Henes: Austerity By Inaction - An Economic Cliff Awaits

Man on branch off edge of cliff
Howard Berman | Image Bank | Getty Images
Man on branch off edge of cliff

America may start a new economic program called “austerity by inaction.”

If this occurs, the United States may find itself in a new economic crisis.

Economic leaders - from both the left and the right - are calling the risk to our attention.

The metaphor is a cliff, for which the economy may be heading. Europe has already reached the cliff and it is teetering on the edge because of austerity. The philosophy behind austerity is sound - excessive debt and massive budget deficits must be reduced. But, the double whammy of austerity destroys growth. Let’s see why.

What is austerity?

Austerity is spending cuts combined with tax increases. Spending cuts plus tax increases equal economic decline. Spending cuts mean less goods and services purchased. It also means that people lose their jobs. The job losses result in a reduction in income for these people and less spending by the recently laid off. On top of that, those people who have jobs are hit with tax increases. Tax increases leave workers with less money to spend. This all equals a significant decrease in spending and an attendant decrease in economic output. Ergo, austerity causes economic decline.

There is no question that Europe and the United States need to get their fiscal houses in order. The budget deficits in many European nations, the United States and many states and municipalities are large and unsustainable. So is the current entitlement system and the United States' tax code, both of which need to be restructured. But the implementation of austerity measures during a period of economic decline is not a solution - it is a recipe for further economic decline. And this should worry the United States.

The United States has had a number of opportunities for leadership to emerge and allow the United States to restructure. But leadership has not emerged. Rather inaction and political ideology has left the United States in grave economic danger. When Bowles-Simpson proposed its restructuring plan for the United States, our politicians could have embraced the bi-partisan plan and the restructuring process could have started. This would have put the United States on a path to real economic growth. But Bowles-Simpson was tabled. It was not debated or discussed. And, the United States today has no plan.

Then, last summer, our political leaders started to debate whether the debt ceiling should be raised. There were "grand bargains" almost made, which would have started us on the right course. But, at the end, "grand bargains" were not reached. The far left wouldn't take a realistic look at entitlement programs and the far right was willing to let the United States default on its debts. Our political process broke down and, at the end of the day, our political leaders agreed to lift the ceiling in exchange for automatic spending cuts if a broader deal was not reached.

The broader deal was not reached. And now we are eight months away from "austerity by inaction."

If our political leaders do not get together and agree on answers to serious issues by the end of the year, then austerity will simply begin.

The United States will see military and medicare spending cuts and the elimination of the "Bush tax cuts," as well as the other tax increases. This will mean less spending and lower economic activity. Why? Because the government will be spending less on goods and services, government employees will be fired and, as a result, will not have money to spend and the tax increases will decrease the amount of money those employed can spend. What will the result be? The United States will be at risk of falling off an economic cliff.

This is serious business and allowing “austerity by inaction” to occur is unacceptable. We need good governance and good governance is not the abdication of responsibility. We need to set ideology aside and make sure we don’t start teetering on the edge of the cliff.

Jon Henes is a partner in the restructuring group at Kirkland & Ellis LLP where he has led some of the most complex restructurings in a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications. Jon has also frequently appeared on CNBC's "Worldwide Exchange" as a guest expert on various financial and economic topics and is a member of the Economic Club of New York.