11 Oct 2013

Shedding Light on the Shutdown

Joseph Fuller

Gridlock has unfortunately become a way of political life in the nation’s capital. But as of midnight on September 30, things went from bad to worse with the shutdown of funding for the federal government. And as if that weren’t unsettling enough, more trouble lies ahead. If the US doesn’t increase its debt limit on October 17, it will start defaulting on its bills – an unprecedented event in the nation’s history. Senior Lecturer Joe Fuller, a member of the School’s Entrepreneurial Management Unit and an expert on competitiveness, sheds some light amid dark days in Washington, DC.

Jim Aisner: The newspapers point out that a federal government shutdown has occurred 17 times before, but that really doesn’t provide much solace, does it?

Joe Fuller: The thing that’s particularly unnerving about this shutdown is its tie-in with other issues, especially the debt-ceiling extension, which historically has not been a matter of contention. The juxtaposition with a change in leadership at the Federal Reserve also adds to the concern. And finally, I think that businesspeople have long had an attitude that, well, politicians will be politicians, but that when push came to shove, failsafe mechanisms will kick in to prevent things from getting to the edge of the proverbial cliff. This time, however, it seems that those failsafe mechanisms haven’t kicked in. All these factors lead to a very high level of anxiety.

JA: Can you elaborate on how the changing of the guard at the Fed plays a role in all this?

JF: There has been a creeping politicization of the Fed. Over the years, a number of Fed chairmen have overtly fought against that, despite the fact that presidents of various stripes would periodically take umbrage at what the Fed was doing -- mostly because it wasn’t being stimulative enough -- and they were worried about their reelection prospects.

Now you’ve got a world capital market that is acutely sensitive about what the Fed does. One thing underreported in the media is that when the Fed flooded the US banking system with liquidity in 2008 and 2009, a huge beneficiary was European banks that had big operations here. The globalization of the top end of the financial services industry means that the Fed is everyone’s central banker. The reactions we’ve seen in developing markets recently to predictions about the Fed’s actions –- it may start tightening, it may start tapering, it may get out of the quantitative easing business – give new life to the observation that if the Fed catches a cold, the world gets pneumonia.

The formal announcement of Janet Yellen’s appointment as the Fed’s next chair follows on the speculation last summer about Yellen vs. Larry Summers as the successor to Ben Bernanke. That saga left many people in business and finance concerned. If politicians in Washington, DC, are having an argument about something as do-or-die as the debt ceiling, they thought, what are the chances that the confirmation hearings won’t be a contentious process? I think that these sorts of scenarios, along with doubts about the effectiveness of recent US foreign policy decisions regarding Syria and Iran, have had a negative effect on how we’re viewed by business and government leaders in the rest of the world. If you’re sitting in the Exchequer in London or the Quai D’Orsay in Paris (the French Foreign Ministry) or the Central Party School in Beijing, where all the top Chinese bureaucrats go, you’re probably beginning to change your views not just about Congress but the whole American system.

JA: What’s your take on the impact of the shutdown on the US economy?

JF: The immediate direct impact on the real economy is measurable but modest. About 800,000 people are now taking unpaid days off, and they are generally people of middle- or upper-middle- class incomes, so they are spenders who will have to cut back on their discretionary spending. And it may take them some time to get over their financial anxiety even after the shutdown has been settled. In addition, programs like Head Start and nutrition assistance, targeted at the disadvantaged, are put on hold, something that obviously has very real and painful human costs.

Then there are other segments of the economy such as defense contractors. Since the shutdown follows on the heels of the sequester, it’s a second whammy for them. If you are a defense contractor, you’ve probably seen a lot of disruption in your long-term programs. You were going to build 300 units of something, but now the government says they really meant 180. That takes its toll.

JA: What about the effect on the financial markets?

JF: When it comes to the shutdown, I’m less concerned about them. I think that equities respond to a lot of things, and any downturns have more to do with the transition at the Fed and the October 17 deadline for extending the debt limit. Beyond that, if you look at sources of profitability for a lot of the select companies in the Dow Jones Industrial Average and even the top end of the S&P 500, there are other reasons to be nervous. Many of those organizations had been making good money in developing markets, but those opportunities are now considerably diminished due to depreciating currencies in the face of high commodity prices, specifically energy prices, which are dollar denominated.

Meanwhile, Europe has all kinds of problems that are interfering with its economic recovery, including too much combined government and consumer debt, inflexible labor markets, and growing political anxiety, which is spreading from southern Europe into northern countries such as Austria and the Netherlands. Under those conditions, if you’re an S&P company, and Europe looks like it will be in a state of siege for the next 15 to 20 years, it doesn’t take much for your stock to drop 10 percent. Compare it to people in a theater watching a good horror movie. They’re already a little edgy. Then someone says boo, and they jump a foot in the air. Companies doing business in Europe may be in for a scare.

JA: Speaking of horror shows, let’s get back to the threat of the government default on its debt obligations on October 17. Why does that option keep coming up for debate?

JF: The satirist H. L. Mencken once said that there was no shortage of simple answers to complex problems, and that the simple answers were always wrong. There are a lot of people out there who sincerely believe that the government is borrowing and spending too much money and that debt is out of control. They’re worried about what this means for themselves, their kids, and their grandkids. It’s hard for them to accept the fact that a lot of the debt obligation is for commitments that have already been made – things like social security, disability benefits, and Medicaid.

That said, I am reminded of a paper co-written by my colleague Bob Kaplan for the Harvard Business School US Competitiveness Project. Titled “Government Debt and Competitiveness,” the paper asserts that “The United States federal government’s current and projected fiscal deficits are not sustainable. No country…can continue to run annual deficits that significantly outpace the growth of the economy (GDP).” I agree completely. This country has to take some steps as soon as possible to stop the growth of deferred liabilities. I think some serious, material, and binding actions are needed to begin containing the continued growth of middle-class entitlements, including a change in the retirement age.

Beyond that, to keep the US economy strong, if you want to improve employment levels in this country, you have to consider removing barriers to hiring such as overly liberal interpretations of workers’ compensation rules and excessive regulatory and healthcare costs. Businesspeople are rational economic players. If you want to make sure that the small- to medium-sized enterprises that are the job engines of this economy are going to continue to grow, the government can’t leave these firms with the impression that their costs will go up non-linearly as they expand.

Finally, as HBS professors Mihir Desai and Michael Porter have pointed out, the United States has the highest corporate tax rate and the most complex tax code in the world. That combination undermines the growth of the economy and with it, the number of available jobs.

All of these issues are crucially important to the American people and to the role of the United States in the world economy. But with the shutdown, they can’t get the attention they deserve and demand. It’s time for Washington, DC, to reopen for business.

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