Will Economic Contraction Affect Debate Over Sequester?

By Frank James

January 30, 2013

There are some people who viewed the news that the economy shrank toward the end of the year as a bracing wake-up call, a gloomy foreshadowing of what could happen if even bigger automatic reductions start March 1. But don't count on it changing the dynamics of the current debate over the so-called sequester.

If Congress fails to reach agreement to stop a sequester, the Defense Department would take a $500 billion hit; $700 billion would come from other domestic discretionary programs.

Steve Bell of the Bipartisan Policy Center in Washington, D.C., worked on Capitol Hill for 39 years, on and off, much of that time as a top aide on the Senate Budget Committee when Republicans were in charge. He's still in touch with people in Congress.

Asked in an interview how much his Hill contacts reacted to news that a 22.2 percent drop in defense spending led to the U.S.'s fourth-quarter gross domestic product shrinking by 0.1 percent, Bell said:

"Not much. There is a sense of resignation among many members on the Hill. The pro-defense people have kind of lost momentum. The big deficit hawks have gained momentum. And the general, not a majority yet, but certainly a strong minority consensus is: 'Let the sequester occur. It's the only spending cuts we're ever going to get out of this entire mess from the last four years.' And I think that idea is gaining momentum. It is beginning to make the defense hawks deeply concerned."

Bell isn't in that camp. He says Wednesday's GDP report was a serious warning of the kind of economic disruption that will occur if the sequester is allowed to go forward. The Bipartisan Policy Center warned that the threat of future cuts would cause companies to act pre-emptively to gird themselves through layoffs and other actions.

"The sequester, and its impact on defense, we believe, will lead to furloughs of civilian defense workers. It will lead to either the sale or bankruptcy of very small subcontractors, things that are occurring right now in the Washington, D.C., area. People are selling their small businesses to larger defense contractors because they can't stay in business. And we think the net effect will probably be, conservatively, a million lost jobs just from the defense sequester alone."

Sen. Carl Levin, D-Mich., who chairs the Senate Armed Services Committee, was among those who saw Wednesday's news as a clamorous klaxon horn sounding danger. In a statement, he said:

"We must avoid sequestration because of the damage it would do to the economy, to important domestic investments and to our national security. Today's GDP report demonstrates what is at stake economically. Top economists have warned us that sequestration could send us back into recession, and we should heed their warnings."

Others who saw danger signals were, not surprisingly, defense contractors who have much at stake. Marion Blakey, president of the Aerospace Industries Association, said in an interview:

"It's what we have been warning about for months and months, because we do know that the cuts to defense spending that are already in place through the Budget Control Act are causing our companies to pull back, laying off workers. That's going on right now. It has real effects in terms of their ability to invest in R&D, to train. There are a variety of aspects that all have an economic impact. We know if a sequester goes into effect, we're going to see a much more dramatic acceleration of job losses."

Blakey cites a study by George Mason University economists that forecast 2 million lost jobs in the first year of a sequester.

Douglas Holtz-Eakin, president of the American Action Forum, a former Congressional Budget Office director and a favorite of Capitol Hill conservatives, doesn't disagree that the sequester is a bad idea. But he thinks too much is being made of the fourth-quarter GDP data.

He notes that the third quarter saw defense spending rise robustly, and he expects the Commerce Department number-crunchers to eventually revise upward the fourth-quarter data. In an interview, he said:

"It would be better not to have [the sequester] happen, but this isn't why. You can make too much of today's GDP report pretty easily ... if you ignore the weird timing and look between midyear and now, defense spending dropped at about a 6 percent annual rate. And that's what we expect to be happening."

The U.S. military withdrawals from Iraq and Afghanistan, as well as the Pentagon following orders to downsize over 10 years, explains part of what we're seeing, Holtz-Eakin said.

"Is the sequester a good idea? No. It was supposed to be such a bad idea that we'd do something good. The fact that it was a bad idea originally hasn't changed. It's still a bad idea. It shouldn't happen."

That said, here's where Holtz-Eakin makes defense contractors and many others nervous:

"I don't think that if the 2013 sequester happened it would be the end of the world. I think the economy could still grow."

But he said the 10 years worth of sequester cuts to defense and domestic discretionary spending is the wrong strategy. It's more like the European-style austerity that has helped throw many of those nations into recession. The focus really should be on entitlement cuts.

Of course, the reason we got the sequester in the first place was because of the competing and partisan views of reality in Washington. Wednesday offered little relief on that front.

White House spokesman Jay Carney blamed Republicans for letting matters get to the present stage. He said in his Wednesday briefing:

"Talk about letting the sequester kick in as though that were an acceptable thing belies where Republicans were on this issue not that long ago, and it makes clear again that this is sort of political brinksmanship of the kind that results in one primary victim, and that's American taxpayers, the American middle class.

"You're correct that the GDP number we saw today was driven in part by — in large part by — a sharp decrease in defense spending, the sharpest drop since I think 1972. And at least some of that has to do with the uncertainty created by the prospect of sequester."

To which House Republicans attempted to hold up a mirror to President Obama.

Brendan Buck, a spokesman for House Speaker John Boehner, said in a statement:

"These arbitrary, automatic cuts were a creation and demand of the White House in 2011. Twice the House has passed legislation to replace them with common-sense cuts and reforms. If there was any uncertainty late last year about the sequester, it was because the Democratic-controlled Senate, per usual, never lifted a finger to pass a plan to replace it."

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