A NEW year, a new economic crisis averted — and another can kicked down the road. Readers returning to work this week after the festive season could be forgiven for experiencing déjà vu, for this scenario could have occurred at the beginning of last year, or even a year or two before that. Lurching from crisis to crisis has become the new normal since the crash of 2008.
The 13th-hour deal approved by the US Congress on New Year’s Day has, with the benefit of backdated legislation, averted the "fiscal cliff" crisis that could have thrown the global economy back into recession. Yet the market’s relief rally will surely be short-lived. This is, after all, a compromise deal that succeeds in preventing the huge tax hikes and spending cuts that would have kicked in automatically in the absence of any agreement, but does not offer any long-term solutions to the fundamental structural problems facing the US.
Prime among these is the swelling fiscal deficit, which the deal does little to curb. In fact, as matters now stand, the deficit will swell by a further $4-trillion in the coming decade. This is the elephant in the room that was obscured for much of last year by presidential election noise and ideological squabbling over whether spending cuts or tax increases were the best approach. The reality is that, sooner or later, the deficit will have to be addressed, and it is almost certain that both will be required.
The measures that would have pushed the US over the fiscal cliff in the absence of a compromise deal were too much, too soon. But the tab that has accumulated due to past profligacy will have to be paid eventually and, with the US economy starting to show early signs of recovery, that day of reckoning should probably not be put off for too much longer lest the US find itself following parts of the European Union into a debt trap.
Tax and entitlement reform is essential. Meanwhile, a payroll tax cut that formed part of the fiscal cliff will expire as scheduled and, along with higher taxes on the rich, will cause significant fiscal drag early in the new year. And negotiations on raising the debt ceiling, the issue that was largely responsible for the creation of the fiscal cliff in the first place, when the Democrats and Republicans were unable to reach agreement last year, will be back to haunt the global economy within a few weeks.
There are glimmers of hope. There are signs, for instance, that Barack Obama’s victory in last year’s presidential election has strengthened the Democrats’ hand in Congress, or at least given Mr Obama the confidence to be more forceful in insisting that taxes in general, but especially on the richest Americans, be raised. The Republicans are right to demand that "entitlements" — politically motivated spending that is not economically productive — be reformed, but until the economy is growing robustly again, federal spending will have to play a key stimulatory role, and making the rich contribute more is the least damaging way of raising the required revenue.
The brinkmanship that served the Republicans so well in the past seems to have backfired in the wake of the party’s inability to retake the White House, and especially since high-profile Tea Party candidates were rejected by the electorate. The Republicans did not appear to have a Plan B when the Democrats did not blink as January 1 approached, and more than 80 Republicans joined almost all the Democrats in the House to approve a deal that, while by no means giving Mr Obama everything he wanted, in effect shatters two decades of Republican antitax orthodoxy.
The party will presumably again attempt to use its majority in the House to secure bigger spending cuts when the debt ceiling negotiations are resumed, but the signs are that Mr Obama has the upper hand and will be less inclined to compromise than in the past.