Skip to main content

U.S. fiscal cliff risks dragging global economy into darkness

By Uri Dadush, Special to CNN
updated 12:34 PM EST, Wed November 7, 2012
STORY HIGHLIGHTS
  • Uri Dadush says Obama will seek to avoid tax increases scheduled for January 2013
  • If the U.S. falls into recession, the outlook for the world economy will darken, he says
  • The risk of a renewed global banking crisis would escalate sharply, he says

Editor's note: Uri Dadush is senior associate and director of Carnegie's International Economics Program. He served as the World Bank's director of international trade and before that as director of economic policy.

(CNN) -- President Obama is immensely popular overseas and his re-election will be welcomed by many. But how will his second-term agenda differ from the first? And what will it mean for a global economy where growth in emerging markets is hesitant, and a massive sovereign debt crisis continues to brew in Europe?

Read more: Five things Obama must do

One thing is certain. In the immediate aftermath of a grueling and divisive campaign, and confronted with a national emergency -- the fall off the "fiscal cliff" -- Obama's immediate priorities will be domestic, not international.

Drawing on the authority conveyed by electoral victory, he will seek to establish a constructive dialogue with Republicans who continue to control the House of Representatives and who can filibuster his agenda in the Senate, just as before.

Above all, he will seek to avoid large tax increases and expenditure cuts worth about 4% of GDP that will be triggered automatically on January 1 next year, should he fail to reach agreement on a long- term plan of fiscal consolidation worth some $3.5 trillion to $4 trillion over 10 years.

Read more: World worries as U.S. fiscal cliff looms

The World Bank head hunt
Sorrell: Biz wants Obama to compromise
Fiscal cliff awaits Obama and the world

If the U.S. falls off this fiscal cliff into recession, the outlook for the world economy, already gloomy, will darken further.

The task of keeping the eurozone afloat, amid scared investors and depression-level unemployment in Spain and Greece, will become even harder.

The risk of a renewed global banking crisis triggered by sovereign defaults in Europe would escalate sharply. Nor could the U.S. or Europe deploy the policy arsenal they possessed in 2008 to right the ship -- their fiscal and monetary bullets have been spent.

Confronted with this dire alternative, Obama will have to compromise by accepting a program of long-term cuts in social programs while Republicans accept phased tax increases -- both departing from their diametrically opposed electoral platforms.

As a minimum, this compromise will include a claw back of the payroll tax reduction, and of extended unemployment benefits as well as some expenditure cuts, adding up to 1% to 2% of U.S. GDP in 2013.

The likely effect will be that the recovery will remain sluggish, and the world's growth locomotives will again have to be found, if anywhere, in China and other emerging markets.

Quest: Which way will economy go?

The uncertainty surrounding the U.S. fiscal outlook is likely to persist for several months and if, as is possible, the only feasible compromise turns out to be temporary, new fiscal cliffs may loom in the future, extending the uncertainty over years to come.

This outcome is possible because the election outcome has not fundamentally altered the balance of forces.

An obvious implication is that the U.S. will remain fiscally bound as far as the eye can see. Europeans will have to rely on their own resource to deal with their dangerous crisis, with the U.S. urging action and support through IMF involvement, but without providing money for rescue programs either directly or indirectly through the IMF.

Read more: Second Obama term would confront fiscal crisis before inauguration

Resources for international aid will remain scarce and may be cut along with other programs. With the Europeans and the Japanese also retrenching, international organizations will increasingly look to China and other emerging markets for additional funds and new initiatives, buttressing the influence of the rising powers in their deliberations.

Perhaps fortified by weather events such as Hurricane Sandy, Obama's second term may bring renewed efforts to encourage control of carbon emissions through environmental regulation, which could yield some modest results.

However, given the profound skepticism about climate change in many quarters, the array of special interests in favor of fossil fuels, and the simple fact that the median American family has seen its living standards decline over many years, the appetite for increased gasoline or other carbon taxes will be low.

The new administration can be expected to pursue the development of shale natural gas (a clean alternative to coal) and reduced reliance on imported energy with alacrity. The positive effect on reduced gas prices in Europe and other regions of these new American technologies is already being felt.

Read more: Fiscal cliff looms over campaign climax

Increased use of natural gas in lieu of other fuels, and the continued "dematerialization" of the American economy, will in any event help mitigate the nation's emissions for a long time to come.

One arena where the new term may bring more daring initiatives is trade. This is ground where the administration and the Republicans in Congress may be able to join forces, perhaps as part of a broader bargain that would include tax reforms in support of business, and assistance for workers displaced by trade -- both of which Obama has also advocated.

Trade measures will likely include implementation of recently ratified trade agreements, determined pursuit of the Trans-Pacific Partnership, and may include a renewed effort to close on a low-ambition and partial Doha deal.

Markets may breathe an immediate sigh of relief that the election did not end in a dead heat or require extensive recounts, or pitted Obama against a Republican senate. Stocks in healthcare and in alternative energy may be boosted more durably by his re-election. But until the deadlock over how, and how quickly, to effect fiscal consolidation is broken for good, and U.S. politics finds a way to address the nation's structural challenges -- including exploding healthcare costs and its chronically low savings rate -- there is little reason to expect a trend shift in equity prices.

For the time being, the U.S. government continues to borrow at the most advantageous rates, in part for lack of better alternatives.

Everyone knows this cannot last -- how long it will is anyone's guess.

The opinions expressed in this commentary are solely those of Uri Dadush

ADVERTISEMENT
Part of complete coverage on
updated 12:34 PM EDT, Wed July 16, 2014
With cyberattacks on the rise and here to stay, it's a modern-day challenge for people and businesses to get smarter about preventing them.
updated 11:24 AM EDT, Sun July 20, 2014
Evidence points to pro-Russian separatists as perpetrators of the attack and Vladimir Putin is facing uncomfortable questions, David Clark writes.
updated 5:02 AM EDT, Thu July 3, 2014
Macau has overtaken Switzerland in the wealth stakes, being named the world's fourth richest territory by the World Bank.
updated 10:47 AM EDT, Fri July 18, 2014
Saudi Arabian Bateel brand is best known for its delectable dates but it now has more than a dozen cafes and a new bakery in the works.
updated 7:00 AM EDT, Thu July 17, 2014
A British nanotech company has created what it says is the world's darkest material. It is so dark the human eye can't discern its shape and form.
updated 12:02 PM EDT, Wed July 16, 2014
Jibo robot is designed to be an organizer, educator and assist family members. CNN's Maggie Lake met him and says she was impressed with his skills.
updated 5:09 PM EDT, Fri July 18, 2014
American burger joints have sprung up all over London, but how to know which ones are best? CNN's Jim Boulden investigates.
updated 8:22 AM EDT, Wed June 18, 2014
Sandwiched in between Iraq and Syria, Jordan's destiny seems to be one of a constant struggle for survival. John Defterios explains.
updated 11:02 AM EDT, Wed June 18, 2014
At the last football World Cup, it was all about 3D. This time around, it's nothing less than 4K.
updated 6:58 AM EDT, Wed July 16, 2014
Bob Mazzer has photographed inside London's Tube network for 40 years. He's captured history.
updated 1:12 PM EDT, Fri July 18, 2014
Exotic animals are becoming a profitable business opportunity for Nicaraguan entrepreneurs. CNN's Rafael Romo reports.
updated 11:29 AM EDT, Fri June 13, 2014
Iraq produces 3.3 million barrels per day and has the world's fourth-largest oil reserves. But the current crisis is putting all this in danger.
updated 8:22 AM EDT, Wed June 18, 2014
Sandwiched in between Iraq and Syria, Jordan's destiny seems to be one of a constant struggle for survival. John Defterios explains.
updated 9:14 AM EDT, Mon June 16, 2014
The gas standoff between Russia and Ukraine could have a knock-on effect on Europe. Explore this map to find out why is the EU nervous.
updated 6:58 AM EDT, Wed July 16, 2014
Bob Mazzer has photographed inside London's Tube network for 40 years. He's captured history.
updated 8:06 AM EDT, Tue June 17, 2014
The UK capital promotes its tech stars and shows it can compete with Silicon Valley. Here are five companies that pitch to make it big.
ADVERTISEMENT