Republicans Face Uphill Battles in 2014 and 2016

Friday, 11 Oct 2013 07:53 AM

By Barry Elias

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The recent government shutdown will most likely exacerbate the historically high economic uncertainty index. As a result, the Republicans can expect more difficult challenges in the 2014 and 2016 elections, since they will rightly receive most of the blame for this debacle.

In an article more than two years ago, I highlighted a disturbing divergence from the Beveridge curve, which measures the relationship between the percentage increase in job vacancies and the decrease in the rate of unemployment. As the percentage of job openings rise, the rate of unemployment drops, since there is a stronger demand for labor relative to supply.

However, since the Great Recession, we have experienced much higher rate of unemployment — perhaps as much as 2 percentage points more — relative to the percentage increase in job vacancies, based on historic standards over the past 70 years.

The principle reason for this divergence is due economic uncertainty, according to Nick Bloom and Scott Baker of Stanford University and Stephen Davis of the University of Chicago, as described by their economic uncertainty index. The index was derived by a statistical technique for which Christopher Sims was awarded the 2011 Nobel Prize in economics, according to William Galston, a senior fellow at the Brookings Institution and former policy advisor to President Clinton and presidential candidates.

The economic uncertainty index consists of three components: 1) newspaper coverage of economic policy uncertainty by 10 large newspapers, which include The Wall Street Journal and The New York Times; 2) tax code provisions that are set to expire over the next 10 years based on reports from the Congressional Budget Office; and 3) the dispersion of individual forecasters from the Federal Reserve Bank of Philadelphia's Survey of Professional Forecasters with respect to the Consumers Price Index and federal, state and local government expenditures.

From 1985 through 2007, the index maintained a fairly stable range, with spikes for unusual events, such as the 9/11 terrorist attacks. However, following the inception of the 2007 recession, the index changed drastically. Economic uncertainty is now more than double the average over the past 23 years, a reflection of uncertain future policy prescriptions and the accompanying effects.

These areas of concern include the debt, taxation, healthcare (Affordable Care Act) and financial regulation (Dodd-Frank). In fact, the highest recorded level of uncertainty occurred in mid-2011 during the debt ceiling debate, which narrowly averted a U.S. default on interest and principle debt payments.

According to Sylvain Leduc and Zheng Liu of the San Francisco Federal Reserve Bank, nearly two-thirds of the shift in the Beveridge curve is the result of economic uncertainty. Since 2009, job vacancies have risen, yet unemployment has dropped more slowly. Increased uncertainty may discourage businesses from filling vacancies, thereby increasing unemployment.

They conclude this uncertainty has translated to a 20 percent decline in the business recruitment index during the Great Recession from late 2007 to mid-2009, with very little recovery since. In addition, they estimate, without this added uncertainty, unemployment at the end of 2012 would have been near 6.5 percent, or 1.3 percentage points lower than the actual rate of 7.8 percent.

As much as a third or more of the Beveridge shift might be the result of poor education and training over the past several decades, where the supply of labor is not sufficient to meet global demand.

Typically, uncertainty falls after a recession. However, since the recession ended in 2009, uncertainty has been rising quickly. As uncertainty rises, consumption and business investment stall or fall, leading to stagnating economic growth, employment and income. In fact, uncertainty may be the highest in history, comparable to the Great Depression years.

The recent government shutdown and impending debt ceiling negotiations will certainly increase the economic uncertainty index. Most of this blame will probably be laid rightly on the Republican doorstep. They made a huge mistake in tying the defunding of the entire Affordable Care Act to the continuing resolution (CR) to fund the government.

A better strategy would have been to insist on equal treatment under the law in order to secure the CR, where subsidies are not given to legislators and their staffs, a ruling that does not apply to the general population.

This scenario will have negative ramifications for the Republicans in the 2014 and 2016 elections.

By applying the laws to all equally, future government shutdowns should include the elimination of salaries and benefits for all federal legislators and executives along with their staffs. Once the government reopens, these benefits can be reinstated, but not retroactively.

I suspect this strategy would greatly reduce the probability of future government shutdowns, thereby increasing economic certainty and prosperity.

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