Crossroads (Toward Philippine economic and social progress)
Philippine Star, 12 December 2012


The “fiscal cliff” issue is best understood through the statement Ben Bernanke, chairman of the US central bank (the Federal Reserve Bank), who said before the US Congress on Feb. 29, 2012:

“Under current law, on January 1st, 2013, there is going to be a massive fiscal cliff of large spending cuts and tax increases. I hope that Congress will look at that and figure out ways to achieve the same long run fiscal improvement without having it all happen at one date.”

This situation came about when, to solve a deadlocked budget debate concerning the fiscal deficit, the US Congress passed a bill that became law specifying the amount of fiscal deficit level but postponed enacting the details of those measures until after the next presidential election.

It was a political face-saving, perhaps a Solomonic device to break a budget deadlock between the Republican-controlled House and the Democratic-controlled Senate  over budget details that they could not fix through compromise. They left those details contingent on the outcome of the presidential election (held in November 2012) without saying so.

President Obama accepted the compromise since he could not squeeze further spending resources from a House-controlled Republican chamber at the time.

US economic recovery and its significance. The US economy is the largest driver of the world’s growth engine. The economic recovery program was ambushed, so to speak, by acrimonious budget debate that stalled getting the fiscal remedies from curing the economic recession.

The fiscal cliff issue has caused no amount of anxiety to world economic recovery badgered as it has been by the Euro crisis, the economic slowdown in both China and Japan, and uncertain developments in the Middle East.

The fiscal cliff as a game of politics. The “fiscal cliff” is a particularly American economic policy problem. It demonstrates to some extent the dysfunction of a two-chamber legislative chamber and the separation of legislative and executive powers, both hallmarks of the American political system. (This is the same structure afflicting the Philippine political system.)

Its immediate cause was a policy disagreement concerning the best way to stimulate economic recovery arising from the 2008 recession. The slowness of the recovery running on for three years now has highlighted the need for a more effective solution.

At another level, it demonstrates the policy divide among Republicans and Democrats on how best to run a government and an economy. Philosophically, it is about the role and size of government.

The Republican Party is more associated with business interests and it tends to favor small government. The Democratic Party is the party of labor and small business and, for this reason, advocates programs that strengthen the social network of protection for the small man.

At extremes, it is laissez-faire capitalism versus socialism. However, the US economy is today a meld of these extremes – a regulated enterprise economic system. The Republicans and the Democrats are just “right” and “left” shades of the regulated economic system.

Rising size of government. All this fiscal history, however, just demonstrates the economic law of rising size of government (often measured as a percentage of GDP). Once new social and other economic programs are enacted as laws, the government expands to take on new responsibilities. With government expenditure increasing, added taxation becomes a natural consequence. The battle of the budget is the practical political application of the fundamental approaches to government of opposing political parties.

Sometimes, however, the results do not conform to the pronouncements and actual intents of the parties. The Republican Reagan administration tried to reduce the size of the government, but instituted economic policies that reduced taxes and enlarged the US fiscal deficit. It took the Democratic Clinton administration to restore the economy to fiscal health by raising taxes and effectively reducing the fiscal deficit. The second Bush presidency, succeeding Clinton, introduced new tax reductions for the high income tax payers that reduced tax income and returned the government to new fiscal deficits.

Budget battle and fiscal stimulus during a recession. Countercyclical spending is the right fiscal move when hard times hit. The recession of 2008 was the most serious economic downturn of the post-Second World War US economy. It was precipitated by a great financial meltdown. It happened also coincidentally when American competitiveness had fallen to a low point.

At the tail-end of the second Republican Bush years, the fiscal deficit rose to 3.2 percent, from 1.1 percent of GDP. This was essential to the program of providing loans to prop up failing banks and insurance companies that had to be done to stave off further economic and financial meltdown.

In 2009, the fiscal deficit became 10 percent of US GDP. In 2010, this was 8.9 percent of GDP. These ratios indicate that there was further room for fiscal stimulus. Massive rescue of the automotive industry from bankruptcy and new programs in infrastructure construction and the expansion of the health insurance reform act necessitated this large rise in fiscal spending.

To gauge this with other periods, during war years of 1943 to 1945, the fiscal deficit was 28, 21, and 24 percent of GDP. (Extreme times such as prosecuting a war also justifies high government spending beyond immediate resources.)

Lacking in more fiscal stimulus efforts because of the budget stalemate, the US central bank undertook a program of monetary easing. It bought sizable amounts of private corporate bonds therefore adding new liquidity to the private economy. This then gave private enterprises with more resources with which to maneuver their operations.

From fiscal cliff to gentler slide? The re-election of Barack Obama changes the manner in which the fiscal cliff drama unfolds. Even though the election was less decisive with the Lower House of Congress still under Republican control, election victory gave Obama a strong hand in the outcome.

The Republicans are more likely to compromise and move toward the Obama’s fiscal path. The fiscal cliff drama will give way to less dangerous approaches. However, the final shape of things to come are not yet certain.

It seems however that new taxes on rich Americans are in the works together with relatively more spending on economic recovery. Fiscal cuts in programs targeted by the Republicans are likely to be less drastic. Obama’s program of health care reform is also essentially secure.

In short, the road toward the US economic recovery is to a large extent also secure for the moment.