- The Washington Times - Sunday, July 10, 2011

The economy’s sudden downshift in growth and employment in recent weeks has increased the urgency for President Obama and Congress to reach a debt-reduction deal at the same time it has made their task more difficult.

A steep drop in job growth in May and June to less than a tenth of the monthly rates of more than 200,000 jobs earlier this year, as seen in Friday’s report, means that the 2-year-old economic recovery, rather than gathering steam as economists widely expected this year, suddenly has become halfhearted and vulnerable to shock from a sharp pullback in federal spending.

Adding to the dilemma, analysts say, is that the harsh political fight over how to tame the debt may have helped fuel the hiring freeze by causing a loss of confidence. Businesses and consumers fear spending cuts and tax increases are on the way and worry that the budget fight will roil financial markets as the government hurtles toward the brink of default on its massive debts.

“A possible explanation for the weakness is that concerns about the global economy and the U.S. government’s wrangling have spooked employers, who are waiting out the uncertainty,” said Sophia Koropeckyj, an economist at Moody’s Analytics.

Nigel Gault, chief U.S. economist at IHS Global Insight, said the White House and Congress will have to move swiftly to dispel these fears without derailing the fragile recovery, which he said appeared to “hit a brick wall in May.”

“The prime objective should be to avoid adding any self-inflicted wounds to the economy’s existing problems” through overly harsh spending cuts in the next year or so, he said. “A plan to stabilize the ratio of public debt to [economic output] over the long term is badly needed; an immediate fiscal contraction is not.”

The Friday report showed how government budget cuts are acting as a dead weight on job growth. Governments at every level shed 39,000 jobs last month, largely offsetting the 57,000 positions that opened in the private sector.

The loss of thousands of jobs and even a 1 percentage point decline in economic growth can reduce government revenues significantly and add trillions of dollars to the debt over a period of years.

That is why Mr. Gault and other economists echoed Mr. Obama’s call for additional measures to ensure that growth continues at a reasonable rate this year even as Congress enacts legislation aimed at slashing deficits.

Mr. Obama is seeking a “grand bargain,” including about $4 trillion in spending cuts and revenue increases in the next 10 years, as well as components to spur growth and jobs in the next year or two.

Reacting to the abysmal jobs report, he said the deal should include an extension of the payroll tax cut enacted at the end of last year and an increase in infrastructure funding that would put millions of unemployed construction workers back on the job. He also called on Congress to pass patent-reform legislation and free-trade deals with Panama, South Korea and Colombia to help spur job growth.

Mr. Obama said Washington deserves some of the blame for the economic slowdown.

“The problems in Greece and in Europe, along with uncertainty over whether the debt limit here in the United States will be raised, have made businesses hesitant to invest more aggressively,” he said.

“The sooner we get this done, the sooner that the markets know that the debt-limit ceiling will have been raised and that we have a serious plan to deal with our debt and deficit, the sooner that we give our businesses the certainty that they will need in order to make additional investments to grow and hire,” the president said.

Ajay Rajadhyaksha, an analyst at Barclays Capital, said the “grand bargain” that Mr. Obama is seeking would be the best outcome for the economy because it would focus on long-term budget discipline rather than short-term austerity.

A smaller deal preferred by some Republicans, which would slash spending in the near term by $2 trillion to $2.5 trillion without tax increases or major changes in entitlement programs, has the potential to disrupt the economy, he said.

“A bigger plan that includes entitlement and tax reform is clearly a better outcome for the U.S. fiscal picture,” he said. “We have been concerned that any smaller agreement would not tackle either entitlement or revenue issues and instead focus far more on near-term spending cuts, causing an economic drag.”

But the president’s proposal of an ambitious program at the eleventh hour - a month before the Treasury runs out of borrowing authority Aug. 2 - also poses considerable risks because it will be opposed by major factions in both parties in Congress, Mr. Rajadhyaksha said.

If Congress rejects any deal worked out between the White House and congressional leaders, little time would be left to negotiate an alternative plan. That increases the likelihood that the Treasury will either default on its bond payments in August or will be forced to impose immediate, draconian cuts in government payments such as Social Security and veterans benefits, further hurting economic growth, he said.

Whether Congress will go along with what the president envisions is a major question. Republicans remain vehemently opposed to any tax increase, and congressional Democrats are opposed to cuts in big-ticket entitlement programs such as Medicare and Social Security.

Many Republicans contend that deep spending cuts would give businesses the confidence to hire without fear that their tax burdens will increase.

Michael Pento, an economist at Euro Pacific Capital, said Republicans know that deep spending cuts will thwart growth and that is part of their game plan.

“Republicans have very little incentive to agree on a deal that includes tax hikes,” he said. “In fact, the Republicans want to force a severe dose of austerity upon the American economy, which could be a double win for the GOP. They may simultaneously balance the budget without increasing revenue and engender a recession that will force the current party out of the White House.”

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