Rebuilding America

Do most Americans feel better off than they were four years ago? Probably not, but this year’s election is not a referendum on Barack Obama’s term in office. Most Americans accept that Obama inherited a difficult set of circumstances from his predecessor. Instead, the key questions Americans are asking are forward looking: who do they trust to lead the recovery, and who do they trust to close the deficit?

The US economy is recovering but progress has been slow. Unemployment has fallen from its peak of 10 per cent in 2009 to just under 8 per cent last month, but it is still far above the natural rate of around 5.5 per cent. If unemployment continues to fall at its current speed,
it would take until September 2016 to return to maximum employment.

Who or what then is to blame for the jobless recovery? Republicans point the finger at Obama, but the problem is structural. A large overhanging debt has persisted since the crisis. The economy has been sluggish as households and firms have focused on paying down this debt. Radical actions from the Federal Reserve have reduced interest rates, but the willingness to take on more debt has only just started to recover.

Could expansionary fiscal policy through cutting taxes help to create jobs? Possibly, but this would add to America’s already considerable structural deficit of $930bn, which both presidential candidates intend to cut. Herein lies the political nexus of this year’s election: how best to balance the seemingly competing objectives of growth and deficit reduction?

In the red corner is Romney. For growth, he promises $480 billion in tax cuts. To reduce the deficit, he promises to limit tax deductions and to cut government spending to 20 percent of GDP. Contradictory or not, Romney’s plan claims to be both expansionary and contractionary at the same time. Superficially, however, large tax cuts do not give the appearance of a ‘hawkish’ approach to the deficit.

{{quote Obama is asking Americans to let him finish the job. Romney is asking them to let him do what Obama has failed to do}}

Conversely, Obama would cut spending by $4 trillion over the next decade. The deficit would be reduced gradually as the recovery is locked in. He would also remove tax deductions for companies that ship plants overseas, but this would only raise $17 million a year. As for
growth, the premise is that Obama is already leading the US to recovery and would finish the job with another term. As such, the plan is light on new growth ideas.

Both candidates shirk the growth/deficit tradeoff from separate directions, which makes them liable to attacks from the opposite side. One way to close the gap is by allowing the Bush tax cuts to expire next January, which would cut the deficit by $333bn a year. However, this ‘fiscal cliff’ could also tip the US back into recession. Obama has proposed a middle way by only letting the tax cuts expire for those with higher incomes. Romney’s original position was to extend the tax cuts in full but his position is evolving. In any case, there is no pain-free option; growth would be hit and most of the deficit would remain intact.

Americans can at least identify the key messages in both campaigns. Obama is asking Americans to let him finish the job. Romney is asking Americans to let him do the job that Obama has failed to do. This is why Romney promises more in the form of tax cuts. But these promises may also be Romney’s undoing as they do not chime well with the need to cut the deficit. Moreover, the fact that unemployment has been falling for three years works in Obama’s favour as a sign of things to
come.

But ultimately, pre-election promises are contrived for political rather than economic reasons. This is why the outcome of the election may be less important than it seems. Regardless of who wins, growth should eventually quicken as structural problems resolve themselves. While the pace of growth may be dampened by the need to cut the deficit, fiscal policy will still need to be contractionary. Unless ideology comes to the fore, circumstances, not personalities, will govern.