A Cliff on Three Continents

National economies today are interdependent, as almost everyone understands.  That should be good news, in that strong economies can buck up the weak.  But it is bad news when most economies are weak.

And unfortunately today, the weakness of some economies extends beyond the obvious.  It includes failures of governance — specifically, failures to address critical problems.  This makes the situation of the United States — and of every other country — all the more dangerous.

To paint the entire picture, let’s start with our very own “fiscal cliff.”  In the debt-limit deal of the summer of last year, Congress and the President struck an awkward bargain to hand the problem to a Supercommittee made up of Senators and Representatives.  To motivate those members to succeed, the deal established a penalty for failure: automatic spending cuts, approaching 10 percent for discretionary spending and smaller percentages for selected entitlements, over the next 10 years (and this in addition to already imposed discretionary spending caps at approximately the levels recommended by the Bowles-Simpson National Commission on Fiscal Responsibility and Reform, and the Domenici-Rivlin Bipartisan Policy Center Debt Reduction Task Force).  “Fail-safes” or “triggers” such as this must strike an uneasy balance between being terrible enough to force action, on the one hand, and not being so terrible as to fail to be a credible threat, on the other.  When it was negotiated, some thought that this fail-safe met that standard.  Now, many consider allowing it to “trigger on” unthinkable — that is, non-credible as an actual policy.

To make matters worse, the sequester coincides with the expiration of the 2001 and 2003 tax cuts (as amended and extended), the expiration of the Medicare “doc fix,” the expiration of the indexation of the individual alternative minimum tax (AMT — which technically expired at the start of 2012, but whose effects will not be felt until next year), the effective dates of new taxes under the 2010 healthcare reform, the expiration of the Social Security payroll tax holiday, and the expiration of the extension of unemployment insurance benefits.  The cumulative hit on the economy is troublingly large; the Congressional Budget Office (CBO) predicts that it would trigger a renewed recession.

Despite fairly wide agreement that this “fiscal cliff” is untenable, the elected policymakers of the two parties have not resolved the issue.  Yes, they are busy running for reelection.  But the fiscal cliff debate pre-dated the campaign.  And the progress of that debate has been much more like a game of chicken than an interrupted negotiation.  The closer we get to the end of the year, the more nervous economic decision-makers become.  Investment and hiring decisions have been postponed, and that is enough to take a lot of the wind out of the economy’s sails (or sales).  With our major trading partners’ economies close to stall speed, that entails risks in the months to come in addition to lost income now.

Sadly, the United States is not the sole offender.  Widely recognized is the ongoing saga in the euro zone.  Many analysts have said that an earlier appreciation of the magnitude of the euro problem, plus timely action, could have cut off this crisis months if not years ago.  However, the strong and weak economies of Europe have been playing their own game of political chicken, trying to stay on the good side of their own — admittedly strongly opinionated — electoral constituencies.  They have remained two long strides behind the ball throughout the crisis, moving ever closer to failure.

Perhaps less widely recognized is the political and financial standoff in Japan.  The ruling party has delayed consideration of legislation needed to authorize sales of long-term bonds to finance a yawning budget deficit.  The opposition party has refused to consider such legislation without an agreement for early elections, which would widely be expected to bring down the ruling government.  Just today (maybe even tomorrow, courtesy of the international date line), the two parties have at least agreed to debate the issue — just as the government previously was expected to run out of cash.  It can borrow using short-term securities, provided that it can resolve the impasse by the end of the fiscal year next March — but recent developments do not provide much confidence that this debate will end positively.  So Japan faces its own fiscal cliff of sorts — without a hard deadline, but certainly within a limited period of time.

But consider the global context.  Major countries on the three most prosperous continents on earth (and dominating two of them) are gridlocked on the most fundamental fiscal and financial decisions.  Nations producing 49 percent of the world’s GDP (55 percent if you are willing to conflate the full European Union with the slightly narrower European Monetary Union — not an outrageous call for this purpose) are in not just financial crisis, but also political and policy gridlock largely causing the financial crisis.  There have been economic downturns that were relative widespread across nations before, given the contagious nature of the common cyclical cold among trading countries.  But this episode is not the common cyclical cold.  It is not only arguably the worst global downturn since the Great Depression, it is also now, given this aberrant political behavior, more like a self-induced case of pneumonia.  The dysfunctional nations comprise more than enough of the world economy to threaten the stability of all.

The term “fiscal cliff” is not quite so good a fit for the European Union as it is for the United States, in terms of a critical deadline.  Japan is an intermediate case.  But prosperity around the world clearly is at risk; and the United States’ standing as a world leader is on the line.  But look at the upside.  If this nation could show its ability to govern — with a carefully timed, gradual plan for budget consolidation, even after a near-term economic stimulus — it would set itself apart from the pack and become the undisputed world leader and desirable place to do business for years to come.  Can our governance system rise to the challenge?

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