The Q4 GDP: Conservative Economics in Action, On To The Budget Battles

A Very Economically Conservative Quarter
The headline was scary - the US Gross Domestic Product contracted by 0.1% in the fourth quarter of 2012.  While this is just ever so slightly below the zero line, we are technically halfway to a new recession (traditionally defined as two consecutive quarters of contraction, although, in modern times, more complex definitions have been used) after what has been a less than stellar recovery from the last deep recession.

The recession more or less started in the first quarter of 2008 and lasted for 18 months.  During that time period, the size of our economy contracted by 4.6%.  This may not sound like a ton, but bear in mind that under "normal" circumstances, the economy needs to grow by 1% just to keep up with population growth and that contraction of the economy disproportionately impacts working class workers in industries like manufacturing, construction and retail and entertainment services, as belts tighten.

During the 18 month recession, unemployment skyrocketed from 5.0% to 9.5% (it would eventually peak after the end of the recession, in October 2009 at 10.0% - it is normal for unemployment to peak slightly after the recession ends, as companies don't start hiring until several months after business picks up) and 7.5 million jobs were lost, meaning that that the actual percentage of people working dropped even more than the official unemployment rate would tell.

Since then, the recovery has been painfully slow, against the norm for recessions (although, many would argue, not for recessions born of deep financial crises) and against the predictions of many, including myself, who expected a more "V-shaped" recovery.  Average growth in the 3+ years since the recession ended has only been 2.3%, which would be okay if the starting point was a healthy economy, but nowhere near sufficient to relieve the pain caused by the recession.  Unemployment has fallen to 7.9%, lower than the peak certainly, but way above pre-recession levels.  There are STILL 3.2 million less jobs now than when the recession started 5 years ago.  And it wasn't until the fourth quarter of last year that the GDP surpassed its pre-recession level.

This gap would make the fourth quarter GDP contraction very troubling.  But, looking at the internals, things aren't as bad as they appear on the surface.  This quarter is actually a positive argument for economic conservatism and austerity, if you look under the covers.

You see, while the overall GDP contracted by 0.1%, private sector GDP rose by 2.6%, while government expenditures at all levels fell by 2.7%.  In other words, the private sector is in recovery, as evidenced by rising corporate earnings and corresponding rising stock prices.  It is government that is shrinking.  Most of the reduction is coming at the state and local level, as governments are forced to balance their budgets and (with California as a big exception) are largely turning to reducing government spending as opposed to raising taxes to make ends meet.  There has also been some reduction of federal expenditures and some modest cuts from prior budget deals take effect and we lap the tail end of the stimulus spending.

So why is this a good thing?  Employment in the quarter is actually the strongest it has been in a long time.  You see, while the overall economy contracted, just over 600,000 net jobs were added in the quarter, even more than that in the private sector.  In other words, at least for this quarter, the reduction in government spending did not have a dampening effect on the thing that matters most to the average person - available jobs.  Private sector hiring more than made up for public sector austerity.

This model seems destined to play out to some degree on the federal level as well.  Sequestration cuts take effect automatically on March 1st and the Republicans have been pretty clear that while they would like to replace the defense cuts, they have no interest in punting on the amount of the overall cuts.  Good for them - I hope they stick to their guns.  We have to solve the budget deficit one way or another and while we can argue the balance between tax hikes and spending cuts, doing something is better than doing nothing.

Also in play is the federal budget - the current continuing resolution lapses March 27th, which means that if Congress does not pass some sort of budgetary measure to fund the government, the government will shut down on that date.  Republicans, having had to give ground on the tax cut debate, since tax rates were slated to go up automatically, are not in a giving mood on the budget.  They, after all, hold the cards this time around - no budget can pass without the consent of the Republican-majority House.

With the debt-ceiling discussion wisely out of the way (sanity did prevail, as I'd hoped, on that topic, with the GOP agreeing to suspend the debt ceiling at least until mid-May, long after the budget battles), federal spending will be front-and-center in Washington.

These debates will play out over the next 1 to 2 months.

Rebuilding a Second-Term Cabinet
President Obama has some work to do.  Much of his first-term cabinet has left or is leaving.  Let's review the status of the key cabinet-level department head positions:

State Department
Hillary Clinton, as we all know, has moved on.  This is one that the President doesn't have to worry about as former Senator John Kerry has already taken the top job at state, confirmed easily by a 94-3 vote in the Senate.  He took office February 1st.

Treasury
Tim Geithner has already departed, officially resigning January 25th.  President Obama has nominated Jack Lew as his replacement.  Lew have his hearing in the Senate, but is widely expected to be confirmed, although he has generated some controversy.

Defense
Leon Panetta, President Obama's second Defense Secretary (his first, Robert Gates, was a keeper from the Bush Administration) is still in office but has asked to leave as soon as a successor can be confirmed.  Chuck Hagel just had his grilling this week before the Senate.  The majority of Republicans are expected to vote no for their dovish fellow Republican, but most expected that all 55 Democrats and Independents will vote for Hagel and that few enough Republicans will want a filibuster fight that he will ultimately be confirmed.

Attorney General
Eric Holder is staying, at least for now.

Interior
Ken Salazar has announced his desire to leave office in March.  President Obama has yet to nominate a successor.

Agriculture
Tom Vilsack has not announced his second term plans, but appears to be staying, at least for the time-being.

Commerce
This has been the most difficult cabinet position for President Obama.  Gary Locke, Obama's third nominee in his first term, finally took office in March of 2009, but stayed only 2 and a half years, basically competing the census and then departing.  Obama's second Commerce Secretary, John Bryson, lasted a mere 8 months, resigning after a bizarre incident involving a hit-and-run car accident and a stroke.  For the past 8 months, Rebecca Blank has been acting Commerce Secretary, awaiting an appointment and confirmation.  President Obama has yet to nominate a new Commerce Secretary.

Labor
Hilda Solis has already left office on January 22nd, leaving the post open.  President Obama has yet to name a replacement and most of his top picks from the world of labor are sure to generate controversy from Republicans.

Health and Human Services
Kathleen Sebelius appears to be staying, at least for now.

Housing and Urban Development
Shaun Donovan appears to be staying, at least for now.

Transportation
Ray Lahood is still in office but has announced his intention to leave when a successor can be confirmed.  President Obama has yet to name a successor.

Energy
Stephen Chu just announced this week that he will also be stepping down.  President Obama has yet to name a successor.

Education
Arne Duncan appears to be staying, at least for now.

Veterans Affairs
Eric Shinseki appears to be staying, at least for now.

Homeland Security
Janet Napolitano appears to be staying, at least for now.

So, to wrap it all up, of the 15 federal departments (I'm excluding "cabinet-level" positions that do not run a federal department) here is where President Obama stands:

Staying on from First Term: 7 (Justice, Agriculture, Health & Human Services, Housing & Urban Development, Education, Veterans Affairs and Homeland Security)
Nominee Already Confirmed: 1 (State)
Nomination Made But Not Yet Confirmed: 2 (Defense, Treasury)
Nominee Yet-To-Be-Named: 5 (Interior, Commerce, Labor, Transportation, Energy)

Clearly, the President has some work to do to rebuild his team.  This is doubly important given the significant budgetary changes to these departments likely to come down the pike with both sequestration and the continuing resolution battle in March.  Having interim leaders is not the best way to go ever, but is particularly bad when there are big changes coming.

Expect a flurry of nominations in the next few weeks as well as a lot of hearings and votes on nominees.  The President has named his most critical team (generally State, Defense, Treasury and Attorney General are considered the most critical positions in the cabinet), but there is much work left to do on the rest of the team.

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What Will a Second Term Obama Cabinet Look Like?

One of the predictable patterns in American governance is changes to the Presidential cabinet in the second term of an administration.  Very few department heads last the entire 8 years of an administration - the George W. Bush administration had only one (Elaine Chao at the Labor Department) and the Clinton administration had only four (Janet Reno at Justice, Donna Shalala at Health and Human Service, Bruce Babbitt at Interior and Richard Riley at Education.)

Note that for purposes of this discussion, I am only talking about department heads and not Presidentially-designated "cabinet-level" policy advisors such as the Chief of Staff, who attend cabinet meetings but don't have direct responsibility for governing and are not confirmed by the Senate.

The reasons for this are fairly obvious.  Eight years is a heck of a long time in any one job, but particularly one that is so high profile, stressful and subject to public criticism as running a large portion of the government.  And cabinet officials don't make a ton of money - current pay scales for cabinet-level positions are $191,300 per year - a lot of money if you are the average middle-class tax payer but a tiny amount compared to comparable executives in private industry, who would typically make millions for running groups that large.  So, most cabinet officials want out eventually.

If politics weren't involved, you'd see a distribution of cabinet officials leaving - some would leave after 2 years, some would leave after 3 and so on and so forth.  But obviously politics are involved and Presidents generally don't want to deal with high-profile cabinet appointments in the middle of an election season, so cabinet-officers are generally asked to stay at least through an election, which creates a pent-up demand for departures at the beginning of a President's second term.

President Obama's cabinet actually appears to be relatively more stable than most.  After George W. Bush won re-election in 2004, within the next year, he had changes at State, Treasury, Defense, Justice, Interior, Agriculture, Commerce, Health and Human Services, Education, Transportation, Energy, Veterans Affairs and Homeland Security, in addition to having already made a change at Housing and Urban Development.  President Obama isn't looking at nearly that level of change.  He has already made a change at Defense (Leon Panetta replaced Robert Gates, who was a holdover from the Bush administration) and has a current vacancy at Commerce (after the bizarre resignation of John Bryson, who was actually Obama's second Commerce Secretary, who was involved in a hit and run after an apparent seizure.)

Of all the cabinet seats, here is what is likely to happen in the next year:
The Big 4 (The 4 largest and most important departments - State, Defense, Justice and Treasury)
State - Hillary Clinton - likely to depart as she has repeatedly stated that she probably will not stay for a second-term.  Will President Obama pick a fight with John McCain and nominate Susan Rice over GOP protestations led by McCain or will he go with a "safer" pick?  This one could be a real filibuster fight.
Defense - Leon Panetta - also likely to depart although the President may be able to persuade him to stay on a little longer to sort out the other seats first - Massachusetts Senator John Kerry appears to be the leading candidate here.  I would be surprised if Kerry had an issue getting confirmed.
Treasury - Tim Geithner - likely to depart.  Jack Lew is the lead candidate to replace him.  He has both the private industry (Citigroup) and public sector (head of the OMB) experience and would likely be non-controversial.
Justice - Eric Holder - likely to stay.  He's not liked on the right at all, but Obama has shown a lot of loyalty to him and he doesn't need to be confirmed to stay.

The Other Seats:
Commerce - Rebecca Blank (acting) - this is an obvious vacancy that the President has to address.  The role has been technically vacant since June with undersecretary Blank filling the interim role.  The President is actually a pretty big fan of Blank's and might look to make her role permanent.
Interior - Ken Salazar - likely to stay - at least for now.  This is Salazar's dream job.
Agriculture - Tom Vilsack - likely to stay - despite some earlier staffing controversies, Vilsack hasn't been particularly high profile and he seems to enjoy the work.
Labor - Hilda Solis - likely to stay for now - Solis doesn't have a resume that would land her naturally in a big private industry lobbing job and labor will be interesting in the next few years with Wal-Mart protests and such - plus President Obama is likely to look for her to stay, knowing that any appointment to this seat would be controversial.
Health and Human Services - Kathleen Sebelius - very likely to stay - if you are going to do this job, wouldn't you want to be around for Obamacare implementation?
Housing and Urban Development - Shaun Donovan - likely to stay - he is one of Obama's closest trusted advisors from Chicago and though HUD has not been a focus, I think Donovan enjoys the work.
Transportation - Ray Lahood - likely to depart - Lahood has basically said he is burned out and looking to move on.  The lone remaining Republican in Obama's cabinet would be an interesting role to replace.
Energy - Steven Chu - 50/50 to depart in the next year - Chu didn't really get the deal he bargained for - the brilliant scientist thought he would be overseeing implementation of meaningful global warming policy around cap and trade.  It hasn't materialized and Chu may want to get out of government.
Education - Arne Duncan - likely to stay - Duncan is another one of Obama's Chicago-era friends, has received lots of bi-partisan praise for his reform-minded approach to education and his willingness to incorporate Republican ideas.
Veterans Affairs - Eric Shinseki - seems likely to stay - I really have no intel on Shinseki, who hasn't been very high profile, but he hasn't given an indication that he is leaving.
Homeland Security - Janet Napolitano - 50/50 to depart in the next year - this is a burnout, thankless role and Napolitano has taken a lot of heat.  Obama is very loyal, however and if Napolitano wants to keep taking the heat, I'm sure he would let her.

It is very likely that none of the vacancies, other than the current one at Commerce will occur prior to the New Year as the President has likely asked his cabinet officials to hold on until after the debate on the fiscal cliff is resolved, which seems likely to stretch right up to December 31st.  But they will be front-and-center in 2013 as the President seeks to remake his cabinet.

One of the many reasons that second-term Presidents tend to get less done is that they burn out the A-players in their cabinet in the first term and are stuck with the B-team in their second term.  How much of that happens in the Obama administration remains to be seen, but there is no doubt that he will have some vacancies to fill.