At least since the current president took office, the American political system and the economy have been singing deeply discordant tunes. The political situation looks like it’s teetering on the edge of crisis: Washington is consumed by the politics of scandal and personal destruction; the ruling party is dysfunctional; the outrage-polarization cycle is accelerating; the threat of political violence is unusually acute. The economy, meanwhile, feels stable and secure: Growth is chugging along, the stock market is soaring, the housing market is in high gear, and unemployment has reached historic lows.
But in the Wall Street Journal, Greg Ip reminds us that it’s entirely possible that the economy, too, will plunge into mayhem in the foreseeable future:
If you drew up a list of preconditions for recession, it would include the following: a labor market at full strength, frothy asset prices, tightening central banks, and a pervasive sense of calm.
In other words, it would look a lot like the present.
Those of us who have lived through economic mayhem before feel our muscle memory twitch at times like this. […]
If today’s conditions don’t dictate a recession or a market meltdown, they expose vulnerabilities that make either more likely in the face of some catalyzing event.
The interaction between politics and economics in Western societies is, of course, highly unpredictable. After the financial meltdown of 2008, the center famously held, in both Europe and in the United States. It wasn’t until well into the long hangover after the crisis, as growth sluggishly returned, that politics turned more radical and establishments started to fall.
A recession today would be like an earthquake rocking a political edifice that is already showing cracks. Many of our embattled institutions, now surviving even under an erratic president and unprecedented polarization, would come under still more strain.
The impact would be particularly pronounced in state and local politics. The Great Recession exposed the fact that many state and local governments were following an unsustainable fiscal trajectory, promising lavish pension benefits for public employees that depended on shady accounting and unrealistic rates of return. A handful of cities, including Detroit and Stockton, were forced into bankruptcy.
Many governments have attempted to adjust their pension systems since the crash, but despite the market boom, there are signs that the situation is continuing to deteriorate. Puerto Rico is insolvent; California has started to renege on some pension payments to retirees; Illinois is paralyzed and unable to pass a budget. A recent Moody’s report showed that even the most optimistic market scenario would not begin to resolve the pension crisis; if markets tumbled, the multi-trillion dollar shortfall would spike significantly.
So one obvious flashpoint as state and local revenue streams dry up would be the conflict between public-sector unions and policymakers in city hall and governors’ mansions. It’s easy to imagine Wisconsin-style protests and Illinois-style government shutdowns on a large scale as governments try to rein in civil-servant benefits to keep schools open and police on the streets. And political polarization (the cities and states that are deepest in debt are disproportionately blue) could kill efforts to deliver Federal aid.
Meanwhile, the politics of trade could also get ugly. In 2010, the Economist called protectionism “the dog that didn’t bark” during the 2008 meltdown—despite the tendency of recessions to pressure governments to erect trade barriers, centrist Western leaders almost universally refrained from doing so. But the dog might well bark the next time. The Overton window on trade has shifted as the post-Cold War consensus took a beating over the past five years. Not only did the current President run on a protectionist platform, the most popular figure in the opposition party is a vocal critic of establishment trade policy. Given that one of the biggest trade villains, from an American trade-hawk’s perspective, is Germany, any conflagration on this front could further weaken the Western alliance. And the prospect of a trade war with China that pundits have been warning about since Trump took office would loom larger.
So resource scarcity and rising unemployment would turn up the temperature of many existing fiscal and economic debates. But those specific fights would take place against a backdrop of broader political dysfunction. In the wake of the Great Recession, many economists set about studying the way financial crises have historically affected political systems. The conclusion is clear: Crises tend to undermine confidence in institutions, produce gains for radical parties, especially on the right, and ratchet up polarization further. (These effects are less pronounced or non-existent in recessions that don’t involve financial crises). The Great Recession has not produced the kind of political radicalism that overtook the world in the 1930s. Liberal democracy is embattled, but alive. But a persistent failure to deliver rising living standards would probably make radicalisms of various stripes more appealing to more people than they are today.
In the run-up to the 2016 election, pundits and economic observers warned somberly that a President Trump would be so menacing to American institutions that he would immediately produce a stock market collapse and a recession. That situation clearly did not materialize. But maybe a recession will happen anyway for structural reasons—and maybe that’s when our institutions will really come under threat.