Deficits

The Sequester's Hidden Risks for the U.S. Economy


The Sequester's Hidden Risks for the U.S. Economy

Illustration by Al Murphy

It didn’t take long for sequestration to bite. Lines more than doubled at some of the nation’s largest airports on the first weekend after the across-the-board spending cuts took effect on March 1; and importers of tomatoes, peppers, and eggplants braced for long lines at border crossings as the Department of Homeland Security reduced overtime to save money.

The impact is almost certain to grow after agencies begin to furlough workers, which requires a one-month notice. If there are further delays at border crossings, at terminals for air passengers, and at food plants that don’t have enough inspectors, the ripple effects could reduce economic growth and hurt jobs and profits more than has been generally estimated. That’s a possibility that seems to have been ignored on Wall Street, where the Dow Jones industrial average surpassed its 2007 record on March 5.

Macroeconomic forecasts of sequestration’s impact don’t take into account the ripple effects from actions that interrupt business activity. Based simply on the drop in government spending, the Congressional Budget Office estimates that there will be 750,000 fewer jobs and that the economy will be 0.6 percentage point smaller with sequestration than without it in 2013. Business interruptions might push those estimates higher.

There could be a domino effect, as often happens in air travel, in which a delay in one location cascades into delays or cancellations far from the source of trouble. Because the economy remains soft, there’s probably enough extra capacity in most production and transportation networks to compensate for government-induced holdups, says Yossi Sheffi, director of the Center for Transportation and Logistics at Massachusetts Institute of Technology. But if systemic delays do break out, they tend to grow “very nonlinearly, very fast,” Sheffi says.

The lack of flexibility in the sequestration act makes matters worse. Agencies are mandated to cut across the board. They can’t move money between line items except with case-by-case written permission from the House and Senate Appropriations subcommittees that oversee them. At the Federal Aviation Administration, for example, “air traffic organization” is a separate line item from “finance and management.” So the FAA can’t keep traffic control towers open by dipping into the finance and management budget without committee chiefs’ approval. And because the parts of the Department of Transportation financed by trust funds are exempt from sequestration, the FAA is absorbing 60 percent of the cuts despite being only 20 percent of the Transportation budget, Administrator Michael Huerta testified in Congress last month.

That’s why the slowdowns at airports and border crossings experienced in early March could be just a foretaste of worse to come. “We have a very watchful eye on what’s happening,” says James Welch, chief executive officer of trucker YRC Worldwide. U.S. Customs and Border Protection said on March 4 that reduced staffing contributed to wait times of more than two hours on 70 flights at New York’s John F. Kennedy International Airport and 55 at Miami International Airport. Its hands tied by law, the Department of Homeland Security can’t unilaterally shift funds from elsewhere to relieve bottlenecks in the line item called “inspections, trade, and travel facilitation at ports of entry.”

Food inspection is another obstacle with potentially far-reaching consequences. Meat, poultry, and egg processors are prohibited from operating without the presence of federal inspectors. A 15-day furlough may cost the industry more than $10 billion in production losses, and workers may lose more than $400 million in wages, Agriculture Secretary Tom Vilsack said in a Feb. 5 letter to Senate Appropriations Committee Chairwoman Barbara Mikulski (D-Md.). Even housing is likely to be hurt if cutbacks at the Federal Housing Administration slow the processing of FHA mortgage loan guarantees. Since 2008 the agency has backed more than a quarter of mortgages.

Markets and many economists have taken sequestration in stride so far, with some dismissing the Obama administration’s warnings of trouble as scare tactics. Bhaskar Chakravorti, an economist at Tufts University’s Fletcher School, says he’s more worried about the long-term damage to U.S. competitiveness from cuts in education and scientific research than he is about short-term blockages. An index of U.S. policy uncertainty created by Spanish bank Banco Bilbao Vizcaya Argentaria (BBVA) spiked in December during fiscal cliff negotiations but plunged in February to below its nine-year average. Michael Feroli, chief U.S. economist of JPMorgan Chase (JPM), says he left choke-point effects out of his calculations of sequestration’s impact because he doesn’t think they will be big enough to matter. “I think it will be an inconvenience more than anything,” Feroli says. Air travel delays, for example, will annoy people without showing up in measured gross domestic product declines, he says.

That remains to be seen. When airports were shut down briefly after the terror attacks of 2001, “all the supply chains went crazy,” recalls Arnold Maltz, a professor of supply-chain management at Arizona State University. “It took people months to recover from that.”

The bottom line: The government’s estimates that the sequester will result in 750,000 fewer jobs may prove to be too conservative.

With Todd Shields, Alan Bjerga, and Kathleen M. Howley
Coy_190
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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