Why the U.S. midterm elections are bad for the global economy

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With all of this incessant talk about the decline of American global influence, we tend to forget that the U.S. is still by far the world’s largest economy, and what happens in the U.S. matters to everyone, everywhere. That’s why people from Beijing to Brasilia are watching the midterms with heightened interest. Shifts in U.S. policy, on issues such as trade, China, the budget, banking reform and so on, directly impact the global economy and attempts to reform it. And with the Republicans taking control of the House of Representatives (but not the Senate), we’re definitely in for a shift from the politics and policies of the first two years of the Obama presidency.

What do those shifts mean for the world economy? My guess is: Nothing good. Here’s why:

First, we’ve got the gridlock problem. A divided Washington probably means that not much will get done to aid the stalling U.S. recovery. Forget about a second stimulus. We’re more likely to see extra pressure on Obama to cut spending. And that’s not good for growth. Longer-term issues, such as financial reform, could just drift. Here’s what economists at BofA Merrill Lynch had to say in a recent report:

We believe the real issue for the economy is whether the two parties can work together. A popular Wall Street adage is that “gridlock is good” because it keeps the government from implementing new policies that further intervene in the private economy. However, the short-term gridlock is very bad for the outlook, in our view. Absent a compromise, there will be a major tax shock at the start of next year as all of the tax cuts enacted under President Bush expire. Other near term challenges include: the expiration of extended unemployment benefits, rising protectionist pressure and the implementation and modification of health care and financial reform. Longer term, a massive structural deficit needs to be sharply reduced. Meeting these challenges will require at least some compromise.

With an emboldened GOP, I can’t imagine a new, bipartisan spirit emerging out of this election, and that means continued uncertainty in U.S. economic policy – and the U.S. recovery. And the fact is, we can’t have a true global recovery from the Great Recession without a sustainable revival in the American economy, however strong the rebound in China and its emerging-market cousins might be.

Confusion in Washington could translate into confusion in global economic policy. Next week, Obama heads to the G20 summit in Seoul, where the world’s leaders will tangle with sticky issues such as banking regulation, currency wars and global imbalances. America is expected to play a decisive role at such forums, to act as an advocate for the tough measures needed to tackle these long-term problems and bring the global economy back to a healthy growth path. But I fear a weakened president facing grave opposition back home may be on unstable ground when trying to forge international commitments that place the good of the world over the narrow interests of each nation.

In fact, the midterms may have made the U.S. an even bigger part of the problem. The spirit of cooperation among the world’s disparate nations that prevailed during the early days of the Great Recession has been degenerating with the strength of the recovery, raising fears of widening currency conflicts and protectionism. The political rhetoric of the campaign makes it more likely that the U.S. will become one of the combatants, rather than the peacemaker. China was used as a favorite punching bag for America’s economic ills during the campaign. Even Senate majority leader Harry Reid jumped in. That raises the political pressure for Obama and Congress to take real, punitive measures against a China portrayed as not playing fair in world trade, stealing American jobs and stifling the U.S. recovery. Perhaps the controversial House bill aimed at punishing China for supposedly keeping its currency undervalued has a better chance of passing through the Senate, tipping off a trade war between the world’s two largest economies.

The whole tenor of the election was decidedly anti-trade. One campaign ad, in which Congressman Zack Space accused his opponent of supporting policies that shipped jobs to China, ended with the line: “Free trade isn’t free.” That makes it less likely that Congress will endorse the free-trade agreements – such as the one pending with South Korea – that could stimulate American exports.

My fear is that the America emerging from the midterms elections will be an indecisive America, an America that lashes out to preserve its own perceived interests rather than one that seeks cooperative solutions to the world’s economic problems. The global economy needs American leadership, not American anger.

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