US Cliffhanger

He won the battle for the White House, but Obama’s fiscal war continues.

Listener: 13 December, 2012.

The day after Barack Obama was re-elected President, attention turned to America’s “fiscal cliff”, despite there being nary a reference to it in the campaign. Another reminder that elections are rarely about the real issues: recall how when New Zealand went to the polls in 2008, politicians and commentators avoided mentioning that the world was in the greatest global financial crisis since the 1930s.

On January 1, various tax reductions end and automatic expenditure cuts take effect. In total, this budgetary precipice amounts to 5% of GDP; going over the edge would cause the US economy to contract sharply. Because the US GDP is such a large chunk of the world economy, the international economy would suffer, too.

Unlike the Westminster system in which the Prime Minister leads Parliament, the US president is elected independently of the House of Representatives and Senate. Obama’s Democratic Party has a majority in the latter, but the House is dominated by the opposition Republicans (dominance that is partly a result of gerrymandering their electorates – redrawing boundaries to give incumbents safe majorities). In any case, there is little party discipline as we know it, so neither Republicans nor Democrats can be relied on to support party policy, which barely exists anyway.

Political commentators tend to see the world in a winner-takes-all way. Obama certainly had a comfortable majority in the Electoral College, but he was only 3.3 percentage points ahead of Mitt Romney in the popular vote. Nevertheless the Republicans have taken their defeat badly. They lost seats in Congress, but more fundamentally, their strategy failed. In 2010, there was a sharp swing to the Republicans, who then pursued an obstructionist strategy, rather than co-operating with the President. They hoped deadlock would bring Obama down this year. It did not.

Obstructionist elements remain among the Republicans (fewer, though, after the election), but the more thoughtful Republicans see the need for a different strategy, especially as opinion polls suggest the public blame them for the economic mess.

Among the fiscal issues is just how much the promised tax increases will be wound back and who will be affected. Similarly, which spending cuts are to be reinstated? It would be foolish at this stage to predict the outcome. The negotiations on the edge of the cliff involve the outgoing more-Republican, more-obstructionist Congress, rather than the one just elected, which does not take office until the end of January.

One option is for Obama to allow the economy to tip over, citing Republican poor faith, and then negotiate the tax and spending proposals with the incoming Congress. It turns out that it is not really a cliff so much as, at first, a gentle slope – although one would not want to roll down it to where things get out of hand.

I wouldn’t be surprised if the eventual package is a mixture of some sensible policies and some self-interested ones, many of which will have to be revisited after the mid-term elections in 2014 or the next presidential election in 2016.

What is surprising is how quiet the “fiscal hawks” have been. Despite their squawking before the election, nobody is now saying the economy would be better off if the US deficit was eliminated, which would be the effect of blundering over the cliff. Even so, a fiscal conservative might hope the new package will have measures that reduce the deficit as the US economy recovers.

There may not be much here to influence New Zealand policy, although there will be a lot of damage to us and the rest of the world if the US ultimately goes over the edge. The US is a large economy that issues the world’s currency. We are neither. It can get away with some unsustainable fiscal indiscipline in the medium run. We can’t.

What is cause for unease is that the world’s largest economy has a dysfunctional political system that is creating a long-run fiscal crisis. Ultimately it will weaken the US economy, and the international one will suffer, too.