El-Erian: Honey, We've Shrunk the Grand Bargain
Some were hoping for a "grand bargain." Others were willing to settle for a "mini bargain." Instead Congress seems now to be working on a "micro deal."
This stopgap measure would reverse the worst of the "fiscal cliff," when tax increases and spending cuts kick in. But it would not provide what America needs to fulfill its considerable domestic economic potential and prosper again. It is also nowhere near enhancing the country's ability to dominate in a highly competitive global economy.
A grand bargain would have delivered medium-term fiscal reforms that address longer-term budgetary challenges in a growth/job-enhancing manner.
Combined with productivity-improving measures in other policy areas and some immediate infrastructure stimulus, America would have experienced a meaningful boost to job creation, medium-term financial stability, and a stop to the worsening inequalities in income, wealth and opportunities.
A mini bargain would have provided a partial agreement that, while falling short of definitive action, would have served as a building block for further progress in the near term.
Bolstered by a new spirit of constructive cooperation,our politicians would have started the new year energized to tackle a host of long-ignored headwinds that constrain the economy, limit companies' investment appetite and raise questions about a big and durable economic recovery.
(Read more: 'New Normal': Low Growth, Few Jobs: El-Erian)
Continued dogmatic resistance by segments of the Republican party to tax increases on the rich has forced Congress to work on an approach that appears to lack sufficient content and adequate momentum. What we may well get in the next few days — and after months of brinkmanship and high drama — is just a temporary Band Aid.
While such a micro deal would reverse quickly some of the more extreme risks of the fiscal cliff, it would not enhance in any durable manner the medium-term economic outlook; nor, as things stand today, would it provide a foundation for better economic governance by Congress.
For those outside the walls of Capitol Hill, what is contemplated would likely translate into more of the same.
Within a few weeks, we would again witness high-stakes drama in Washington, this time in the context of negotiations to increase the debt ceiling. Meanwhile, most Americans would resume their frustratingly long wait for the economy to heal endogenously, unaided by enlightened policies out of Washington to overcome market failures, to invest in our human resources and infrastructure, to strengthen other public goods, and to reduce our sensitivity to collateral damage from economic mishaps in Europe and elsewhere.
While Americans wait on Congress to step up properly to its responsibilities, unemployment would remain excessively high; and a growing part of this horrid problem would get more deeply embedded in the structure of the economy. Meanwhile, income and wealth inequality would get worse, and access to opportunities would become even more unbalanced.
This is not just a domestic issue. America also risks falling further behind countries that understand that, in today's highly competitive global economy, laggards risk also becoming losers.
Some market participants believe that all this can be remedied by an activist Federal Reserve. After all, the Fed is the one public sector institution with sufficient operational distance from our dysfunctional Congress; it is also a central bank that, under the determined leadership of Ben Bernanke, has shown little hesitancy to venture deeper into the unknown,applying more and more experimental (and untested) medicine to the economy.
Yet, as hard as it tries — and it has been trying extremely hard — the Fed does not have durable remedies commensurate with the extent and complexity of the economic and political challenges facing the country. The best it can do is to continue to build a temporary bridge over bickering politicians who retain control of the economy's destination. And without a proper destination, the bridge would ultimately prove both costly and ineffective.
(Read More: 'Death Spiral' How the Fed Will Lose Its Power)
America would avoid yet more economic substandard performance if, for a start, the more extreme political factions were to recognize what is obvious to many: their current approach even hurts those they favor.
Indeed, the debate on Capitol Hill is not just about what is right and fair in terms of sensible burden sharing and joint responsibility in a post-bubble economy. Nor is it just about helping the middle class and supporting the less fortunate segments of society struggling to meet their families' needs.
It is also about the well-being of entrepreneurs, of small businesses, and of the rich. Their prosperity cannot be separated forever from a persistently sluggish economy, and from the prospects for society as a whole.
To use a real-estate analogy, even good houses suffer in deteriorating neighborhoods. The sooner this is realized on Capitol Hill, the higher the likelihood that America realizes its tremendous economic potential and regains its standing in the global economy.
Happy new year to all. May the coming twelve months bring you happiness, health and success ... and a less dysfunctional Congress.