Jack Lew’s expected nomination as the next U.S. Treasury secretary is a clear sign the second Obama administration expects the focus of its economic policy to be firmly on rounds two and beyond of Washington’s interminable fiscal cliff debate. Lew is both a budget expert and Washington insider who knows both ends of Pennsylvania Avenue. Whether the White House likes it or not, the budget and tax reform negotiations that will likely dominate the Treasury secretary’s year will be as much political as technical discussions.
The global headwinds buffeting the U.S. economy are rough enough without a second fiscal front blowing in from the windbags in Washington. Yet it has (so far) proved resilient enough to suggest a continued ability to slog its way through them.
The world’s largest economy has never been larger. Real GDP is 2.5% above its previous peak. Japan, France, Italy and the U.K. still haven’t yet got back to where they were before the 2008 global financial crisis hit. The U.S. economy has grown 7.5% since the trough of the recession that followed. No developed economy apart from Canada’s has recovered as rapidly since the second quarter of 2009. It just doesn’t feel like it to most Americans because the pace of recovery has been less than half the average they experienced during previous recoveries over the past half-century.
Wherever the political arguments come out on spending cuts and tax increases, fiscal reform will almost inevitably retard growth, just as the rapid contraction in the public sector has since 2009. Private sector real GDP growth has been 10.7% since the 2009 trough, 3.2% more than total GDP growth, the gap reflecting the effects of cuts in national, state and local government regardless of government stimulus programs.
On top of that, the U.S. economy has had to absorb a credit crunch, the loss to American households of $7 trillion of wealth from falling home prices and some longer-term structural factors such as slowing growth rates of the labor force, capital services and total factor productivity (average real output per unit of combined capital and labor). The Congressional Budget Office (CBO) estimates that such structural factors may account for two-thirds of the difference in the recovery rate this time and the historical average.
Points of strength are that consumer spending and business fixed investment have recovered. They are now more than 3% and 1.2% above their previous peaks, respectively. Not so, though, residential investment, still more than 50% below its previous peak. Yet it is the improvement in trade that has underpinned the recovery. The CBO estimates that the contraction in the U.S. trade deficit as a result of a 27% increase in exports versus a 26% rise in imports since the second-quarter 2009 trough accounts for one-third of GDP growth since then.
If the housing market can deliver on the promise of the signs of recovery it has shown in recent months, the U.S. economy should be able to power through whatever Washington throws at it this year, and continue to outperform the other developed economies, perhaps even besting its neighbor to the north. None of that though is likely to make Jack Lew feel he will be having anything but a tough year.