Uncle Sam's great political conundrum

Dennis Morrison, Contributor

After first stumbling and then acting decisively to prevent economic depression on the eve of the 2008 election, the United States is now in a political-economic conundrum that could further erode its dominance. It was only two decades ago that Americans waxed triumphant about the fall of the Soviet Union, which left them as the single superpower. National confidence was high in the aftermath of the spectacular victory in the first Gulf War.

Now, weighed down by two long and costly wars and a slow economic recovery, Americans have been gripped by a negative psychology that has itself become a stumbling block to the recovery. Underpinning this negative psychology has been an increasing incoherence between its politics and economics that showed up more starkly when Congress first voted against the bailout of the financial sector at the end of the Bush administration. While economically, the administration had no alternative but to rescue the financial system in order to avoid disaster, politically, this was anathema to the ideological purists of the Republican Party.

As the American economy was reeling from the effects of the financial crisis with skyrocketing job losses, the newly elected Barack Obama administration mounted the stimulus package to counteract the decline in private sector economic activity. The consensus around the world was that with the private sector and consumers destabilised by the crisis, economic depression could only be avoided by increased government spending. But this proved a rallying cry for the ideological purists who gained the upper hand in the Republican Party, mobilising opposition on a platform that expansion of governmental activity violated American free enterprise philosophy and would ruin the economy.

Recovery not robust enough

Objective analysis shows that government intervention through the bailout of the financial sector, as well as the stimulus package, saved the US from a second Great Depression. Leading economists, including the International Monetary Fund and Federal Reserve, agree, however, that the reality of the American economic situation is that the recovery is not yet robust enough that it can be sustained without continuing fiscal stimulus. In recent weeks, the evidence of this has become more pronounced as unemployment has picked up, GDP growth has slowed, and consumer and business confidence has fallen. Moreover, the US economy has been buffeted by continuing fragility in the European financial system, debt crises in peripheral European countries, and spikes in oil prices.

So, in strict economic terms, the time is not yet right for the US government to pull back from its interventions to support economic recovery. But with the large Republican majority in Congress, and the dominance of the ideological purists, the political atmosphere is hostile to further stimulus. Even worse, Republicans are demanding immediate cuts in public spending as a condition for raising the US federal government debt limit. The politics and economics are clearly in conflict.

On a wider level, Americans are having to adjust psychologically to the highest level of unemployment in their modern history, in terms of actual numbers of people out of work for an extended period. With the recent hike in oil prices, it is no surprise, therefore, that the so-called 'misery index', which measures the combination of unemployment and inflation, is at a near 30-year high. The political fallout was felt by the Democratic Party in last year's elections, and the risks for the Barack Obama re-election campaign are obvious. The harsh reality, though, is that after financial crises, economies take longer to heal than is typical of recessions. American economic history shows that this can be as long as five years compared with two years for a normal recession.

Need for reform undermined

The political-economic conundrum is also manifested in issues related to health reform, financial-sector reform, energy policy, and investment in infrastructure. While Americans are hand-wringing, and ideological rigidity is threatening to undermine needed reform in such vital areas, its competitors are racing ahead. It has long been accepted that American health-care costs are the highest, and rising out of control. Yet, the Barack Obama health-care legislation, which adopted market mechanisms previously advocated by Republicans going as far back as Richard Nixon, has become a lightning rod for the Republican base.

The breakdown in the regulatory system of America's financial sector nearly brought the country to its knees and pushed the world into the worst recession in more than 60 years. It is estimated that by the end of the crisis, the loss of wealth amounted to some US$33 trillion globally, and this, as well as the job losses, is a big factor affecting economic recovery. Economics dictate that reform of the system is essential, but the ideological purists inveigh against government regulations. Politics and economics are again in conflict.

The US remains the global technological leader, with the capability to transform its energy system to exploit renewable sources, and to revolutionise its industries in terms of energy efficiency. Changes in public policy are necessary, but ideological fanatics have erected roadblocks even where Republican ideas are at the core of new policy.

Americans speak chauvinistically of the 20th century having been the American Century. In the 21st century, the challenge of managing the increasing incoherence between its politics and economics may prove overwhelming.

Dennis Morrison is an economist. Email feedback to columns@gleanerjm.com.