This Shutdown Is Not the Same as 1995 and 1996…It’s Worse
I’m generally an optimist about the resilience of the U.S. economy, its ability to bounce back from shocks and power through disasters, whether they’re imposed by nature, markets, or politics. But today, four years into an expansion that few people saw coming, I’m more pessimistic than many about the impact of the shutdown.
The predictions have come fast and furious. The shutdown costs $300 million in lost gross domestic product per day, according to IHS Global Insight. Economists surveyed by Bloomberg last week said a one-week shutdown would reduce fourth quarter GDP growth by .1 percent. Macroeconomic Advisers, one of the most sober and best forecasters, said a two-week shutdown could shave .3 percent off the fourth quarter. Neil Irwin at the Washington Post has helpfully aggregated a bunch of Wall Street forecasts that project that a one-month shutdown could reduce fourth-quarter growth by anywhere from .5 percent to 2.0 percent.
That’s a pretty big dispersion.
Market and economic analysts have looked back to the experience of 1995 and 1996 for guidance. The stock market actually rose during those two shutdowns. (Therefore, the suggestion goes, this time won’t be so bad for stocks either.) Paul Ashworth, chief U.S. economist at Capital Economics, told Reuters that “the shutdowns in late 1995 caused Federal spending to contract by 14.2 percent annualized in the fourth quarter, subtracting around 1.0 percent from overall GDP growth.”
It is natural to look back and make comparisons. But investment professionals often note that past performance is no guarantee of future performance. And there’s plenty of reason to be skeptical of the models and forecasts analysts are making, whether they rely on data from 1995 or data from 2011. That’s because the U.S. economy is an extremely dynamic organism. Just as the economy of 1995 looked a hell of a lot different than the economy of 1978, the economy of late 2013 looks a lot different than the U.S. economy of 1995. (I could provide a lot of data to support this claim, but the Bureau of Economic Analysis’s website is shut down.)
Think about it. In 1995, the internet wasn’t really a commercial force, China was still a minor economic power, and the acronym “HELOC” (Home Equity Line of Credit) had yet to enter the vernacular. Many of the forces that define our economic lives simply didn’t exist. I’d argue that many of the big changes in the way America works make the U.S. economy more vulnerable to government-shutdown-induced damages. When you look back over the past 18 years, one of the unavoidable conclusions is that, for a variety of reasons, the federal government is much more involved in the economy than it was. What’s more, the economy is now more dependent on certain sectors that can’t operate at their fullest capacity without the government being entirely open.
As this chart shows, the federal government has become a larger part of the economy over time. In 1995, federal spending accounted for about 19 percent of GDP. Now, it accounts for about 22 percent of GDP. Entitlements like Medicare and Social Security, which have yet to be affected, account for a big chunk of this rise. But the fact remains that federal government spending accounts for a significantly larger chunk of GDP than it did 18 years ago. So if you slam the brakes on that spending, it will have a bigger direct impact than it did 18 years ago, for example in the effect the furloughs of defense contractors is having on the private sector. Politico had a good piece Tuesday morning about how Charleston, South Carolina, which is represented by shutdown advocate Mark Sanford, is remarkably dependent on federal spending.
The U.S. is more trade intensive than it was back in the mid-90s. That is to say, exports and imports—the volume of goods, people, and services moving in and out of the country—have risen far more rapidly than the economy as a whole. The U.S. today is the world’s largest importer and the world’s largest exporter. You can go look at the data at the World Bank’s website. Last year, trade accounted for 24.8 percent of GDP. In 1995, it was 18.5 percent. That’s a big difference. The U.S. economy is now one-third more trade intensive than it was in 1995. That means many more people’s livelihoods depend on trade today than 18 years ago. The shutdown isn’t stopping trade entirely, but the Wall Street Journal has an excellent article that details how the shutdown is gumming up the works. It turns out that dozens of agencies are involved in the process of releasing shipments for import and export. And many of them are closed or operating with fewer staff.
“All pesticide imports to the U.S. have been halted, according to the Environmental Protection Agency, which must approve them but has had more than 90% of its staff furloughed. Some U.S. technology companies can’t fill overseas orders because they cannot obtain U.S. Department of Commerce authorization to export. Steel imports are stranded at customs-clearance warehouses awaiting paperwork.
Then there’s finance. The trend of financialization—the fact that a larger number of people are involved in moving, trading, and managing money—has long been documented and lamented. (Here’s a great report from the Kauffmann Foundation on the topic.) In 1995, the financial sector accounted for about six percent of GDP; last year, it accounted for about eight percent. That’s an increase of one-third. And as we well know, the financial industry can’t function without the government. Today, the Export-Import Bank is closed, and so is the Small Business Administration. That means small businesses can’t get loans. The inability to get data on income from the IRS is hampering the ability to close mortgages, including jumbo loans, as Diana Olick of CNBC reports. The U.S.D.A. isn’t giving out information on pig prices, which means it is harder for traders to trade contracts based on those prices. These may sound like one-percent problems, but they’re not.
Simply put, there’s a lot of economic activity going on today that might not have existed in 1995 and 1996 and that is affected—directly, indirectly, tangentially, inadvertently, partially, wholly—by disruptions in government operations. Some of this activity may not have been taking place two or three years ago. All of which is to say that models constructed based on prior data and understanding of the economy may not be accurate measures of what is happening now and what will happen in the next few months. When new, unprecedented things happen, models get thrown out the window. We learned that the hard way in 2007 and 2008, when a subprime crisis morphed into a systemic crisis that brought global trade to a standstill.
This isn’t to say that a government shutdown is unprecedented. It’s not. But a government shutdown in an economy that looks like today’s economy is unprecedented. Even the people who follow these issues full-time for a living don’t understand the interconnections. To a large degree, we’re flying blind. And that’s one of the reasons brinksmanship is so dangerous.