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Blame Washington for the GDP Dip

Rick Newman

Those Washington politicians think they're awfully important. Unfortunately, they're right.

The economy nose-dived during the last three months of 2012, with GDP shrinking by 0.1 percentage point, according to the latest government figures. That's the first time the economy shrank since 2009, during the final months of the recession. Most economists expected slow growth of 1 percent or so, but few predicted the size of the economy would actually decline.

One quarter of negative growth doesn't mean we're in a recession, and it's possible the discouraging GDP number could end up being revised higher, which happens sometimes. On the other hand, another quarter or two of such weak performance probably would signify a recession. More ominously, the forces that pushed down GDP at the end of 2012 are likely to intensify in 2013.

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The big drag on growth in the fourth quarter was a 22 percent drop in defense spending. That fell because of the coming "sequester," a big set of spending cuts Congress first approved in 2011. The idea back then was to implement across-the-board spending cuts of about $110 billion per year, for 10 years, if Congress couldn't come up with a better way to start reducing the $16 trillion national debt. Congress couldn't, so those cuts were scheduled to go into effect starting Jan. 1, 2013.

The last-second fiscal cliff deal delayed those cuts by two months, giving Congress time to come up with a better plan. But defense agencies, not knowing what Congress would end up doing, apparently started to cut spending anyway late in 2012, anticipating that the cuts would go into effect. That makes sense, because you can't run complex, billion-dollar programs by simply turning off the flow of money as the calendar flips from one day to the next. Like any business, defense programs require extensive planning.

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Congress, however, is making a rational spending strategy virtually impossible. What it ought to do is lay out a long-range plan for gradually reducing spending and fixing Washington's finances, with clear deadlines that allow for predictability. Instead, Washington is consumed with petty brinkmanship that is harming the economy in real, tangible ways.

President Barack Obama isn't helping either. He ought to lay out clear spending priorities that gives Congress a template to work from. Yet he's playing his own tactical games with Congressional Republicans, hoping to gain political leverage that will carry him through his second term.

Dallying on the national debt means Congress faces yet another deadline for those $110 billion worth of spending cuts. If they kick in on March 1, it would cut GDP growth by 0.7 percentage points, according to forecasting firm Macroeconomic Advisers. The economy's weak performance in the fourth quarter of 2012--which occurred before any spending cuts were actually legislated--suggests there could also be potent knock-on effects that damage the psyche of the markets and harm the economy even more.

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There's a blithe assumption in Washington that as long as policymakers reach some kind of last-minute deal on every contentious matter, everything will turn out fine, with no net harm to economy. There's a pile of evidence that demonstrates how wrong that idea is. Political infighting has severely damaged trust in the U.S. government and harmed America's reputation. Global business leaders view it as increasingly risky to invest in the United States, largely because of manic policymaking (or no policymaking) that creates a needlessly turbulent business environment. In the latest survey of global competitiveness by the World Economic Forum, the United States ranked 41st in the quality of its institutions and 111th in macroeconomic stability. The world's model for democracy? Not any more.

There are signs that poor policymaking is already harming the economy in 2013. After rising for most of 2012, for example, consumer confidence has plunged so far this year, largely because of tax hikes that will reduce take-home pay for many Americans in the coming year. If the gloom persists, it will cut into spending, make businesses even more reluctant to hire and raise the risk of a recession.

Congress showed one flash of responsibility recently, by agreeing to temporarily extend the government's borrowing limit instead of forcing a destabilizing showdown and threatening default, just to make a point. Several more big decision points are coming soon, when politicians can either find a way to govern or cultivate friction and decline. The economy's recent performance suggests the odds are falling the wrong way.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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