Washington thinks a resolution of the tense debate over the national debt will unlock a burst of economic growth by lifting uncertainty that has stymied investment.
It is a widely held view on Wall Street as well, derived from the glaring signs of weak business confidence over the last year as the US struggles to get its fiscal house in order.
However, evidence for this belief is far from clear and is an issue of considerable debate. Even some businesses wonder how big a factor uncertainty is.
In Lexington, Kentucky, new sales are slipping at Gray Construction, a family-owned builder of factories and distribution centers. Clients say they are holding back because the US could fall into recession if Congress and the White House fail to strike a deal soon to avoid a “fiscal cliff” of about US$600 billion in tax increases and government spending cuts due to begin next month.
“They’re saying: ‘Let’s wait. Let’s see what happens,’” chief executive Stephen Gray said.
Yet the company still has a record backlog of work and has hired about 30 people in the last six months.
The firm’s CEO has seen little dips in the sales pipeline before and said it is hard to know how different business would be if Washington’s politicians inspired more confidence. As it is, Gray sees no reason to stop hiring: “I’m not super-worried.”
Like Gray, economists are also unsure how much they can attribute business decisions to something so indeterminate as uncertainty, and they are divided over the degree to which erratic policymaking has dragged on the economy in recent years, if it has at all.
Answering this question could give clues on how the economy will perform next year, whether or not Congress strikes a deal to avoid the fiscal cliff.
Toward that end, researchers at Stanford University and the University of Chicago have created an index to gauge just how murky the future looks.
They count soon-to-expire tax provisions and mentions of uncertainty in major newspapers, as well as how much economic forecasters disagree on things like future government spending.
In a sample period between 1985 and last year, they found heightened uncertainty went hand in hand with weak economic growth and hiring. Their index hit an all-time high last year when congressional gridlock nearly led the US to default on its debt. It remains high, with a host of temporary tax cuts due to expire at year’s end and the debate over the fiscal cliff regularly splashed across front pages.
Nicholas Bloom, a Stanford economist who helped make the uncertainty index, says weak levels of investment, along with surveys in which businesses say they are holding back because of concerns over the direction of policy, suggest uncertainty has weighed on growth since late last year.
This year, business investment on capital goods has fallen short of what economists would expect considering the US$1.7 trillion in cash that companies were holding in the third quarter.
New orders for non-defense capital goods other than aircraft fell 7 percent in the year through October, while total business investment in the third quarter dropped the most since 2009.
Bloom says businesses would spend their cash more readily if politicians united around a grand bargain to put US fiscal policy on a stable path. Using past correlations between uncertainty and economic growth as a guide, he estimates that lifting uncertainty could add about 3 percent to GDP over the next 18 months — enough growth to create roughly 2 million jobs.
“There should be a surge of investment and hiring,” he said.
That would be a big boost to the lackluster 1.9 percent growth rate many economists expect next year.
A deal in Congress that avoids the fiscal cliff while taming the nation’s US$16 trillion debt over the long term may come by year-end or early next year. It is also plausible Washington will avoid the fiscal cliff but kick the can into next year when it comes to the details of longer-term deficit planning.
Republican House Speaker John Boehner, who has looked exasperated in public over the fiscal debate, has edged closer to US President Barack Obama’s key demands in the last few days, and the president made a counteroffer on Monday that could put a deal within reach. The two sides still differ on where to set tax rates and how to overhaul social spending programs.
The tense negotiations have corporate America on edge.
So far this month, companies have submitted 148 statements to the Securities and Exchange Commission expressing concern about the fiscal cliff. Last month there were 215 such warnings, up from 80 in October and none prior to May. About half of 200 big companies surveyed by American Express last month said Congress will not resolve the fiscal cliff this year.
Chemical maker DuPont is trimming its capital investment plans due to uncertainty. “We’re not going to spend as much as we thought next year,” DuPont CEO Ellen Kullman said last week in an interview.
US Treasury Secretary Timothy Geithner told CNBC earlier this month that reaching a sensible fiscal deal would get rid of the biggest roadblock to stronger growth. Many business leaders and lawmakers agree.
However, some economists doubt uncertainty has played such a central role holding back the US economy. If they are right, growth next year could disappoint even if politicians wow investors with a grand bargain.
Researchers at Goldman Sachs say the weak economy might be boosting measures of uncertainty as much as the other way around.
The bank does not rule out an “uncertainty shock” over the next few months — most economists think uncertainty must matter for something — but its researchers crunched numbers and found there might be a simpler explanation for the disappointing levels of business spending.
The bank’s economists calculated how much the business sector would normally be investing given its assets and the stage of the business cycle, and found the recent shortfall could be mostly explained by a lack of available credit.
Rather than being too scared to invest, companies might simply be having trouble getting loans. That makes sense considering many banks are still licking their wounds from the recent financial crisis.
“The evidence that a policy uncertainty shock is already depressing activity is far from unequivocal,” Goldman Sachs economists Jan Hatzius and Sven Jari Stehn wrote in a recent note.
Their research suggests some of the hype over uncertainty is overblown. Indeed, much of the country is not paying attention to the fiscal cliff debate.
A poll by Gallup conducted on Dec. 1-2 showed only 60 percent of Americans were following the talks at least somewhat closely. In the history of national events tracked by Gallup, that ranks somewhere between the Iraqi election of 2005 and the confirmation hearings for Supreme Court Justice Samuel Alito in 2006.
Households, whose spending drives more than two-thirds of the economy, are not as worried as the country’s CEOs, although a recent consumer sentiment survey showed concerns appeared to grow early this month.
Some economists say the most important issue for Congress is not to resolve policy uncertainty but rather to strike a fiscal deal that does not hurt the economy by ushering in harsh budget austerity measures.
Surveys of small businesses show companies are worried about higher taxes, but over the last few months and years they have worried even more about poor sales. Adjusting for inflation, household incomes are still lower than they were before the recession. This has depressed spending, a situation that could be exacerbated by tighter fiscal policy.
“The biggest uncertainty is whether the US consumer is really back,” said Stephanie Kelton, an economist at the University of Missouri-Kansas City.