and harmony.
David Blanchflower is the NS economics editor and a professor at Dartmouth College, New Hampshire, and the University of Stirling
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