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It’s Not Too Late to Avoid Slide into Dependency

Irwin M. Stelzer

Slow, slower, and maybe even stop. That’s a quick summary of how Federal Reserve Board chairman Ben Bernanke sees the US economy. It grew at an annual rate of 2.5% last year, 1.9% in the first quarter of this year, “and available indicators point to a still-smaller gain in the second quarter” he advised Congress last week.

Household spending is slowing down because “confidence remains relatively low” (its lowest level since December); numerous factors (a supply overhang, unavailability of credit) “impede growth” in the housing sector; manufacturing production has slowed; business investment has “decelerated;” there is “further weakness ahead” for investment demand; and “reduction in the unemployment rate seems likely to be frustratingly slow.”

Now for the bad news. “US fiscal policies are on an unsustainable path.” Unless Congress acts, the economy is due to fall off a “fiscal cliff” at year end, when scheduled tax increases and spending reductions will, if implemented, cut 4% out of GDP and throw the country into a sharp recession. But there won’t be more quantitative easing, at least not just yet. Bernanke wants to keep the pressure on the politicians to act rather than look to him to bail them out.

The prospects for a compromise between soak-the-rich Democrats and no-tax-increase Republicans are somewhere between dim and nil. We are in the midst of an election campaign in which President Obama has decided to replace argument with mudslinging, Chicago style—the style that has brought his home state of Illinois to the brink of bankruptcy, but which has boosted the president’s polling numbers in swing states.

Mitt Romney is so busy responding to Obama’s charges that he has committed a felony by filing false information with regulators that he has not indicated how he would reverse his opponent’s disastrous economic performance—if, indeed, he has a fully thought-through plan to do just that.

In 114 days, this campaign will end, leaving the winner to negotiate with a Congress that includes we-know-not-how-many lame ducks, congressmen who have lost their seats but will have a vote until the new crowd is sworn in late in January. The Democrats are inclined to let the Bush tax cuts expire on December 31, pushing up rates. They would then introduce legislation to re-institute the cuts for all save those earning more than $200,000 ($250,000 for families). They are guessing that the Republicans would be loath to vote “no” to what would be a tax cut for the middle class merely because it doesn’t benefit “the rich.” Never mind that treasury secretary Timothy Geithner says this would be irresponsible. Or that many of those into whose wallets the president wants to dip are hardly the “millionaires and billionaires” he derides as greedy, or that soaring marginal income tax rates, added to the taxes lurking in Obamacare, are not likely to encourage small businessmen to expand or create jobs.

More than 80% of small businessmen think the economy is on the wrong track, according to a Harris Interactive poll of companies employing fewer than 500 employees. Because Obamacare imposes costs on firms that employ more than 50 full-time workers, and because of uncertainty about future tax rates, only one in five small businesses expects to add employees next year. To which Democrats respond that another stimulus package, sought by the president, would increase consumer demand and change small business gloom to cheer.

Nor is it likely that big businesses will dip into their cash reserves until the fog of uncertainty obscuring future fiscal policy lifts. Or that unconfident consumers will unzip their purses: retail sales declined in May for the third consecutive month.

Even workers not among the 23m-strong reserve army of those seeking full-time work, or too discouraged to do so, worry they might be the next involuntary enlistees in that sad force and crouch on the couch rather than stride through the mall.

Which brings us to the longer-run outlook. It will mostly depend on broad changes that have already occurred in the US economy. Bret Stephens in The Wall Street Journal fears Americans have developed a European-style “habit of dependency.” About half of all Americans live in a household that receives some government assistance. That compares with 44.4% when the financial crisis broke in 2008 and 30% when Ronald Reagan lived in the White House. Half pay no income tax (they do pay payroll taxes), up from 34.1% when George W Bush took office in 2001.

Stephens foresees a “civilisational” rather than merely an economic crisis because this dependency is irreversible—it “will sooner drive a man to degradation than to reform.”

Wrong, suggests Senator Bob Corker, a Republican from Tennessee. He believes we are “only a fiscal deal away” from resuming the sort of growth that has provided rising living standards and relatively full employment. Corker may be right:

  • American consumers have cut debt from 133% of their income in 2007 to 114% and are seeing real wages rise for the first time in nearly two years. They are thus in a better position to spend.
  • US banks are far better capitalised than those in almost any other country.
  • One-third of manufacturers are considering “re-shoring” (bringing operations back to the US), suggests an MIT survey.
  • Manufacturing jobs are returning to America, with Airbus joining overseas firms locating in the South.
  • In June, builders broke ground for more new houses than at any time in almost four years.
  • High value exports are booming, led by tech giants such as Apple, Google, Facebook and games makers.
  • Energy costs are plummeting as “frac gas” hits the market.

Most of all, America remains the home of risk-taking entrepreneurs and venture capitalists. “There’s no way you can bet against America and win,” says Warren Buffett. Let’s hope he’s right.

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