Failure of the Super Committee Might Be the US’s Best Hope for Economic Recovery

The bipartisan super committee will probably fail to meet the self-imposed November 23rd deadline to enact $1.2trillion of cuts over the next ten years. That failure, as Paul Krugman notes in the New York Times, is a good thing: “Any deal reached now would almost surely end up worsening the economic slump. Slashing spending while the economy is depressed destroys jobs, and it’s probably even counterproductive in terms of deficit reduction, since it leads to lower revenue both now and in the future.”

If the super committee fails to come up with an alternative plan by Thanksgiving, the cuts will hit defense and domestic programs equally. But those cuts won’t begin to go into effect until January 2013, two months after next fall’s election, which also means that the programmed fiscal restriction planned for next year won't come into effect. The likelihood of failure is provoking a negative reaction in both the markets and the mainstream press. But in spite of that, failure might be the difference between sluggish, moderate growth in the U.S. and double dip recession.

The travails of the euro zone are perpetual front page news right now, but let's try to put them aside for a moment and focus solely on the U.S. The latest U.S. economic data suggests that the economy has continued to muddle along at a positive rate of growth somewhat below its trend rate of growth. This has happened even though an unwind of the 2009 $860 billion stimulus package is now leading to moderate reductions in government spending.

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October core retail sales were up +0.6%. The three-month annualized change now stands at +6.6%. This is consistent with personal consumption expenditure growth of perhaps +3.0%. The increase is consistent with the above trend U.S. economic growth.

Dallas Fed President Richard Fisher thinks such growth is sustainable. He expects U.S. economic output to grow +2.5% to +3.0% in this quarter and expects it to improve next year.

But not if the super committee goes big and enacts huge budget cuts. In that kind of scenario, economic growth in the U.S. next year will be held back (or worse) by programmed fiscal restriction as even greater amounts of income are withdrawn from the economy, especially if cuts are implemented in programs such as Social Security. Lower incomes means lower sales, and sales are what ultimately drive economic activity. Remember: businesses lay people off when their customers stop buying, for any reason. So the reason we lost 8 million jobs almost all at once back in 2008 wasn't because all of a sudden all those people decided they'd rather collect unemployment than work. The reason all those jobs were lost was because sales collapsed.

I am also skeptical of the validity of the recent strong trend in consumer spending because it appears to be a product of consumers drawing down on savings, which began to be rebuilt in the aftermath of the 2008 crash. Unfortunately, consumers no longer have the credit availability to do that. Nor do they have the incomes to sustain taking on ever increasing burdens of private debt, as was the case in the 1990s.

And let’s be clear: Despite the distortions floated by many politicians and pundits in the mainstream press, most of the growth of the government’s deficit can be attributed to the rotten economy–which destroyed jobs and thus tax revenue. As the U.S. private sector retrenched to rebuild its balance sheet, the government’s balance moved toward deficit. This had very little to do with “excessive” and “unsustainable” entitlement programs. The positive contribution of the U.S. fiscal stimulus (with supporting monetary policy) cannot be overstated, even though many notable mainstream economists (such as Robert Barro, or Greg Mankiw) claim it made the recession worse. Without the two-pronged attack – first of shoring up the financial system to ensure the banks could lend and second, the substantial increase in government net spending (which was both the product of discretionary fiscal decisions and what economists call “automatic stabilizers” like unemployment benefits) – the world economy would have collapsed into Depression. That is not to say that the fiscal interventions were sound and well designed. I generally think they were unsound in the sense that they did not support job creation as much as they should have. But that is a separate issue.

The outlook for 2012 then depends very much on fiscal policy. Right now according to the Congressional Budge Office (CBO), we are programmed for fiscal restriction of perhaps 2.5% of GDP or more in 2012. That could overcome the natural tendency of economies to grow, especially with real interest rates at negative levels. The question then arises, will we really go through an election year with so much fiscal restriction? The answer, of course, is in the hands of the politicians. As it now stands, the President wants a $447 billion dollar jobs plan. That is equal to almost 3% of GDP. He wants most of it to be financed with borrowings in 2012, with offsetting tax increases in future years. Passage of all of this jobs plan would turn programmed fiscal restriction into marginal fiscal stimulus.

The Republican position has been that, even if they go along with parts of this job stimulus plan like an extension of the payroll tax cut, they demand offsetting greater expenditure cuts. In other words, even if they concede to some of Obama’s demands, they insist on maintaining the overall fiscal restriction that is now programmed because they say that demonstrating a commitment to “budget discipline” will enhance business confidence and allow the private sector to create more jobs.

So let’s assume that the GOP is right: imagine a new government being elected on the promise of cutting national debt and in its first budget outlines a very clear plan to seriously cut the national budget deficit, reduce taxes (but definitely not put them up), cut public employment and free up the regulative environment. And let's say that such a government also pronounced its “pro-business” credentials (self-styled).

In that situation, if the Republican view was correct, we would expect to observe within a few months (certainly within a year) of the new government a reduction in private uncertainty, which, if the concept has any operational application, should influence discretionary behavior such as spending and employment.

It would be reasonable to expect business confidence to rise, which should mean that private investment would accelerate as business owners anticipate a consumer revival. It would be reasonable to expect firms to be keen to get staff in place to meet the renewed expectations of increased orders. It would be reasonable to expect consumers to become more confident and this confidence to translate into their consumption expenditure.

So… how does one explain the UK, which continues to deteriorate in spite of making very clear its plans and implementation for budget cutting? And how does one explain Australia, which has also been working toward reducing government spending, even as its unemployment rate has begun to tip up again?

The economics of the super committee, indeed that of virtually all of the mainstream Washington policy establishment, is still predicated on the economic equivalent of Medieval blood-letting. Continuing to “draw blood” from the US economy via ongoing cuts in government expenditure at a time of high unemployment and underused resources will ensure the patient’s death, not recovery.