At this point it’s very clear that the United States and world economic outlooks are dependent on the decisions taken by policymakers. It should also be clear that the developed economies are in the midst of reducing debt levels, a process called deleveraging.
The U.S. economy has managed to continue to grow despite the threat of the “Fiscal Cliff,” automatic spending cuts and tax hikes scheduled for January 2013 that could instantly lower GDP by a few percentage points, having already frightened many companies into postponing plans to invest in expansion. At the time this column is being written it is not clear that a politically divided Washington will be able to make progress on the Fiscal Cliff, and critical major bills impacting energy, transportation and agriculture could also languish until the mid-cycle elections.
Given that Europe is struggling to get out of a recession, Japan is in a recession due to declining exports to Europe and the major emerging market economies like China and Brazil are slowing for the same reason, the hopes for global economic recovery are pinned on the United States.
It is most likely that the Fiscal Cliff will be postponed; although it’s hard to see how meaningful legislation, which could resolve the uncertainties that now hold private sector investment back, will be passed given Washington’s current political composition. There is, however, hope that the Fiscal Cliff can be resolved and this would improve the operating environment for the freight movement industry.
In terms of the outlook for the economy and trade, it’s best to consider potential scenarios over different periods:
The Fiscal Cliff continues to weigh on investment and employment growth. The consequence could be a decline in GDP of 5 percent in the first half of 2013, compared to the first half of 2012. A second relatively severe recession would be hard on the transportation industry, particularly participants that are already struggling to make payments on their debts. On the other hand, if the Fiscal Cliff is avoided then growth could surge and create congestion problems in some segments of the freight movement industry.
There are several reasons why economic growth has been sluggish, but the root cause can be summarized as U.S. and European deleveraging — that is, reducing debt levels. Emerging markets went through this painful process in the late 1990s when Russia and Brazil defaulted on their bonds. In the United States, households have been deleveraging since 2008 when their debt-to-income ratio peaked after rising for 20 years. Governments in Europe are trying to do the same. However, fiscal austerity in Europe was initiated while some member countries were still in recession and it has resulted in a financial crisis. The U.S. Fiscal Cliff, very similar to European austerity, is expected to have the same consequences.
Concern over the Fiscal Cliff is evident in the data on company investments in plants, property and equipment, which shows a marked slowdown. Investment spending, which accounted for 65 percent of economic growth in 2011, has contributed less than 20 percent to GDP growth in 2012. Inventories have not kept pace with consumer spending, which is also evident in slow growth in container port import volumes. Consumer spending, which is not as forward-looking as company spending, continues to grow at a low rate. To some extent this seems to be forcing companies to hire in order to meet growing consumer demand. It is likely that a long-term postponement or repeal of the automatic budget deficit reduction would cause a jump in economic activity as a result of companies reactivating their planned investments.
The key question is whether or not Washington can find a way to eliminate the Fiscal Cliff. There are several arguments that could be used by both parties to accomplish this. The main argument is that the Fiscal Cliff might not reduce the deficit by the amount of the automatic spending cuts and tax hikes, because the associated negative impact on the economy of lower profits and increased layoffs would cause tax revenues to decline and unemployment insurance benefit expenses to increase. This is similar to how fiscal austerity in Europe resulted in a recession there. Resolution of the Fiscal Cliff might not occur until the end of 2012 and, if not then, it would be immediately after the cuts go into effect in January. Until the Fiscal Cliff is resolved all forecasts are explicitly a prediction of how it is resolved. This is shown in a chart (p. 24) as three possible scenarios.
There are other global factors that impact the near-term outlook. Europe is making some progress on resolving its debt crisis and developing policies to address the ongoing recession that resulted from that. Major developing economies like China and Brazil are initiating policies to offset weak export trends by investing in their own public infrastructure. These trends would not compensate for the impact of the Fiscal Cliff, but the removal of this threat to the U.S. economic outlook, in tandem with a more stable global economy, suggests that 2013 could see much higher growth than 2012 since companies have delayed their investment plans. If so, the transportation industry could be dealing with congestion issues next year resulting from strong growth of both imports and exports. If not, there could be more bankruptcies among companies in the freight movement industry.
The Fiscal Cliff affects forecasts out to 2015. If a recession occurs in 2013 due to the Fiscal Cliff, then the years 2014 and 2015 could be characterized by a slow recovery, supported by more expansionary policy action (quantitative easing) by the Federal Reserve and potentially fiscal stimulus. If the Fiscal Cliff is eliminated or postponed for many years, the economy would grow quickly in 2013 and likely motivate the Federal Reserve to reverse its expansionary monetary policies, potentially as early as the second half of 2013. As these policies are withdrawn and interest rates begin to rise, economic growth will slow and could come to a standstill, with the possibility of a modest recession. Beyond 2013, depending on how the Fiscal Cliff is resolved, the transportation sector could either be dealing with healthy growth of exports and imports, or continued intense competition among industry participants to maintain or increase their market shares.
Beyond 2015 and regardless of the Fiscal Cliff outcome, it’s difficult for the United States to avoid a prolonged period of low growth and higher inflation. Baby Boomers are just beginning to retire. Their spending on goods will slow and given that many are heavily indebted and possibly unable to afford to retire, the public sector will be pressured to subsidize them. Higher taxes and/or inflation due to the Federal Reserve printing money to buy the government’s debt would be the outcome. Interest rates would rise and that would slow investment spending, which would further hold growth down.
China could also abandon its policy of keeping the yuan undervalued relative to the dollar since the U.S. market would become less attractive. That would make imported goods more expensive and also contribute to inflation. Low trade growth would extend the already long period of intense competition in the transportation sector.
Yet, it doesn’t have to be like that.
The growing middle classes in the emerging markets represent a major opportunity for U.S. export growth. Export growth would generate jobs and continue to inspire investment spending in those export-oriented industries. This would raise productivity and reduce the trade deficit, which in turn would help strengthen the dollar and reduce inflationary pressures. Higher productivity would also reduce the need to raise taxes to subsidize the retiring Baby Boomers.
The potential for exports to impact long-term growth is shown in the scenarios forecast chart. Export growth is the key differentiator in the three scenarios. In order to achieve higher export growth it is likely that improvements to transportation infrastructure will have to be made.
Unless the upcoming mid-cycle election provides either party with control in Washington, so that policies which would stimulate economic growth like investment in transportation infrastructure could be passed, the U.S. economic and trade outlook may end up being driven by policies deployed by other countries. At this juncture, economists have to look carefully at trends and policies in other countries and regions in order to develop forecasts for the United States.
Kemmsies is chief economist of Moffatt & Nichol, a marine infrastructure engineering firm. He can be reached at (212) 768-7454, or by e-mail.
|Sources: Moffatt & Nichol.