Sequester: Economic Doom And Gloom?

Some days I wish that Economics was indeed a science, but alas it is not. This means that tweaking the  economy may indeed not lead to a useful result, or maybe it will. We can speculate. We can certainly think about it, but what do we know?

We would like economists to say that if a certain economic policy is undertaken that there will be a specific outcome. But what an economist is likely to say is that one the one hand this might happen, but on the other hand that might happen–and “this” and “that” turn out to be opposite results, one desired the other not.

This propensity for predicting opposite the possible results of economic policy — on the one hand this, or the other hand that — lead Harry Truman to ask one of his advisers if “a one-handed” economist could please be found. Actually he was a great deal more blunt that that. What he said was, Give me a one-handed economist! All my economists say,  on the one hand or the other.

Things haven’t changed much, and as with the so-called “sequester” passed, or rather allowed to take effect on Friday, March 1st, we may have a number of possible outcomes. Some predict that jobs will be lost and that in general the economy will be depressed. Certainly, in time, the across-the-board cuts prescribed to most government agencies will reduce contracts made to industries supporting this agencies. This will lead to jobs being cut in the public sector, layoffs or simply reduced workloads. For example, workers will work one day less per week and lose perhaps 15-20 percent of their take home salary. Other agencies may react differently but overall about $85 billion per year less will be spent by the government. This will not balance the budget, but it does mean that expenditures will drop by about that amount. Thus, we will appear to chip away at our rate of debt accumulation. But will we?

Since several hundred thousand people will lose jobs outright or will work 20-25 percent less time then they will either not be paid or will be paid about 20 percent less. This money will be lost from the economy. It will not be spent. It may only amount to millions at the outset, but it will have a multiplication effect as less money will be spent on all sorts of items and those who lose jobs outright will be added to the unemployment rolls. Many industries will lose sales. Sales taxes will decline and overall the cost to the economy from these across-the-board cuts due to the sequester may be much more than the loss of about 20 percent of the workweek looks like initially.

Looked at in this way the reduction of government spending by 85 billion is not simply a savings as we may lose the income from lost taxes.  Worse than that the loss of sales and general decline from less money flowing to consumers may deflate prices as there is less consumption of goods. This results in further decline. In short, when the government suddenly spends far less there is a general economic decline but also a sudden multiplication effect on that decline that follows. As prices deflate other industries become involved, workers in those industries are reduced in numbers as less-profitable product lines are reduced or their manufacture is automated or moved off-shore to lower wage workers to improve productivity so that profits can be held at a certain level even though prices have dropped. Where it ends we cannot be sure. But what we can be sure about is that we do not simply save all the money that we cut directly from expenditures.

What economists hope for in the present case is that a growing economy can absorb all of the above negative influences as they are produced and that the loss of a half percent say in growth will not have a profound effect. This is what the “other hand” is saying, promoting the idea that growth is sufficient to gradually absorb the effect that 85 billion in cuts will have on the economy. The higher the growth rate to begin, the more easily the shock is absorbed.

Clearly, the sequester offers us a test case in the outcome of austerity budget cuts in the American economy. In Europe and the UK austerity budget cuts are driving economies back into recession. While that may not happen here due to the fact that the American economy has begun to grow more rapidly than most European economies, the outcome is by no means certain. Further tweaking to the details of the sequester may be necessary to offset the economic hit which is certain to come.

 

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