Wednesday, November 20, 2013


IF THE DEPT OF DEFENSE and the rest of the Federal government share the pain of the Sequester, the forced federal budget cuts what weren't supposed to happen this way, then roughly $5 billion will be removed from the economy between May or June and September.  I arrive at that figure by doubling the $2.5 billion the Pentagon said yesterday that it expects to save from furloughing its employees for 14 days between June and September.

The 14 days is down from the 22 days DoD predicted a week ago.  According to a CNN article I read, the Dept of Justice and the EPA will furlough its employees for 14 days as well, while the Office of Management and Budget will knock 10 days off of their employees pay.  I wonder if Congressional staff are being laid-off as well; and should members of Congress give up one day of pay for every two days they are in recess?  It only seems fair.

What does that $5 billion, just in personnel wage cuts, represent over that four-month period?  It represents 0.1% of the Gross Domestic Product (GDP).  Next year, when spread over 12-month period, the reduction amounts to 0.03% of GDP.  Now, numbers like 0.1% don't seem like much, but, considering that a 3% growth (or $449 B) in GDP is considered good, then a $5 billion cut represents 1.1% of the amount needed to obtain a 3% growth.

Looking at it another way, the rest of the economy is going to need to increase by $5 billion through growth, anemic at best given the political in-fighting going on, in order to hold the GDP constant.  This is not a likely outcome since the sequester is pushing the economy in the other direction.

Up to this point, we have only considered the cut in federal employe wages.  The impact of the Sequester will go far beyond these simple numbers.  There is an effect in economics called the "multiplier effect".  It just means that for every dollar spent in the economy, it will generate, say, $1.10 in economic activity by the time the dust settles.  

Yes, there are a lot of caveats about this theory, the main one being if you are looking for an increase in economic benefit from this effect, then the economy must be in distress and with unemployment high; otherwise, the dollar simply gets absorbed into the ongoing economic maelstrom. 

Why should there even be such a benefit?  Good question, because many Conservatives do not believe that there is.  But, understanding what is behind this idea will help understand the negative impact the Sequester may have on today's economy. 

Consider that you just spent a dollar at the store, what did that do?  It did two things, it 1) created demand and 2) caused the store to replenish its supplies.  What happens to your dollar?  Four possible things, it:

  1. is used to pay an employee,
  2. increases the owners profit, 
  3. buys other goods and services, and
  4. pays taxes.
Notice the first two uses of your dollar increases somebody else's personal wealth.  Further, in all four instances, your dollar is used to create even more demand because in the third case, the store is purchasing things directly, and in the last case, the government pays salaries or buys goods and services with the taxes it collects. 

The reason this cycle always dies down is that individuals don't always spend their wages or profits, they either save or invest them; both of which take money directly out of the economic cycle (although investing may put some of it back in, in the form of loans by banks).  So, what creates the "multiplier effect" is those parts of the dollar you spent the first time are spent many times over again by others, which multiplies the buying power of that initial dollar.

It is easier to explain this process when you spend a dollar than when you stop spending it, but the process and "negative benefit" is the similar, just reversed.  The multiplier effect, whether it is to magnify the gain or loss of changes to total money supply in the buyer-retailer-wholesaler-manufacturer economy, is always there; it is just a matter of magnitude or how much of an effect it is; will it be a .9 multiplier (slowing the economy down, a 1.01 multiplier (which as no particular effect) or 1.2 (which is quite stimulative).  It also depends on the scale of the economy, i.e., locally or nationally. For example, if every American took a dollar out of there savings and simply spent it, I doubt any economic charts would register the increase.  If, instead, we all spent it in Gainesville, FL (go Gators), there would be a mini-boom as those dollars circulated and recirculated in that small economy.  

To have any real impact on changing the course of a national economy by having the government give it a shot in the arm (stimulus) or the reverse (stop spending), the economy must be in distress and unemployment is high, like it was in 2009 and is, to a lesser degree, now.  Fortunately, these situations do not occur very often and your economy runs smoothly through even serious changes in cash flow.  Having said that, it is nevertheless much easier to send the economy into a tailspin than it is to bring one out of it; primarily due to the impact of the "herd mentality" of the populace in times of instability.  (It should be noted that it is this idea of the influence of "herd mentality" that is one of the major differences between Conservative and Progressive economic theories.  Conservative economists deny it has much impact while Progressives accept it and take measures to minimize it.).

A principal reason for this is when the economy is growing, both wages and employment grow.  When the economy declines we find that wages are "sticky", as economists like to say, and do not fall as easily as they went up.  Consequently, businesses, in order to control costs are much more likely to to do so by laying employees off; which, of course, has a much more drastic impact on their ability to continue to purchase goods.  The effect of laying people off is to abruptly decrease demand rather than let it decline naturally as wages decline.

So, between June and September, $5 billion of demand will be removed; sales will decline.  That is $5 billion stores will not 1) pay their employees, 2) earn in profit, 3) buy other goods and services, and 4) pay in taxes.  So long as employees are not laid off, and that is the big question, then the $5 billion is spread among the remaining three cost centers; magnifying the impact on reductions in profit, secondary purchasing, and tax revenues.

History shows this kind of scenario simply leads to lower growth or maybe a mild recession.  It is when employers cannot, or choose not to, maintain the workforce where the danger lies.  While slowdowns in secondary purchasing and government spending are bad, it is when there is a significant decline in consumer spending where an economic "death spiral" can begin.  It is at this point where Conservative (Classical) economics fails; in fact, the solutions offered by this theory make things worse than they otherwise might have been because these "remedies" feed the fire of an economic downturn; this fact was evident in every recession/depression prior to 1937.

OK, enough on history already, its depression, err depressing.  Let's move on to the latest anecdotal impacts from the sequester.

  • The Navy mothballed the USS Miami, a damaged nuclear submarine because the delay in repair made it too expensive to fix
  • Eleven other Navy ships have been kept in port rather than take up their operational stations
  • Thirty-three Air Force squadrons have been grounded to save money causing a 10% increase in the AF flying hour program next year to make up for it.  The problem is, the sequester is worse next year.
  • The Pentagon stopped asking bidder on construction contracts to build energy efficient products into their plans to save on the extra short-term cost, which, of course, leads to higher long-term costs
  • 57,000 fewer poor children will participate in Head Start, but then that is not high on the Conservative agenda in any case is it; that is a Progressive priority
  • Likewise, a high priority item for Progressives, but not for Conservatives, is help for poor children in school. Federally funded school programs for poor communities and mentally and physically handicapped children have been disproportionately hit by the sequester. The amount of federal funds to local school budgets averages 8 percent but rises to above 50 percent in some areas.
  • One of the biggest threats to long-term national interests is the destruction of the National Science program even though it is the source of most major innovation in America.  Investment in raw science stopped increasing during the Bush 43 administration, and, because of the sequestration and other Conservatives initiatives, is in actual decline.  For example, the sequestration caused the NSF to cancel 700 grants and the Army to cut their R&D in half!
  • The sequester means a Houston-area school bus driver will face a $300 per month increase in her rent; multiply that by hundreds of thousands of Americans in her position.  To stay in her apartment, she will need to take on a third job, assuming she can find it! (yep, that is the American Dream alright.)
  • Cuts in the nations housing assistance programs has yet to throw anyone out on the street yet, it has, however, frozen any further help; another one of those pesky Progressive programs that keep people from getting jobs that don't exist.  A prolonged sequestration may likely put people out on the street.
  • And, on 11/20/13, the President of Harvard just came out denouncing the Sequester and outlined the great damage it is doing to the Nations standing in the world community vis-a-vis keeping intellectual knowledge within our borders because of the huge cutbacks in government R&D efforts. She said their is a noticeable migration of brain power from the U.S. and its declining R&D programs to countries where the government does invest in its future.
Around mid-December 2013, a Congressional conference committee is supposed to report out a budget agreement to prevent a Continuing Resolution for the remainder of 2014 and that locks in the next round of even more draconian Sequestion cuts.  The failure of agreeing on a budget, which is likely in my opinion, has a very good chance of leading to a second, even more disastrous government shutdown in early January 2014. Not a pleasant prospect is it?