For months now, commentators and economists have been warily eyeing the U.S. economy and asking what will cause the next recession. Risky corporate debt seemed to be building up in the system, but with profits robust and interest rates low, servicing the debt didn’t seem to be a problem. The Federal Reserve raised rates by a modest amount, but signaled that it didn’t have much appetite for future increases. President Donald Trump’s trade war didn’t seem to be having much effect yet.
Then came the government shutdown. In an attempt to force Congress to build a southern border wall, Trump has caused about 800,000 government workers to be furloughed, or in some cases work without pay.
On one hand, that’s not a huge number of workers — only about 0.5 percent of the labor force. And those workers are slated to receive back pay once the shutdown ends. But while they’re not earning money, it’s much harder for them to make payments on their credit-card debt, mortgages, cars, not to mention rent and grocery bills.
And in the meantime, many government services are simply not being provided. The Transportation Security Administration is struggling to perform security screenings for air travel, leading to long lines and congestion. The loss of those services will undoubtedly gum up the wheels of the American economy.
In addition to those 800,000 workers, a much larger number of government contractors is going without pay. The shutdown is reducing payments to contractors by about $245 million a day, or about 0.4 percent of daily gross domestic product. Some estimates put the number of workers who will be affected at more than 4 million — and unlike government employees, contractors won’t receive backpay once the shutdown ends.
Together, those 4 million contractors and the 800,000 furloughed employees constitute about 3 percent of the country’s labor force. That number is heading into territory that could have macroeconomic implications — for comparison, the increase in unemployment in the typical recession is usually about 2 percent to 4 percent. Furloughed workers and unpaid contractors are not quite the same as unemployment, but the macroeconomic spillovers might be comparable.
But the real damage to the economy could come not from cutbacks by workers, but from reduced investment by companies. Private investment tends to be more volatile than either consumption or GDP; in good times it soars, and in bad times it plunges:
Companies might delay investment due to regulatory disruptions — already there are ominous signs. Thanks to the lack of government workers to grant regulatory approval, new products from aircraft to beer to trucks can’t be released. That uncertainty will almost certainly give companies pause about investing. If anxieties about the decline in demand due to the shutdown make companies even more reluctant to invest, the result could be that many businesses stampede for the exits. And since many businesses serve other businesses, a lack of investment could quickly ripple through the supply chain. A general slowdown in business activity would result, with the attendant layoffs, pay freezes and cuts — in other words, a recession.
Economists Scott Baker, Nicholas Bloom and Steven Davis have tried to measure the public’s uncertainty about the course of government policy by analyzing the text of news stories. They found that spikes in their index were often followed by recessions. Of course, it’s not always clear whether erratic policies hurt the economy, or whether a slowing economy makes the public worry more about policy. But either way, it’s concerning when Baker et al.’s index rises to unusually high levels. Figures for January aren’t available yet, but in December the index was rising ominously:
And this is just the U.S. If the rest of the world starts to worry, the troubles Trump is creating could go global.
Trump’s record shutdown is the latest in a long, frightening trend of U.S. politicians intentionally creating government dysfunction in order to force their opponents to accede to their demands. The government shutdowns of 1995, 1996 and 2013 were harbingers of the current troubles. But so were the debt-ceiling crises of 2011 and 2013, in which Congress threatened to let the country enter into a technical default on its debt if President Barack Obama didn’t meet its demands.
So far, none of these battles has caused a recession. Let’s hope the current shutdown ends before the harm it does to the economy becomes too severe. But just because the U.S. has managed to dodge several bullets doesn’t mean that its leaders should keep firing more bullets. Eventually, it seems likely that businesses consumers and other countries will decide that the U.S. is not the bastion of predictability and stability it once was. And the loss of that confidence will be very bad news for the U.S. economy.
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.