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Steinbock: America's Fiscal Hurricane

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During the past few months, President Barack Obama and Republican Mitt Romney have offered two very different visions of how they would govern the United States in the next four years.

Meanwhile, the October employment report offered fresh ammunition. While the U.S. economy added 171,000 jobs, the unemployment rate increased to 7.9%.

Since F.D. Roosevelt in 1936, no president has won a second term when the jobless rate has been so high on Election Day.

But these are no ordinary times. Washington is about to face a political earthquake that has far more consequences than Hurricane Sandy.

U.S. long-term unemployment

Since February 2010, payrolls have grown by 5 million jobs, or some 155,000 jobs per month. A robust jobs recovery would require some 200,000-300,000 jobs a month.

The comprehensive unemployment rate measure, which includes people who are unemployed and people who can't find full-time jobs, was 14.6%; almost 6% higher than before the recession in December 2007.

By that measure, roughly 23 million Americans remain unemployed or underemployed.

In turn, the 7.9% rate of unemployment translates to 12.3 million unemployed Americans. The problem is that more than 40% of them are long-term unemployed and have been looking for work for more than 6 months.

Historically, every major recession since 1958 has witnessed the launch of emergency federal unemployment insurance. These programs have not been allowed to expire until the unemployment has fallen at least to 7.2%. However, the current emergency federal unemployment insurance is scheduled to expire on December 31, 2012.

If that happens, millions more Americans will not only be without a job, but at risk of poverty. The Republicans hold these unemployed as captives, as they did in late 2010, in return for an across-the-board-tax-cut extension.

Today, the fate of the long-term unemployed is intertwined with the so-called fiscal cliff – a cluster of economic challenges, which also include the Bush-era tax cuts, automatic spending cuts, and the payroll tax cut.

The Bush-era tax cuts

In the absence of substantial changes, the U.S. debt burden will increase by another $10 trillion in the next decade.

Almost 40%-50% of the debt can be attributed to the so-called Bush tax cuts for the "rich" (families making more than $250,000 a year). If Washington allowed them to expire, nearly half of U.S. deficit would dissipate overnight.

What makes economic sense lacks political support, however. Republicans believe that the Bush era tax cuts create jobs. While historical evidence does not support the assumption, it is a central article of faith among the Republicans.

In turn, Romney has suggested lowering tax rates and paying for it by closing tax loopholes and eliminating certain deductions (which remain unidentified).

In contrast, Democrats are reluctant to let the Bush tax cuts expire fully. They favor making such cuts permanent to middle-class families.

Automatic spending cuts

In August 2011, when Washington lost its historical triple-A sovereign debt rating, America's public debt climbed to over $14.2 trillion. In order to avoid comparable problems in the future, the Congress agreed to the idea of automatic spending cuts.

The assumption was that the two parties would find a bipartisan resolution before November 2012 (which did not happen).

However, neither Democrats nor Republicans would like to see the sequester take effect in 2013 because it would involve both defense and non-defense outlays.

Republicans will demand large cuts in discretionary non-defense spending as part of any tax deal with a Democrat-majority Senate (which would be unacceptable to Democrats). In turn, Democrats are more likely to demand substantial cuts in defense spending as part of any deal with a Republican-majority Senate (which would be unacceptable to Republicans).

Recently, the debt burden exceeded $16 trillion. Washington needs urgently a credible, long-term fiscal adjustment program. In the absence of such a plan, increased volatility in America could spread to the Eurozone, which has been coping close to its own fiscal cliff for two years now.

By the same token, increasing uncertainty in the U.S. and the Eurozone would almost certainly spread to Asia, through trade, finance and investment.

Economic polarization, political gridlock

So how bad could the post-election aftermath get in America?

Theoretically, a potentially severe contraction in the fiscal deficit could shave off nearly 4-5% of GDP in 2013. If reason prevails, the hit would reduce growth by some 1%.

Taking into consideration the fact that U.S. growth is likely to remain around 1-2% in 2013, the growth impact could halt U.S. growth in 2013. That's the benign scenario. In an adverse scenario, the impact would cause a recession in America, which would intensify and prolong recessionary conditions in the Eurozone.

Each presidential candidate has his plan against the fiscal drag, but both are constrained by a political stalemate.

If President Obama gets a second term, he needs a bipartisan compromise, which is likely to alienate the Republicans' Tea Party and the Democratic left. If Mitt Romney wins the presidency, he, too, would need a bipartisan compromise, which is likely to alienate his Democratic opposition and the Republican conservatives and Tea Party.

In 2008, the presidential election brought no change to Washington. In 2012, the outcome will be similar. Unlike in 2008, the economic pressures can no longer be deferred. In 2008, Americans voted for change. Now change is forced upon voters.

In all scenarios, it is the world economy that will bear the consequences.

Dan Steinbock is research director of International Business at India China and America Institute (USA), visiting fellow at Shanghai Institutes for International Studies (China) and in the EU-Center (Singapore).

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