The US economy is perilously perched on the Harrodian razor’s edge, caught between the Scylla of impending deflation and stagnation on the one hand, and the Charybdis of explosive growth and rising inflation and interest rates, which could stifle an incipient recovery, on the other.
The US policy makers are in no less a quandary as in the next presidential election, just over a year away, the economy will loom much larger than any media-manufactured perception of victory in the war on terrorism and the triumph over Iraq, which has so far helped salvage the fortunes of a president who entered the White House without a majority of popular votes.
The president is also haunted by the memories of the economy’s nemesis that robbed his father of a second term, despite the political windfall which he had reaped from the first Iraqi war.
Hopes for the imminent recovery of the US economy have repeatedly turned out to be illusory since November 2001 when the National Bureau of Economic Research, the professional institution assigned to monitor business cycles, put its imprimatur to the end of the recession, much in the same way as President Bush declared the end of the war in Iraq over three months ago in a dramatic landing on a returning aircraft carrier.
After experiencing a nine-year long economic boom, the US economy fell into recession in March 2001 as a result of the irrational exuberance of the US investors and the burst of the technology bubble. Although the recession that followed was relatively short, the unwinding of the excesses of the 9-year boom has been extremely painful and prolonged. During the 20-month period since the official end of the recession, the US economy has grown at an annual rate of about 2.6 per cent. The recovery has been slow and halting and fears of a double- or triple-dip recession continue to stymie business and consumer confidence necessary to revive the economy.
Indeed, each time the economy is on the verge of a ‘take-off’ it gets held up by some unforeseen factor, frustrating the hope of the Bush administration to overcome what is increasingly becoming the most serious threat to its aspirations for a second term, notwithstanding the lack-lustre array of Democratic presidential candidates. The recovery has proved elusive in the face of major economic shocks since Mr. Bush assumed office, including the September 11th attacks, major corporate scandals, such as Enron and WorldCom, continued stock market volatility, and the prolonged debate on, and the lack of international consensus over, the war in Iraq.
The Bush administration which took the reins of office from a Democratic administration in January 2001 has been short of ideas on social and economic policies, in general, and how to revive the economy which had already entered a period of recession, in particular. His conservative economic agenda consisted mainly of tax cuts and privatisation of social security system. The plans for implementing them were ill-conceived and based on narrow political calculation, rather than on broad economic vision. The veil of ‘compassionate conservatism’, shrewdly adorned to woo the minorities and the poor, was often too thin to hide the corporate and military-industrial interests that the Bush administration represents.
To add to its woes, Mr Bush’s economic team of Treasury Secretary Paul O’ Neill and CEA Chairman Glen Hubbard was no match to Clinton’s team of such distinguished economists as, among others, Larry Summers, now Harvard President and Joseph Stiglitz, a Nobel laureate. Only Alan Greenspan remained on board to steer the drifting ship of the economy. He was, however, at best, an ambivalent supporter of Mr Bush’s economic policies. (Last spring, dissatisfied with the performance of his old economic team, Mr Bush installed a new one, which included, as his chief economic advisor, a distinguished macroeconomist, Professor Gregory Mankiw of Harvard).
It was difficult to see how the Bush administration could reverse the economic downswing that had greeted his arrival in office. His tax cut proposals in themselves, vigorously opposed by the Senate, whose leadership passed on to Democrats as a result of a defection of a Republican Senator early in his term, were clearly insufficient to reverse the substantial boost needed by the economy. In general, the evolving pattern of business cycle management in the Bush administration, in the succinct expression of Berkeley’s Professor Brad de Long was one of “blithe unconcern”.
These inauspicious beginnings of the Bush administration suddenly came to an end with the terrorist attacks of 9/11/2001. Although it brought untold suffering to the victims and families directly involved, as well as a period of great insecurity and uncertainty for the American people and the world at large, it turned out to be a blessing in disguise for a flagging Presidency. It gave President Bush a new sense of mission, which in his initial burst of enthusiasm he unguardedly called a ‘crusade’, unmindful of the sensitivity of the Muslim world. It helped him to erase the stigma of a narrow and controversial election victory and to become an unquestioned national leader,silencing and acquiescing in most of his critics at least for the first few months. What is more, it gave him almost a blank check on the economy and allowed him to whittle down a budget surplus, on which his campaign agenda was based, into a whopping deficit of $450 billion.
The Afghan war military spending and homeland security expenditures were provided additional budgeting for fiscal 2003 (beginning in October 2002) amounting to $48 billion and $38 billion, respectively or, together, about 0.7 per cent of GDP. This by itself was not a huge burden on the economy which was in recession and needed some economic stimulus any way. These expenditures could be defended both in terms of the perceived threat to national security (albeit in very narrow terms) and the likely short-term effect on the national economy. However, the huge tax cuts given across the board were hardly warranted .
Substantial reductions in income tax rates were legislated in June 2001 and substantial additional tax cuts were legislated in May 2003. These measures contributed to a massive shift in the federal government’s unified budget balance, from a surplus of 2 per cent of the GDP in FY 2000 (October-September) to a deficit likely to exceed 4 percent of GDP in FY 2003. With the recession also weighing heavily on revenues at the state and local level, necessitating cuts in essential services, such as education and health and resulting in serious fiscal crises (epitomised by the recall of Governor Davis in California), the combined balance of the general government could reach a deficit of 6 percent of GDP in 2003.
Mainstream economists in the United States, including almost all the living Nobel laureates, have severely criticised the Bush tax proposals, which have been whittled down by a recalcitrant Congress, including a sizable number of Republicans, from $674 billion, as originally proposed, to $350 billion in additional tax for over 10 years. This was in addition to a tax cut of 1.35 trillion in 2001 agreed to by a Congress which found it hard to oppose the President who was immersed in the glory of a warrior against terrorism.
There are four main grounds for the mainstream economists’ critique of the Bush tax plans. The first is that it is not a stimulus package at all, as it has failed to provide any significant boost to the economy since the tax cuts were introduced last year. Instead, it creates deficits so large that the funding of other priority programmes, such as medicare and social security, are being jeopardized.
Secondly, because the tax cuts are long term and quasi-permanent, it’s very likely that instead of being a stimulus, they will act as a damper on the economy and will disable future governments to make any future tax cuts to engineer a recovery. At the rate at which they are being used by the Right populists, there may not be any taxes to cut in the future. Fiscal policy will become devoid of any ammunition, just as monetary policy can become ineffectual if interest rates are pushed down too far, as in Japan.
The third argument against the Bush tax cut plan package is that it would result in higher long-term interest rates, that will increase the deficits even more. Higher long-term interest rates will increase the interest payments on the national debt. The additional debt repayment burden means that the current estimates of the government deficits are far too conservative.
The last, though not the least, worrisome part of the Bush plan is its overtly perverse redistributive aspect, redistributing wealth in a very big way, to the highest end of the income distribution. The people who least need a tax cut in the US economy are those whose major source of income is taxable dividends, which the package seeks to reduce substantially. The average tax dividend dollar will go to people who are already indeed quite rich. In terms of redistribution of income, this is probably one of the worst possible places to give money.
A much better alternative to a short-term tax rebate as a fiscal stimulus, it is argued, would be a limited-time-only decrease in the payroll tax—what individuals pay for social security and medicare. That’s a regressive tax, so on average, a reduction in it would go to people at the lower end of the income scale.
The military intervention in Iraq, achieved through questionable means and at enormous political and economic cost, may, however, have started to pay some economic dividends in terms of a firmer recovery. On July 31st, the commerce department announced that America’s economy grew at a 2.4 per cent annual rate in the second quarter, the fastest rate since the third quarter last year, beating the markets expectations of around 1.5 per cent. The rise owed much to defence spending, which was up nearly 45 per cent in the second quarter (the fastest pace at which it has grown since the early 1950s), as well as continued strength in consumer spending, which have been shored up largely by mortgage refinancing spurred by falling interest rates.
Despite continued optimism by the Treasury and the Federal Reserve about the economy’s ability of achieving 4-5 per cent annualized growth rate in the next 12 months, without incurring any serious threat of inflation and hence of rising interest rates, the incipient recovery seems very fragile and flawed in important respects. Firstly, the recovery has been devoid of any signs of stemming the rate of unemployment which has reached a record level of 6.4 per cent, compared to 4 per cent, a decade earlier. Much of the growth in output has been due to productivity gains, rather than absorption of labour or capital.
Secondly, the boom in consumer expenditures and housing, is likely to end soon, as interest rates begin to back up in response to growth-induced fears of inflation. The Federal Reserve and the bond markets are engaged in a see-saw battle between the former’s fear of deflation and the latter’s dread of inflation. Two other uncertainties also undermine the possibility of an unambiguous recovery of the US economy. The first is the value of the dollar, whose recent depreciation has provided considerable tail-wind to the US exports and the price of oil, which could spike up if the Bush doctrine in the Middle East suffers serious set-backs.