Tuesday, August 29, 2006

The Economy's Fear Factor

News Analysis
August 29, 2006

Business Week Online


The Economy's Fear Factor

Will Republicans' focus on the threat of terrorism heighten voter pessimism about the economy ahead of the November elections?

Sex sells, but what about fear? It's been evident for months that terrorism and the war in Iraq would be central to Republicans' bid to hold Congress through November's midterm elections. Indeed, the specter of a terrorist attack looms large in the minds of economists, a new survey shows, highlighting a possible contradiction in the GOP strategy.

The biggest short-term problem facing the U.S. economy continues to be terrorism, say 34% of economists polled in August by the National Association for Business Economics (NABE). Among other leading economic trouble spots were energy prices, cited by 29% of economists, followed by inflation. The portion of economists listing terrorism as the biggest threat jumped from 26% in March.

While the latest survey coincided with the outbreak of war in Lebanon, economists' heightened concerns about terrorism are real, analysts say. Recent headlines about alleged plots against airliners have only underscored the anxiety. "Everybody is worried that the next terrorist attack is going to cause problems—both for oil prices and for consumer confidence—that could create a recap of the kind of recession we saw back in 2001," says David Wyss, chief economist at Standard & Poor's.

BACKFIRE RISK.  Economists aren't the only ones expressing concern about terrorism and the economy (see BusinessWeek.com, 8/21/06, "That Sinking Feeling"). Nearly two-thirds, or 64%, of Americans think it is at least somewhat likely that there will be another terrorist attack in the U.S. within the next few months, according to a recent CBS News poll, up from 53% in January.

As for the economy, American voters have offered dismal forecasts in public opinion polls for months, while Republicans are burnishing their antiterrorism bona fides. The new survey results raise an interesting question: Could an electoral strategy focused on stoking voters' terrorism fears backfire by increasing their economic pessimism?

The latest view from economists comes as conservative columnists such as George Will and Fred Barnes have been wondering why voters give President George W. Bush so little credit on the economy. In the most recent Wall Street Journal–NBC poll, only 14% of respondents say they believe the economy will get better in the next 12 months, down from 16% in June and 17% in April.

STRONG EARNINGS.  Center-left pundits have raised similar questions. The economic news is "absolutely good," ABC News political commentator Cokie Roberts said Dec. 4, 2005, on This Week, but "voters don't seem to be feeling it." On July 12, Hardball host Chris Matthews asked: "If it's that great out there, why isn't [Bush] getting credit for it?"

By some measures, the economy is indeed strong (see BusinessWeek.com, 9/4/06, "Housing: The Roof Won't Collapse on the U.S. Economy"). S&P 500 companies have posted 17 consecutive quarters of double-digit earnings growth. The advance reading for second-quarter gross domestic product, however, showed a 2.5% rise, down from 5.6% in the first quarter. Investors will get another reading on second-quarter GDP on Aug. 30, ahead of Sept. 1's payrolls report.

Renewed fears of terrorism might be one key reason for Americans' pessimism toward the economy. Indeed, views on the economy surged 13 percentage points after U.S. forces killed Al Qaeda affiliate Abu Musab al Zarqawi in Iraq, according to Ed Lazear, chairman of the White House Council of Economic Advisers. "Of course, that had almost no effect on the economy to speak of, and yet people's opinion of it went way up," Lazear said in an Aug. 18 press briefing.

NO THANK-YOU CARDS.  Top Republicans have kept the threat of terrorism front and center in recent weeks. "People will focus on that issue," Senator John Thune (R-S.D.) told a Lincoln (Neb.) newspaper in the wake of the foiled London airplane bombings. On Aug. 9, Vice-President Dick Cheney said the Connecticut primary victory of antiwar Democratic Senate nominee Ned Lamont may encourage "the Al Qaeda types."

Americans tend to vote based on their pocketbooks, but the White House isn't doing enough to highlight economic issues right now, according to Grover Norquist, president of the conservative Americans for Tax Reform. "They're wrapped up in foreign policy, but just because you're interested in something doesn't mean most voters are," Norquist says. "What matters for voters is: What are you going to do for them next? Don't expect a lot of thank-you cards for an O.K. economy."

That may be an acceptable risk to the Republicans, who are keen to retain their edge in Congress. The GOP may be willing to take a short-term hit on economic issues to draw attention to terrorism, where Republicans have traditionally outpolled their Democratic rivals. "The Republicans have put all their political eggs in the war-on-terror basket," says Peter Rundlet, vice-president for national security at the liberal Center for American Progress. (Representatives from the Republican and Democratic parties did not return calls prior to publication of this article.)

MISPLACED JITTERS?  Like economists, ordinary Americans probably see terrorism as only one of a rogue's gallery of threats to the economy, with inflation and a softening housing market also causing some agita. Some liberal pundits charge that Americans are unhappy because double-digit corporate profits and solid economic growth have yet to trickle down to typical workers. "It's hard to convince people that the economy is booming when they themselves have yet to see any benefits from the supposed boom," wrote New York Times columnist Paul Krugman on Dec. 5, 2005.

Meanwhile, Wall Street's terrorism jitters could be misplaced, economists say. While a terrorist attack would likely send oil prices higher and dampen travel spending, it wouldn't necessarily derail the economy, notes S&P's Wyss. Terrorism "changes what people spend money on, but it doesn't change them spending money," he says.

When asked to name longer-term threats to the economy, economists named a number of other daunting challenges. One-fifth of respondents point to the federal deficit as their biggest long-term concern, according to the NABE poll, while another fifth cite an inadequate educational system. Separately, only 38% of respondents believe that any combination of policies can eliminate U.S. dependence on foreign oil.

DEFICIT CONCERN.  The survey results also indicate uncertainty from a Fed policy standpoint. While 29% of economists polled want further interest-rate hikes, another 17% prefer cuts, and 53% favor keeping rates steady. Still, 71% say current monetary policy is about right, and just 57% expect the Fed to raise rates, down from 89% six months ago. In fiscal policy, 75% of respondents want budget deficits to drop, but only 17% expect them to do so.

In a market environment fraught with question marks, terrorism remains one of the biggest uncertainties—for economists and voters alike. But the complex feelings the issue evokes leave no clear indication as to how voters will respond in November—perhaps making the GOP a little nervous as to whether its trump card will ensure victory.

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