As the global economy weakens and markets grow more volatile, it is hard to imagine a worse time to stop 25% of US federal spending for over a month. The government shutdown has already cut into the pocketbooks of hundreds of thousands of government employees and contractors who rely on a federal paycheck. While the markets have been largely ignoring it so far, the absence of so much government activity is gathering force. It’s hard to believe it won’t damage the economy.
Previous experience shows that the price of long shutdowns is always high. There have been 18 budget stalemates since 1974 that forced at least partial government closures (under presidents Ford, Carter, Reagan, Bush Sr, Clinton and Obama). The 16-day day shutdown in 2013 cost the federal government $2.5 billion in lost productivity, slowed GDP growth, and lowered consumer and investor confidence, according to the Congressional Research Service.
Regardless of who is declared the political “winner” of the current shutdown, this protracted episode will produce economic damage. Aside from the well-publicized direct costs, there are at least five hidden costs a shutdown of this magnitude.
First, the loss of government spending has multiplier effects that ripple across the economy. Every $1 of reduced federal spending can lower GDP by between $0.40 and $1.90, according to the Congressional Budget Office.
President Trump’s own Council of Economic Advisors reports that the current shutdown is lowering quarterly economic growth by 0.13 percentage points per week. This means the closure has already shaved a one-half of a percent off growth for the first quarter.
Second, there is a downstream impact on regional economies. Places that have a high percentage of federal employees and contractors (like Northern Virginia and Maryland) suffer disproportionately from shutdowns. Nationwide, states derive some 30% of their revenues from federal aid and grants. Yet local jurisdictions still have to keep schools and programs open even if the federal government has shut off the flow of funds. This means that local taxpayers may wind up paying more to close the gap. Rural states like Montana and Alaska are especially afflicted by the shuttering of the Departments of Interior and Agriculture.
There is also a direct hit to federal employees and contractors. Although the plight of 800,000 federal employees has been widely publicized, the economic impact is likely to be even more severe for federal contractors—who outnumber federal employees by 2:1. Over the past 20 years, budget pressures have forced government to rely increasingly on the private sector to help deliver virtually every government program—from food and water inspections to cancer research.
This work is completely stymied during a shutdown. Contractors are not allowed to access government space, use federal IT systems, or even to work remotely. For many contractors, especially small businesses, the loss of billing revenue threatens payroll, and may jeopardize their access to bank credit and relations with suppliers and vendors. Some companies may be so fed up with Uncle Sam that they refuse to work for the government in the future or re-assign their best talent to non-government projects. At a minimum, most contractors may demand higher prices to cover the perceived higher risk.
Another cost to the broader business community is the interruption in the availability of basic economic data—which the federal government normally compiles on a regular basis. As Robert Shapiro, a former Under Secretary of Commerce points out, the cancellation of government reports on manufacturing sales, retail sales, residential construction and other vital information will complicate planning efforts for businesses across the country.
Finally, the shutdown will cost all taxpayers more in the long run, as the government scrambles to reorganize complex projects and to make up for lost work. For example, the 42,000-person Coast Guard has been carrying out essential operations, such as such as search-and-rescue efforts, without pay for the past month. But it has delayed many important but routine inspections and activities. The agency will need extra funding in order to rapidly catch-up when the government re-opens.
Beyond the direct economic costs, the shutdown is likely to further erode public confidence in the ability of government to get anything done. According to Pew Research, only 18% of Americans say they can trust the government in Washington to do what is right “just about always” (3%) or “most of the time” (15%)—a historic low.
Leading companies tend to view their employees as a core asset. By contrast, the U.S. government is treating its workforce like pawns in a political game of chess. Nearly half the federal workforce is already eligible to retire. After this fiasco, they may do it sooner rather than later—crippling the capacity at some agencies. Young people considering careers in the federal government are likely to think twice about the idea.
Like medieval duels, shutdowns are a crude and ineffective way to settle budget disputes. It is time to fix the budget process by strengthening budget committees, adopting cost accounting techniques, aligning federal and state budget cycles and setting up platforms for legislators to consider all revenues and expenditures at the same time. Until we tackle this underlying budget dysfunction, the U.S. will continue to inflict economic harm on ourselves through periodic shutdowns.