'Sequester' harm to economy? Maybe for longer than you think.
Economists say spending cuts from the budget sequester will slow growth in the GDP somewhat in the near term. But a new analysis says a reduction in innovation could double the long-term impact.
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Scheduled cuts in federal spending could deal a sizable blow to the US economy this year, but won't tip the nation into recession.Skip to next paragraph
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That's what many economists conclude as they look at the so-called sequester that appears set to squeeze the federal budget starting Friday.
Here's one way to think of it: The gross domestic product has been growing tepidly, at an annual pace of about 2 percent. Prominent forecasters say the sequester, if implemented for the rest of the year, could knock about half a percentage point off that pace -- maybe a bit more, maybe a bit less.
But, some warn, the impacts come in ways you wouldn't expect.
Yes, the cuts would impose a sharp slowdown on defense contractors such as aerospace and ship-repair companies.
And yes, the cuts would pull spending out of the economy in a range of other ways: federal workers having smaller paychecks, fewer low-income families getting child-care subsidies, fewer seniors having access to Meals on Wheels, etc.
But, beyond those immediate subtractions of dollars from the economy, the spending cuts could affect GDP in a longer term way as well.
Many government programs represent investments in the future: in worker skills, in scientific research, and even in such mundane things as helping commerce flow by providing fully staffed air-traffic control towers.
Those programs face cuts, too.
"The most devastating, long-term effects from sequestration will be in innovation, and these could ultimately reduce U.S. GDP by over $200 billion per year," concludes an analysis released this week by economists at the Information Technology and Innovation Foundation, a Washington think tank.
That amount is double the roughly $100 billion in total annual spending cuts that the sequester would impose.
The group's report doesn't argue that federal deficits should be ignored. The sequester originated in federal law as a blunt tool, to ensure that if politicians couldn't agree on a substantial deficit-reduction plan, some spending cuts would be imposed automatically.
Other economists also say the sequester will affect the economy's productive capacity -- not just withdraw some "spending money" from the pockets of consumers or corporations.
"Fewer air traffic controllers imply a reduction in flights, both passenger and freight, [and longer airport delays]," writes Paul Kasriel, an economist who publishes The Econtrarian blog. "This ... will slow the wheels of commerce, i.e., slow real GDP growth."
For some individuals and industries, the sequester's effects may be severe. Examples would be a low-income worker who loses access to child-care subsidies, or a defense contractor asked to put a big project on hold.
Virginia and Maryland, which have lots of federal or defense-contractor employment, would take big hits, compared with other states.
But the larger impact on GDP remains uncertain.
Financial markets haven't appeared concerned as the clock has ticked toward the March 1 deadline. The Dow Jones Industrial Average has continued to hover near 14000.
In part, that may reflect expectations that the sequester won't be in place for long before Congress and President Obama come up a fiscal Plan B.
At the same time, many economists say that it's a bad time to be throwing wrenches into the economic gears. The unemployment rate remains high, US workers were hit with a payroll tax hike, as of January. And the implementation of President Obama's health-care reforms looms as another source of employer and consumer uncertainty.
What many economists bank on is that strength in the private sector – with improvements in home values and the job market – will more than offset any negative impacts from federal cuts.
One forecasting firm, Macroeconomic Advisers, says a fully implemented sequester would shave 0.7 percentage points from economic growth. Another, IHS Global Insight, pegs the fallout at closer to 0.3 percent.