Deficit or Unemployment

Patricio Navia

Buenos Aires Herald, July 12, 2011


As talks over extending the debt ceiling approach the crucial do or die moment, President Obama and the Republican leadership in the House will have to choose between deficit reduction or job creating policies. Whatever comes out of the negotiations will determine the fate of the U.S. economy for the next couple of years and will also set the stage for the upcoming presidential elections. Since more Americans care more about jobs than about the deficit, fiscal conservative zealots will pay an electoral price come November 2012.


Since winning the midterm elections in 2010, Republicans have transformed the growing deficit in their main political priority. After eight years of spending increases and growing fiscal indiscipline under President George W. Bush, Republicans have tried to reinvent themselves as fiscal conservatives. Historically, Republicans have advocated for fiscal discipline, but they have not been fiscally prudent in office. On the other hand, though they favor higher spending, Democrats were in power with Bill Clinton when the government last had fiscal surpluses. True, the Republican takeover of the House in 1994 helped induced higher fiscal discipline during the Clinton era. Still, in recent memory, Democrats have a better track record in complying with one of the basic premises of the Washington Consensus.


After the 8 Bush years of lower taxes and higher spending, the fiscal has deficit increased to levels not seen since the aftermath of World War II.  The economic crisis of 2008 further reduced fiscal revenues and the stimulus packages have sharply increased fiscal spending. The economic recovery  has been sluggish—thus keeping fiscal revenues down—and the extension of the Bush tax cuts, which mostly favor those in the highest quintile, has also prevented the government from reducing its deficit. Most of the spending is now allocated to defense (with the wars in Afghanistan and Iraq accounting for a sizable share), social security, Medicare and Medicaid, which together comprise almost 70% of the budget. As a result, there is little room for massive spending cuts without affecting the most popular and politically sensitive items on the federal budget.


As the August 2nd deadline approaches, the debate over the fiscal deficit has become the central political issue in the country.  Republicans want to extract significant concessions in spending cuts from the White House while President Obama wants to put pressure on Republicans to agree to increasing taxes on the top quintile of Americans and reducing tax breaks and loopholes for corporations. The two sides are playing politics as usual in the negotiations, caring more about satisfying their constituencies than compromising on a viable solution.


Failure to broker an agreement will have negative—but probably not devastating—consequences on the U.S. economy. The recovery will be further delayed and job creation will be adversely hurt if no compromise is reached. Naturally, the President will be affected immediately more so than Republicans. As no Republican hopefuls are directly participating in the negotiations, they will be able to distance themselves from the responsibility of the political elite to broker an agreement.


The effects of a failure are less evident in the midrange, especially when considering the 2012 election. If the President is able to cast Republicans as intransigent partisans more concerned with defending its views than with finding a solution, Obama will be able to cast himself as the positive and conciliatory leader. Moreover, as polls show that Americans are more concerned with unemployment than with the deficit, President Obama will score much needed political points with moderate voters if he puts job creation ahead of anything else.


To be sure, not all looks good for the President. Republicans do have a chance at casting Obama as fiscally irresponsible. If they are able to distance themselves from the Bush legacy of fiscal deficits—as they have so far been able to do—and convincingly present the American voters with the argument that higher deficits lead to higher interest rates and higher inflation, they might come out with a significant advantage toward the 2012 election. After all, Americans are more concerned with inflation than with unemployment.  While a weak labor market affects millions, higher inflation affects all Americans.  The slow-moving economic recovery makes it more likely that the U.S. will face higher unemployment rather than higher inflation in the near future. Yet, if the U.S. government is no longer authorized to borrow more money, the effects over inflation are difficult to anticipate.


Still, the odds are in favor of Obama in this showdown.  Because the President is making an effort to work out a compromise, distancing himself from hardliners within his own party, he has already secured control of the moderate position, favored by a majority of Americans. Obama has minimized the costs he will have to pay if Congress fails to act to raise the debt ceiling by August 2nd, while Republicans are taking a risky gamble in pleasing their hardline constituents rather than seeking to work out an agreement, the position favored by the moderate voters who will decide the election in 2012.