The U.S. Can Survive a GOP Shutdown but Not a RepubliCon Cult Default

By Charles Kenny October 14, 2013

As the World Bank and IMF meetings wrap up in Washington and the world’s finance ministers give Jack Lew little sympathy hugs on their way out, it’s a good moment to look at the U.S. government shutdown from an international perspective.vThough Congress’s refusal to pass a clean continuing resolution has inflicted considerable damage on the U.S. economy, the shutdown is a comparatively small economic event by global standards. The reverse is true, however, should the U.S. default on its debt obligations—where costs are likely to dwarf those associated with debt crises elsewhere in the world. And the combination of debt crisis and budget blockage together will make matters even worse.

To borrow an analogy from the world’s most popular sport, the federal shutdown was a stunning own-goal. Despite the fact the considerable majority of government employees remained at work and most spending continued, the budget impasse unnecessarily hurt prospects for recovery. The safety net, including supplemental nutrition for women, infants, and children, has been (further) shredded. It’s taking longer to get a mortgage. The U.S. did less health research and didn’t track diseases—breaking international commitments in the process. And we don’t even know the full impact on the economy, because a lot of the statisticians who usually calculate those numbers were sitting at home.

If there’s a silver lining to the shutdown, it’s that the U.S., far more than just about any other country on earth, can withstand it. America’s federal government spends a little more than $11,000 per person each year, compared with a poor developing country whose expenditures are often less than $500 per head. Large, rich countries can afford to employ more “nonessential” employees than small, poor countries. About 97 percent of NASA’s employees were furloughed, for example, but most countries don’t have a space agency at all. Most NASA staff do provide globally valuable services that justify their employment; keep them home long enough, and some of the weather satellites on which the world depends might start falling out of the sky. Still, the immediate effect of benching those 17,500 NASA staff was probably muted compared with doing the same in such countries as Gambia, where total government employment is smaller than that. STORY: Congress's Blueprint for Global Catastrophe

Furthermore, compare a three-week shutdown estimated to cost $2 billion to $3 billion in lost output with the $86 billion sequester that both Congress and the White House appear to have factored into their negotiations about a possible “grand bargain” on debt reduction. The sequester is equal to a little more than 0.5 percent of GDP. Even that is trivial compared with the kind of government spending volatility we see (pdf) in small, poor countries. Since 1960, according to World Bank data, the U.S. government’s share of consumption expenditure (that’s excluding investment) has never shrunk by more than 0.7 percent of GDP in a single year—and that was all the way back in 1973. Compare that with Ghana, which has seen 16 government consumption spending contractions larger than 0.7 percent of GDP since 1960, six of which were larger than 2 percent of GDP—or about four times the size of the sequester. Research by Santiago Herrera at the World Bank shows that kind of volatility can have an outsize impact on economic growth and consumption—worth an average of 8 percent of total consumption in developing countries.

On a global scale, then, the volatility caused by furloughs and sequesters looks pretty small. But the relative impact of default will be much worse in the case of the U.S. than it is when it comes to smaller, poorer countries. A recent review of sovereign default in the Journal of Economic Literature concluded that over the past 20 years, defaulting countries had seen limited access to international capital markets and more expensive borrowing for the two years after default—but a small impact after that. And the impact on GDP growth was only around 1 percent.

The difference is that U.S. Treasury bonds are vital to the functioning of the global financial system. The government has $12 trillion in outstanding debt that is used (not least) to underpin short-term borrowing among banks and investment houses on Wall Street. A default could freeze that market and lead to widespread bank collapse, a debacle that would be sure to spread worldwide. Because a U.S. default would be such an unprecedented event, it’s hard to know how bad it could be—but Goldman Sachs (GS) suggests it could cost at least 4.2 percent of GDP over the year. BLOG: Why People Don't Trust Government—and How to Fix It

But we shouldn’t take too much comfort that the economic consequences of the government shutdown and sequester are relatively modest so far. According to research (pdf) by Andre Meier at the International Monetary Fund and colleagues at Center for Economic Policy Research, the moment when government spending has the biggest impact on overall output is during times of financial crisis—when $1 of government spending can increase GDP by as much as $2. The last time you want to rein in spending is when you’ve just blown up the financial markets—but Congress is still on track to engineer an unprecedented combination of the two.

So if the House wants to continue stabbing itself in the foot and bleeding all over the country, at least it should limit itself to furloughs. That might suggest the country is heading toward banana republic status. Defaulting on our debts would mean that we’ve already become one.

http://www.businessweek.com/articles/2013-10-14/the-u-dot-s-dot-can-survive-a-shutdown-but-not-a-default