Yesterday the Commerce Department reported that the gross domestic product (GDP) fell by an annual rate of 0.1 percent in the fourth quarter of 2012. The negative growth rate was the first seen since the economy was officially in a recession in 2009. Many analysts were unconcerned with the dip, saying the overall trends still pointed towards economic growth. However, there is real concern among many experts spending cuts may derail an already fragile economic recovery.
The decrease in GDP over the fourth quarter was attributed in large part to the damage done by Hurricane Sandy and to defense spending cuts. Without those two factors, the economy would have grown at a healthy rate of 2.5 percent in the fourth quarter. The report showed that other fundamentals, such as personal consumption and investment spending, remained strong.
God-willing there will be no more disasters with the scope of Hurricane Sandy in 2013. However, there are over $1.2 trillion worth of spending cuts scheduled to take place on March 1, 2013. The country will likely avoid a natural disaster, but it may suffer from another self-inflicted one in the process.
These spending cuts, commonly called the sequester, were passed as part of the Budget Control Act in August of 2011. The cuts were supposed to be implemented if Congress did not agree to a different deficit-reduction agreement by November 23, 2011. However, the cuts were then delayed until January 1, 2013, and then delayed again until March 1, 2013 as part of the fiscal cliff compromise.
Democrats now favor delaying or mitigating those cuts again, but Republicans are now standing firm and demanding that the sequestration cuts become law. Since Republicans control the House of Representatives, the spending cuts will take effect unless they budge.
The spending cuts ultimately amount to capital being taken out of the economy. When the government cuts a defense contract it causes the company holding that contract to lay off workers or put a freeze on future hires. Those layoffs cause those workers to spend less, which impacts all the companies that sell products to those workers.
Defense spending is only half the scheduled spending cuts. Other programs and agencies like Medicare, the Education Department, the Justice Department, NASA, and the Transportation Department would all either need to furlough or lay off workers to meet the demands of the sequestration.
All of these job losses have a multiplying effect. According the Bipartisan Policy Center, the spending cuts will kill one million jobs in the economy this year. Macroeconomic Advisers estimates that the cuts will knock off 0.7 percent of GDP growth. Finally, these studies are confirmed by the Congressional Budget Office, which details the devastating effects of the sequestration in this report.
Ironically, if the economy does decline because of the spending cuts it could only make the deficit worse. In a quest to reduce the deficit, which amounts to a broken leg, the country is essentially shooting itself in the heart.