Industry Market Trends

Industry Experts: What the Fiscal Cliff Means for Manufacturing

Dec 18, 2012

With the fiscal cliff deadline rapidly approaching, the U.S. economy is poised to take a severe hit from major spending cuts and tax increases.  Experts from ISM and MAPI tell IMT about how these changes would affect the industrial sector and what manufacturers can expect if the country goes off the cliff.

Although fiscal cliff measures have yet to take effect, the risk of government spending cuts and tax increases  is already having a negative impact on business prospects, particularly in the manufacturing sector.

"We pick up on the fiscal cliff issue in our comments panel. We have about 350 respondents out there in sectors of the manufacturing economy right now, and they're supply people, not economists, so they don't know quite what to make of the fiscal cliff, but they know it's scary," Bradley J. Holcomb, chair of the Institute for Supply Management's Manufacturing Business Survey Committee, told IMT. "Taxes will be higher, spending will be cut - it's a worst-case scenario. None of those outcomes are comforting. The threat of the cliff is causing companies to hold back on capital spending, hiring and on inventory. We've seen that in the last few months, manufacturing is basically going sideways."

According to estimates from the non-partisan Congressional Budget Office, the automatic enforcement procedures detailed in the Budget Control Act of 2011, commonly known as the fiscal cliff, would create economic conditions that would plunge the economy back into a recession. The budget deficit would shrink to roughly $641 billion in fiscal year 2013, with real gross domestic product (GDP) decreasing by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to 9 percent in the second half of next year.

Daniel J. Meckstroth, chief economist at the Manufacturers Alliance for Productivity and Innovation (MAPI), told IMT that manufacturing production is set to increase 2 percent next year, but economic models indicate that going off the fiscal cliff will take 3 percentage points off production growth, resulting in a net decline of 1 percent. The overall impact will push the economy into recession for two quarters due to the combination of immediate tax increases and immediate spending cuts.

Companies that rely on government contracts would be especially hard-hit by the projected spending and budgetary reductions.

"Defense contractors will lay off people on January 1 - they have to. Either they get paid or they don't work, and they're going to be cutting back. That will have a supply chain impact on other companies throughout the manufacturing sector," Meckstroth added. "This isn't like Hurricane Sandy; this isn't something you can't plan for. It's a known risk, so it's prudent to plan ahead and that means cutting hiring, cutting spending and sometimes making layoffs."

Apart from manufacturing, fiscal-cliff-related changes would have a significant influence on consumer spending, which constitutes approximately 70 percent of the U.S. economy.

"It goes beyond manufacturing, which is driven by new orders," Holcomb explained. "These orders ultimately are driven by the consumer, and the consumer is reluctant to spend a lot of money to boost the economy. It's everybody's problem. The uncertainty is shared by everyone, and it's impeding growth."

Despite several rounds of negotiation, the federal government has failed to reach an agreement that would resolve the fiscal cliff. President Obama's central position is to extend existing tax cuts for those earning less than $250,000 a year, while increasing taxes for top earners for a goal of $1.6 trillion in new revenue and making targeted spending cuts in defense and non-defense budgets, as well as certain benefits programs, such as Medicare.

Republicans prefer a plan that would not raise taxes on any part of the population, but make up the difference through additional revenues by closing tax loopholes, capping deductions and making steep reductions in Medicare, Social Security and entitlement programs.

While the government appears to be deadlocked in its negotiations, many experts predict that a last-minute resolution, based on a compromise between the two opposing sides, will come through.

"There will likely be spending cuts and tax increases. It's unrealistic to project that all the deficit reductions can be done through taxes because there's not enough money there long-term, and there's not enough on the other side to get through all the entitlement cuts and spending cuts," Meckstroth explained. "Any agreement will almost certainly involve a combination of tax increases and spending cuts. However, these 'cuts' are really reductions in the rate of growth, they're not outright cuts."

However, given the current timeframe for reaching an agreement and the entrenched viewpoints that are steering the debate, any resolution made prior to the deadline is likely to be a temporary measure.

"I think we'll get to the end of the year and they'll settle on another delaying resolution to pass the problem along to the next Congress," Meckstroth added. "It's too big to be solved in the next couple of weeks. The negotiating positions are being laid out, they'll argue and gnash their teeth, but it won't get done permanently this year. It could, but it won't."

Even with a delaying resolution that puts off a final decision until later in the year, most manufacturers are hoping for some level of bipartisanship in the temporary plan, which would at least improve confidence in the government's ability to function effectively.

"Everyone is hoping for a bipartisan resolution that minimizes increases in taxes, and minimizes spending cuts as well," Holcomb said. "Overall, if Washington starts collaborating again in favor of U.S. business and manufacturing (and the fighting and bickering and polarization in Washington have not gone unnoticed), it will have a positive effect. It's disturbing when they're bickering rather than working to find solutions. This creates a lack of confidence in the process itself, and manufacturers are very process-oriented."

Despite the threat of another economic downturn, the fiscal cliff may prove beneficial for the U.S. economy in the long run. According to Meckstroth, under current projections for the debt-to-GDP ratio, the only way to stabilize and eventually reduce annual deficits over the next decade is to craft a balanced plan with a goal of having an under 2 percent deficit by 2022.

"It's something that has to be done because the alternative is so much worse," he noted. "We had to get to a point where we were forced to face the issue and we have no other choice but to recognize the problem now. There will be austerity going forward, we'll have slower growth in the short term, but in 10 years we'll be in better shape."