Whether it’s Barack Obama or Mitt Romney taking the presidential oath of office in January, someone will have the misfortune of overseeing an economy that looks a lot like the one we have today: low growth, persistently high unemployment, and huge amounts of debt. Depending on what happens with the “fiscal cliff,” there’s at least a chance the U.S. will be in recession. The mere threat of $600 billion in tax hikes and spending cuts is already delaying business spending. Yet even if Congress does broker a deal and the worst of the fiscal cliff is postponed, 2013 is shaping up to be a rough year.
Big economic forces, both domestic and abroad, are combining to dampen growth. Fundamentals such as demographics and household finances that helped spur past recoveries are now slowing things down. These trends aren’t affected much by policy, so fixing them will be beyond the immediate grasp of an Obama or Romney administration. “No matter who wins the election, from a truly economic standpoint, 2013 will be an extremely challenging year,” says David Rosenberg, chief economist at Gluskin Sheff + Associates.
As the economy has cooled, so have economists’ forecasts. The average estimate of the 79 economists surveyed by Bloomberg is for gross domestic product to rise 2.1 percent in 2013, down from the consensus of 2.5 percent in May. The fiscal cliff poses the biggest threat: The combination of deep spending cuts and tax increases set to hit in January could strip as many as 4 percentage points off 2013 GDP growth. On top of that, the global economy is weakening, particularly in China and Europe, two of the biggest export markets for the U.S. China’s industrial output is growing at its slowest pace since May 2009. Although Europe’s leaders appear to be making progress in taming their debt crisis, much of the continent is already in recession.
In July, U.S. exports fell by more than they have since April, pushing the monthly trade deficit in manufactured goods to a record $63.9 billion. In August, factories cut 15,000 jobs, their biggest drop in two years. “The European situation has really dampened exports more than what we had seen through the earlier part of the summer,” says Joe LaVorgna, chief U.S. economist at Deutsche Bank (DB). He expects U.S. economic growth in 2013 to be “probably around 2 percent, rather than the magic 3 percent number we were hoping for.” The slowdown in industrial demand will ripple through the economy, eventually hitting production, employment, and ultimately consumer spending. “In an environment this anemic, you have the potential to grind down to zero in terms of job growth next year,” says Jacob Oubina, senior U.S. economist at RBC Capital Markets.
While growth slows, productivity is climbing. Output per hour rose 2.2 percent in the second quarter of 2012, as businesses squeezed more work from their current staff rather than take on new employees. Over the long haul, productivity gains are good for the economy, but in the medium term, the combination of rising output and falling growth is a bad sign for hiring.
A comparison with the deep recession of the early 1980s highlights the difficulties facing Obama or Romney. By the end of Ronald Reagan’s first year as president, the economy was shrinking at an annual rate of nearly 5 percent. By the end of his second, unemployment had hit 10.6 percent. But in the summer of 1983, GDP was growing at an annual rate of 9.3 percent. The economy was able to snap out of recession thanks to some built-in advantages a U.S. president can no longer count on. In the early 1980s, the ratio of household debt to GDP was about 50 percent; today it’s nearly 90 percent. Americans were saving about 10 percent of their income, vs. 4.2 percent as of July 2012. “When you overleverage with debt and have a low savings rate, it’s like having a weak immune system,” says Carmen Reinhart, an economist at Harvard’s John F. Kennedy School of Government and co-author of the book This Time Is Different, which argues that it takes far longer to recover from a financial crisis like the 2008 bust than it does from an inflation-induced recession. “We were much more able to absorb the economic shocks back in 1982 than we are today,” Reinhart says.
Demographic shifts aren’t helping. In the early 1980s, the average baby boomer was 25; today, she’s 55. In 30 years, the U.S. has gone from having its youngest workforce on record, with an average age of 35, to its oldest, with an average age of 42. Younger workers cost less, are more flexible, and create households, prompting consumer spending. “It’s not that the recovery is dysfunctional, it’s that the demographics have turned against us,” says James Paulsen, chief investment strategist at Wells Capital Management.
Today’s monetary situation is more difficult as well. In 1982, after then-Federal Reserve Chairman Paul Volcker tamed inflation and cooled demand with high interest rates, he had plenty of room to lower rates as the economy took off. Current Chairman Ben Bernanke has much less space to maneuver after taking interest rates as low as he could to boost demand and guard against deflation. “It turns out that killing inflation is a much simpler task than quashing deflationary pressures,” says Rosenberg.
Whoever the next president is, he won’t be able to change America’s demographics or keep Europe and China from slowing down. Under either Romney or Obama, Congress will remain divided, meaning Obama likely won’t be able to pass more stimulus, and Romney will have a hard time lowering taxes. Neither campaign has a convincing growth strategy, though both say they’re committed to reducing the federal budget deficit. In the best case, a serious attack on deficits could persuade private investors to make a bet on America’s future, increasing spending and investment. But the more likely effect of shrinking the deficit, through spending cuts and tax increases, will be to slow growth even further. Says Reinhart, “The fiscal housecleaning we need to do won’t get us a rebound in growth anytime soon.”