Fantastic Article by Ruchir Sharma in the Economic Times Mumbai on Monday 12 November 2012.
EXCERPTS: (I highlighted some sentences in red colour for emphasis)
Ruchir Sharma on Why Obama won?
Even before the vote, prognosticators like Yale's Ray Fair who use just economic metrics to forecast election results pointed to a defeat for Obama, given persistently weak growth in per-capita income over his first four years. Fair was calling for Romney to win by a 51-to-48 margin. The polls showing that most voters saw the economy as the key issue only added to the mystery of how Obama beat the odds. The answer may be that, in their gut, voters understand that the US is not recovering from a normal recession, but from the worst crisis since the Depression, and, therefore, they chose to give Obama four more years, just as they did for Franklin Delano Roosevelt in 1936.
Historical evidence shows that the American economy has, in fact, not performed badly over the last four years, not when compared to its own previous track record in severe crises, or to other countries in similarly dire condition. The forecaster who expected an Obama defeat focused on how the debt problem is undermining US growth, which has fallen from a long-term rate of 3.4% in the decades before 2007 to just 2% this year, and is running slower than during the recovery phase of most post-war recessions. US economic output is now 10% below the trend line it was on before the crisis and still falling, which is the real reason for high unemployment. This case for the historically 'weak recovery' was the essence of the case against Obama's handling of the economy.
Voters seemed to choose, intuitively if not deliberately, the historical and global perspective of Harvard economists Kenneth Rogoff and Carmen Reinhardt, who argue that the relevant point of comparison is not the dozen or so recessions the US has seen since World War II, but the very different case of systemic financial crises. These are much more traumatic and rare, and by this standard, the US is recovering lost per-capita output faster than it did following previous systemic crises, from the meltdown of 1873 through the Depression of the 1930s, and also faster than most of the eurozone nations following the systemic crisis of 2008.
Ruchir Sharma on US FISCAL CLIFF - on US SPENDING CUTS - on US DEBT
He stresses the importance of debt reduction through spending cuts rather than tax increases.
The history of financial crises suggests that Washington has to get moving and address the debt burden now. In the developed world, the two most successful cases of recovery from a debt crisis were Sweden and Finland in the 1990s, and both began by cutting debt in households and corporations, while raising public debt to stimulate the economy. That is the path the US has followed - and followed more successfully than other rich countries since 2008 - with steep declines in US corporate and household debt. But this is the critical juncture. The Scandinavian cases show that, four years into the crisis or about where the US is today, the government needs to shift aggressively from stimulating the economy to putting in place a long-term plan to lower the public debt.
It can't be just any plan. From certain quarters of Washington, one hears a steady refrain about how the only way to balance the budget is to cut spending and raise taxes. But research clearly shows that the recovery is likely to be much stronger if the debt is reduced through spending cuts rather than tax increases.
Over the past quarter century, eight European countries have undergone periods of sharp government debt reduction, and those that reduced debt mainly or only through spending cuts, including Britain and Austria, saw their economies speed up during the belt-tightening process, and after some initial pain. In the Netherlands, Sweden and Finland, the governments actually lowered taxes while cutting spending, and saw the GDP growth rate accelerate, sometimes by a large margin. In the two best cases, Sweden saw its GDP growth rate roughly double, and Finland saw its GDP growth rate roughly triple, both to around 3%, which is very respectable for developed economies. In contrast, the countries of southern Europe - Italy, Greece and France - tried to put the budget in balance mainly through tax increases, and all of these economies saw GDP growth slow down.
So, economies digging out of debt perform better following spend cuts. But why? An August 2012 paper from the National Bureau of Economic Research, The Output Effect of Fiscal Consolidations, offers an extensive comparison of how countries have performed after periods of budget deficit reduction, and it concludes that the difference in results is nothing short of 'remarkable'. Spending cuts are typically followed by mild recessions, or no recession at all, while tax increases have been followed by prolonged recessions. The authors, Alberto Alesina, Carlo Favero and Francesco Giavazzi, note that the gap in performance is so sharp, it can't be explained away by differences in monetary policy; rather, the key seems to be the impact on business confidence compared to consumer confidence. Businesses tend to react to tax increases by dialling back, and to react to government spending cuts by investing more, which is what the US economy could use right now, when many businesses are sitting on record levels of cash on their balance sheets.
Regardless, the US economy looks likely to take some pain in the coming year, as Washington begins to deal with the debt problem. The market's worst fear is the 'fiscal cliff' that looms in January, when current law would impose a combination of tax hikes and spending cuts equal to 5% of GDP, which is likely to induce a recession if Congress doesn't act. However, a risk this clearly telegraphed typically gets resolved, even in Congress. The more likely risk is that Washington begins the process of debt reduction with a compromise package that could reduce growth by nearly 2% of GDP. That's a step in the right direction, long term, but could make for a rough 2013.
Over the coming decade, the global economic race will be decided in good part by which nations are first to tackle the debt problem, and one often overlooked factor is that the wealthy can cope with large debts more easily than the poor. By that measure, the total US debt burden of 350% of GDP may pose less of a challenge to Washington than, for example, China's total debt burden of 180% of GDP poses to Beijing.
The bigger picture for 2013 is that if Washington can produce a credible road map to lowering public debt, it could keep the US on track to be a Breakout Nation - as the strongest growth story in the developed world - this decade.