Friday, absent Congressional and Presidential action, the Budget Control Act’s Sequester kicks in, forcing across-the-board spending cuts of $1.1 trillion spread out over nine years, with $85 billion cuts coming in 2013. Without question, this reduction in federal spending will impact the economy, particularly as we measure it. Government spending is a component of aggregate demand, and reduced demand in the economy will have its consequences. Also, government spending is a component of Gross Domestic Product (about 23% of it), and since recessions are indicated (in part) by declining GDP, a cut in federal spending increases the probability of an indicated recession by the simple math of it.
While such mandatory cuts will be painful, there nonetheless may be a “silver lining” to the Sequester: Forced reductions to the operating budgets of many federal regulatory agencies may lead to increased economic growth.
As we noted last year in our paper entitled Regulatory Expenditures, Economic Growth and Jobs: An Empirical Study, my colleagues and I at the Phoenix Center used fifty years of data and modern econometric methods to quantify the relationship between government spending on regulatory activity and the important goals of economic growth and job recovery. We found that reducing the size of the federal regulatory budget by even modest amounts will have significant positive effects on both GDP and private sector job growth. Since a portion of the Sequester cuts hit regulatory agencies, these mandatory cuts may offer a positive influence on economic activity.
Assessments of the budget impacts of the Sequester indicates that a number of federal regulatory agencies will see meaningful cuts. The budgets of the Department of Energy, the Environmental Protection Agency, and the Department of Labor are expected to see cuts of about 8%. Not all regulatory agencies are affected, however.
Using the results from our study, we can make some predictions about how the Sequester’s mandatory budget cuts may positively impact our economy. As you can see in the table below, our analysis indicated that even a small 5% reduction in the regulatory budget will result in about $75 billion in expanded private-sector GDP each year. While the reduction in spending will reduce government employment by about 12,000 jobs, the economy is predicted to see an increase in employment of 1.2 million jobs annually. Roughly, eliminating the job of a single regulator grows the American economy by $6.2 million and nearly 100 private sector jobs annually. A regulatory budget cut of 10% produces an additional $149 billion in GDP and 2.4 million private sector jobs. As we measured it, the decline in the regulatory budget is likely to be closer to the 5% figure, so it may be that whatever economic activity is lost from the reduction in government expenditures, it could be made up by the stimulation of economic activity in a less-regulated economy.
It is, of course, hard to say exactly what the full economic impacts of the Sequester will be, since its implementation will be complex, spread over time, and distributed across a number of agencies and economic sectors. However, the Sequester does reveal a lot about the state of the country—i.e., our quality of government—than just the immediate impacts of a spending cut. Sequestration is not just about dollars; instead, the sequestration process speaks (and has spoken) to the competence and courage of our nation’s leaders.