Two years ago, political dysfunction in the U.S. manifested in Congressional gridlock, or brinkmanship over the debt ceiling, generated unwanted uncertainty and threatened the U.S. and global economic outlook (see my earlier post, here). As it happened, the fiscal impasse likely did result in serious economic harm: while the debt ceiling was raised, the quid pro quo was the use of sequestration to limit government spending which probably cut a full percentage point off U.S. growth. Output and employment are lower today than would have been the case and inflation has been below the Fed's target for longer.
Two years on, the U.S. economy is one of the very few bright spots in a rather bleak global conjuncture. And, yet, mid-term elections have once again focused attention on the prospects of dysfunctional politics. Of course, the risk of a return to the fiscal cliff was already present before the elections: the deal that backed the U.S. away from the ledge had a "best before" date that is due to expire in early 2015. Regardless, the fear now is that, with control of the Senate shifting to the Republicans and Congress firmly in the grip of one party, the stage is set for a return to stalemate.
If that is indeed the case, the recent return of volatility in financial markets could be replayed. The concern is that policy making will be blocked by a renewed impasse between Congress and the White House. In this scenario, legislation would be blocked by Presidential veto, while the President’s ability to pursue his own agenda at one end of Pennsylvania Avenue is obstructed at the other end. The outcome could, once again, be brinkmanship over the budget and debt ceiling. Needless to say, at the domestic level, this would likely adversely affect the economic outlook. But divided government could also impair efforts to project American influence on the international stage at a time when the international system of cooperation and the foundations of the institutional economic, development and security architecture are in need of strengthening. Such an outcome would kindle the fears of Americans who have expressed angst about the U.S. role in the world.
The thing is, though, this pretty much describes the recent past. So, if the situation can’t get any worse, might things improve?
Good question: frankly, I don’t know.
It is possible, however, to construct a scenario in which Republican control of the Senate leads to an improvement in the politics. After all, with Congress controlled by one party, it is hard for either party to blame gridlock on the other side of the isle. And while the President’s ratings are low, they do not sound the depths to which the public’s perception of Congress has sunk. If the prospects of re-election hinge on passing legislation, self-interest would likely dictate that compromise isn't a word to be feared. At the same time, while the President will clearly veto any attempt to erode his signal achievement — Obamacare — he will need the support of Congress to provide the leadership needed to deal with the economic, financial and security challenges that confront the global economy and the international system. In this respect, the deal might be support for sensible, moderate domestic initiatives in return for Congressional support of U.S. leadership in global fora.
Abraham Lincoln, drawing on the Bible, famously declared “a house divided against itself cannot stand.” For the past several years, a divided Congress and dysfunctional politics have, arguably, posed risks to the global economy. More brinkmanship could well undermine recovery and cast more gloom on a global economy already struggling in the new age of uncertainty.