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Will Businesses Feel the Bite of Sequestration?

Sequestration has provided plenty of fodder for late-night comedians. But the $85 billion in federal budget cuts scheduled to occur this year is no joke to the U.S. economy.

Q2 / Spring 2013
“There has been a lot of confusion about the sequester, but make no mistake, these are real, actual cuts,” says Kevin Thorpe, chief economist at Cassidy Turley in Washington, D.C. The federal spending cuts that began on March 1, 2013 as an austerity fiscal policy are expected to create a drag on economic growth, consumer confidence, and job creation. The big question is how those cuts will trickle down to impact businesses, industries, and local economies.

Most economists agree that the sequestration will reduce national GDP by about 0.5 to 0.6 percent this year. For example, Cassidy Turley revised its forecast from 2.5 percent to 1.9 percent due to the sequestration, with 510,000 in both public- and private-sector jobs lost this year. The majority of those job losses will likely occur in the last four months of the year, notes Thorpe.

Initially, the focus will be on job furloughs among government agencies and civilian contractors. Over time, the bigger strategy is to freeze hiring and reduce the work force through attrition. “Government is certainly going to be an area where we are not going to see much growth, and probably will see more near-term losses in the form of attrition,” says Carlos Ortea, real estate economist at Boston-based Property and Portfolio Research (PPR), a subsidiary of the CoStar Group.

The other big sector that will be hard hit by the sequestration is government contractors. There have already been some large Department of Defense contractors such as BAE Systems, Nasco, and Serco Inc. that have announced layoffs ranging from 200 to 3,000 workers, notes Ortea. Those reductions also send out a wave of ripple effects to smaller manufacturers that service those accounts.

Certainly, the sequestration will not impact all cities or regions of the country equally. Those local markets that have a higher percentage of government spending as a percent of their local GDP face the biggest risks. According to 2010 data, the city with the highest volume of federal spending as a percentage of the local GDP is, unsurprisingly, Washington, D.C., at 39.9 percent. However, there are about a dozen metros across the country where federal spending accounts for at least 20 percent of the overall GDP. That list includes some obvious government hubs such as Baltimore and San Diego, as well as markets such as Tampa, Louisville, Raleigh, Columbus, and Nashville. In addition, there are a number of smaller towns where almost the entire economy is linked to military bases. That is particularly true in the South. “So, a full sequestration could really crush some of these smaller towns,” says Thorpe.

That being said, exposure to federal spending does not necessarily equate to automatic cuts. For example, Baltimore is home to a strong cluster of cyber security firms that contract with the federal government. The government has plans to expand rather than reduce government spending in that area. “So, there are exceptions and it is difficult to accurately pinpoint exactly the potential impact because the government is still in the very early stages of sequestration,” notes Ortea. Moreover, there is some flexibility in where those cuts will be made. For example, after cuts to the FAA resulted in delays in air travel, Congress passed a stop-gap measure in April that reinstated furloughed air traffic controllers.

Some economists are optimistic that sequestration will be scaled back dramatically. Congress could decide to reduce the cuts to about $30 billion, which would be more in line with the budget cuts that occurred in 2012. That key move could come soon as the Congress tries to come to an agreement on balancing the budget and addresses a key deadline related to the debt ceiling limit. However, if Congress does not reach an agreement, the austerity measures will remain in place through fiscal 2021 with a total of about $1.2 trillion in total spending reductions scheduled over the next several years.

“I ultimately believe that a lot of these cuts will be scaled back; I just hope that it is soon,” says Thorpe. The government is very slow at cutting spending and equally slow in starting things back up, he notes. “So, if the cuts go on, potentially thousands of government contracts could be cut or canceled in the next couple of months. By that point, the damage will already have been done.”

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