America's frightening budget farce

A game of budget 'chicken' between President Obama and the Republican party will jeopardise the global recovery, unless a mighty effort is made today.

Make no mistake: the so-called 'sequester' of budget spending cuts that kick off in the United States today are a dumb policy that will drag on the world’s largest economy just as recovery is taking hold.

The United States is already undergoing its biggest contraction in government spending since its military withdrawals from the Vietnam War and the Cold War. Back then, this contractionary impact was offset by state governments increasing their spending. But this time, states are also cutting back.

The sequester was born in July 2010 as part of a deal between Democrats and Republicans to increase the debt ceiling in return for a long-term plan to reduce deficits over time.

It was a decision to put into the never-never the pain of actually making decisions.

But the never-never has arrived and the hard decisions have still not been made.

The Australian born economist Justin Wolfers, now living in the US, offers this succinct definition of the sequester: "When Congress dares itself to do something stupid. And then accepts the dare.”

US Federal Reserve chairman Ben Bernanke this week urged Congress to slow down the pace of budget cuts, pointing out that by weakening activity and revenues from income taxes and company profits, the cuts may in fact add to government debt, not reduce it.

Budget cuts during an economic downturn are an example of 'pro-cyclical' fiscal policy and economic convention is that they are to be avoided.

According to the Congressional Budget Office, the sequester cuts – totalling around $85 billion a year, roughly half from defence spending and half from discretionary domestic spending, will deduct 0.6 per cent from growth this year.

They come hot on the heels of the $600 billion of revenue hikes and spending cuts agreed to at the midnight hour of the New Year as part of the fiscal cliff deal, including the payroll tax hike on January 1.

Some economists have argued the sequester cuts should be allowed to stand. Fully one half of Americans are unaware that the sequester is coming into effect today. The main barrier to politicians cutting spending is usually concern about adverse voter reaction. And there’s none of that yet.

But, as the general rule goes, if something sounds too good to be true it usually is. Politically pain free budget cuts? No such thing.

The White House has been busy this week releasing detailed information about spending cuts and how they will affect individual states.

It has warned of "cascading flight delays and closed [air traffic control] towers” as staff reductions affect air travel.

America’s 217,000 strong prison population will experience more frequent 'lockdowns' due to guard staffing pressures.

Nursery schools will have fewer staff. A nutrition program for seniors and 600,000 disadvantaged women and children will be cut.

Disability payments will be delayed. Vaccines for children and programs to stop violence against women will be curbed.

Eventually, people are going to notice.

Economists are so sure the cuts will be repealed, most assume that only around $50 billion of the annual cuts will stick – the rest will be reinstated.

But President Obama is playing a game of chicken. He’s betting that when people realise, they’ll blame the Republicans and their anti-government spending fetish.

Indeed, it would be entirely within the president’s power to propose a one-sentence piece of legislation outlawing the sequester. But he hasn’t. The idea is to smoke the Republicans out.

The consensus of most economists is the cuts are 'dumb', applying indiscriminately to every budget program. When the Australian government enforces 'efficiency dividends' – i.e. uniform spending cuts across departments – it at least allows individual department heads to decide where the cuts should come from, i.e. the least efficient programs. No such wiggle room with the sequester.

National account estimates released in the US overnight suggest the economy eked out growth of 0.1 per cent in the last three months of last year, revised up from a contraction. The US economy is now in its 44th month of growth as the housing sector picks up.

While the sequester cuts might not be enough in itself to derail this recovery, they sure don’t help.

The confidence of the world’s biggest consumers is delicately poised. They might be in for an almighty fright after today.