May 9, 2024 - Economy

America’s political polarization could cost the U.S. economy

Illustration of the United States flag with the stars replaced by dollar signs

Illustration: Sarah Grillo/Axios

Despite it all — disputed elections and a Capitol insurrection, debt ceiling showdowns and massive fiscal deficits — global investors have shown unwavering confidence in the U.S. government.

The big picture: If that were to change, even just a little bit, it would be awfully expensive, warns a new paper from a former Biden White House economist.

Why it matters: The U.S. enjoys a "safe harbor premium." It is viewed globally as among the most sound and stable places on Earth in which to invest. That results in lower borrowing costs for U.S. citizens, companies and government entities, and more abundant foreign investment.

  • But if global investors start to view the U.S. political environment as creating economic risks, that could change abruptly, writes Ernie Tedeschi with the Yale Budget Lab.
  • Tedeschi, formerly chief economist at the White House Council of Economic Advisers, sought to quantify the potential cost of global investors' loss of confidence in U.S. political and economic institutions.

Zoom out: Investors in emerging markets are inherently making bets about the stability of countries where they consider buying bonds or building a factory.

  • Will courts enforce contracts fairly? Will my funds be expropriated by a political leader? Will the central bank allow hyperinflation?
  • But even in stable, affluent countries, the same dynamics can apply, if less dramatically.

State of play: The U.S. currently enjoys zero risk premium, according to data Tedeschi cites from NYU Stern economist Aswath Damodaran, meaning investors do not demand any extra compensation for deploying capital here.

  • It's one of only a handful of countries of which that can be said, a list that includes Canada, Australia and Switzerland.

By the numbers: Other wealthy, advanced economies have a significant premium. It's 0.72 percentage points for France and over 3 percentage points for Italy and Greece.

  • Britain's number was 0.48 percentage points in the immediate aftermath of its Brexit vote, and has risen to 0.88 points amid a revolving door of prime ministers (five of them since 2016!).
  • By Tedeschi's calculations, if the U.S. risk premium rose merely to the level of Britain, over 10 years it would reduce Americans' wealth by $50,000 per household and reduce GDP by 1 percent.
  • In a more dire scenario in which a crisis causes U.S. political risk to surge toward Italian or Greek levels, it would cause a 3.5 percent hit to GDP and earnings per worker falling by $5,900 over a decade.

What they're saying: "If you're talking about a contested election or political chaos, the question is 'what does that mean for me as an investor?'," Tedeschi tells Axios.

  • "Even advanced economies have gone through this, and not collapsed but had a little bit more risk and been a little bit less favorable destinations for investment," he says.
  • Global investors' views of U.S. soundness "may end up being much more fragile than we thought," Tedeschi says.
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