More to come in the United States' cliffhanger drama
The US Senate last week passed overwhelmingly, by 89 votes to 8, compromise legislation to avert the so-called "fiscal cliff". The House followed the Senate less than 24 hours later and voted 257 to 167 to pass the Senate-sponsored bill. President Barack Obama indicated that he would sign into law the legislation.
There is, however, more to come in this overhyped cliffhanger drama that was entirely politically motivated, self-inflicted, designed and manufactured by Washington. The legislation was passed in the House over the objection of a large majority of conservative Republicans; 151 House Republicans (and 16 Democrats) voted against it and only 85 for it.
The bill deals only with tax issues and not spending cuts. It delays the "sequester" of automatic, across-the-board spending cuts, including defence spending, for two more months, to allow time for further negotiations. In the coming months the drama will continue with negotiations over spending cuts and expenditure reforms, the debt-ceiling, and funding the operation of the government, which requires a new budget law or a continuing resolution because the existing one expires on March 27.
The financial markets in the US and around the world reacted positively to the news. While the last-minute compromise and action in Washington reduces some of the risk posed by the fiscal cliff to the US's economic recovery, the more important message of economic and policy significance has unfortunately been overshadowed, even forgotten, by the theatric performance that can only be delivered by the US Congress.
The phrase "fiscal cliff" was coined by the Federal Reserve chairman, Ben Bernanke, and was used in the US House Financial Services Committee hearing in February last year. It has become a catchphrase and was used as shorthand for political posturing and positioning in the budget negotiation. The real message of Bernanke's metaphor was intended to warn the US Congressional Committee of the danger of too drastic, too fast, across-the-board spending cuts and tax increases that were scheduled to go into effect on January 2, which was part of the deal to end the debt-ceiling standoff in 2011.
The Fed chairman also explicitly left unsaid that the 2013 federal budget deficit should be significantly bigger than what it would be in the absence of new legislation. He hoped to get political leaders to end the paralysis and come up with fiscal measures to complement his monetary policy in response to the sluggish US economic growth and unacceptably high unemployment.
Going over the fiscal cliff was about its effects on the health of the US economy and the forgotten millions of unemployed. The latter include nearly 5 million unemployed over six months and 3.6 million for more than a year as of October, not counting discouraged Americans who have dropped out of the labour force and are therefore not counted officially as unemployed.
The political discussion often oversimplifies the complex challenge of America's budget deficits and debt. Overhyped deficits and debt phobia should not be a basis for sound fiscal policy. There are historical experiences of how advanced economies dealt with high debt levels, as high as or higher than those prevailing today; in some countries near or higher than 100 percent of GDP. These experiences, including analyses of six individual case studies - the UK (1918), the US (1946), Italy (1992), Canada (1995) and Japan (1997) - were highlighted in the International Monetary Fund's (IMF) "World Economic Outlook" (October 2012). They can provide an empirical basis and policy guidance.
First, support for growth is critical in order to manage the contractionary effects of austere fiscal policy for lowering the budget deficit and debt. Policy reforms to deal with structural problems and accommodative monetary policy are necessary.
Second, reducing national debt takes time, and expectations for the path toward lowering the debt level should be realistic, especially in the context of a weak global economic environment. In the case of the US, as the largest economy, policy-makers need to consider trade-offs between too fast a drastic debt reduction at the expense of growth.
Finally, because debt reduction takes time, budget deficit reduction and public finance reforms must focus on enduring structural changes to public finances and their institutions over temporary, on-and-off fiscal measures.
In the coming months as Act II of this drama unfolds, many of us hope that those who believe in the drastic and quick reduction of budget deficits and debt will consider and absorb the lessons of history.
As for President Obama, many of us hope that he will provide strong leadership and political courage to reform the current US social insurance programmes and institutions, such as Social Security, Medicare, Medicaid, as well as other discretionary programmes, including defence. There are several substantive, economically sensible proposals being offered that deserve serious consideration.
Dr Kiertisak Toh is a former senior Foreign Service officer with the US Agency for International Development. He is currently a member of the economics faculty at Radford University, Virginia, and a senior fellow at Duke Centre for International Development, Sanford School of Public Policy, Duke University, North Carolina.