Monday, December 31, 2012

Obama, A Bad Deal, and the Fiscal Cliff

There is a lot of rending of garments and gnashing of teeth, as well as criticism about Obama, among liberal pundits with regards to what we're hearing about tentative deals regarding the fiscal cliff.

I have a couple of thoughts. First, I largely agree it's a bad deal. Our current political culture and incentives probably make this necessarily so. Republicans have been pulling a bait and switch with regards to spending cuts since Obama took office, they are eager to talk about them in the abstract but refuse to vote on anything (Paul Ryan at least proposed cuts, but it is notable these weren't voted on) that would make large cuts to any major programs. They have managed to maintain public belief in large amounts of wasteful spending on programs that don't benefit anyone, while simultaneously attacking Democrats whenever Democrats propose spending controls on the three big budget busters, Medicare, Social Security, and the Defense Department. The only cuts that seem to pass is to programs to help the poor (which most analyses show increase economic growth by much higher margins than the taxes to pay for them decrease growth), and that's not where the money is at. So an impasse is somewhat necessary, everything we actually spend money on is sacrosanct in public opinion, while there remains a widespread belief that we are spending large amounts of money on things we aren't spending money on that could easily be cut.

That said, this doesn't matter very much to the current negotiation. There is no way to reach an agreement that is consistent with the public's priorities on taxing and spending, since the public is misinformed about what we spend on, so it is largely irrelevant.

What is relevant is who is going to agree to an unpopular deal and why. Here I think Obama's motivations differ from other actors. While having little control over the economy, many people do ascribe responsibility to the President for the economy's state. Given this, I think it is perfectly understandable that Obama will cave on the cliff, even if this weakens the Democrat's long term goals.

The reason is rather simple. While the odds may be low that the fiscal cliff will tip us into a major recession, there is some risk the economist's are wrong about this. We do know that austerity is bad for growth, we can' be certain that the austerity from the fiscal cliff (or austerity bomb or whatever your favored phrase is) won't be too much too soon and tip us into a self-reinforcing downward economic spiral, like the 2007-2008 recession. Since Obama likely feels a sense of responsibility for this, unlike other actors he has a strong incentive to avoid the possibility of a large downside tail risk. It may be that he is choosing a certain minor loss relative to what he should be getting given his relative negotiating position, but he is doing this because he is the individual that feels responsible for the outcome and given this, he has a responsibility to avoid even long odds on a nationwide catastrophe.

To sum up, I don't really like the deal, but given his position I think it makes perfect sense to take it. I think most any of us would if the responsibility for what happens lay with us, the small chance of a really bad outcome outweighs the certainty of a somewhat bad outcome.

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