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Sequester will sock a vulnerable economy

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The U.S. economy won’t collapse when the automatic spending cuts start hitting after Friday’s deadline. A few economists even say the sequester and its indiscriminate whack at the budget could eventually help the economy grow faster than it would have otherwise.

That’s the silver lining. Here are the clouds: The sequester is coming at a particularly inopportune time in the still-fragile U.S. recovery, it promises to bite consumers and business activity quickly, and the Washington area will feel its pain acutely.

While the cuts represent a relatively small slice of federal spending — about $44 billion this year in actual dollars — most forecasters say they are large enough to reduce economic growth by at least half a percentage point for the year. They will kill public- and private-sector jobs and drain precious buying power out of the economy.

Forecasters also expect the economy to lose a full point of growth this year from the payroll and income tax increases that lawmakers agreed to in the “fiscal cliff” deal at the end of 2012. And in recent weeks, a new threat to growth has emerged: a sharp rise in gasoline prices that many economists had not predicted for this year.

In other words, the sequester would hit exactly when you wouldn’t want it to, just as the slowly strengthening economy is struggling to shake off other drags on growth.

Federal Reserve Chairman Ben S. Bernanke told a Senate committee Tuesday that the sequester and tax increases “could create a significant head wind” for the economy. Given how slowly the economy is growing as is, he added, “this additional near-term burden on the recovery is significant.”

Ian Shepherdson, chief economist for Pantheon Macroeconomic Advisers, sounded a more dire warning in a research note this week. “The danger is real,” he wrote, “and markets are still, in our view, much too relaxed about the possible extent of the damage.”

The Washington area will absorb a disproportionate share of that damage because its economy depends so heavily on government spending.

Virginia, Maryland and the District depend more on federal contracting as a share of their economies than any other states, the Pew Charitable Trusts estimated in a recent report.

Two out of every five dollars in the metropolitan area’s economy come directly from the federal government, according to economists at the George Mason University Center for Regional Analysis.

Half of that money comes from federal contracting, a quarter comes from federal wages and salaries, and a quarter comes from other government sources, such as Medicare and Social Security payments.

The bulk of that spending is vulnerable to the impending cuts. The Center for Regional Analysis estimates that the D.C.-Maryland-Virginia region is the recipient of 21 percent of the federal money subject to sequestration, even though it is home to less than 5 percent of the U.S. population.

Just the threat of sequestration is already slowing the region’s economy, said Mark Vitner, a senior economist for Wells Fargo who has analyzed the sequester’s impact extensively. Contractors have pulled back on hiring, and government agencies have chosen not to renew some contract workers.

The effects of those pullbacks figure to ripple into areas of the economy not directly supported by the government. Workers who receive furlough notices will probably eat out less, for example, affecting restaurant profits and hiring.

Federal spending growth helped insulate the Washington area from the worst effects of the recession, Vitner said. Now that the region is about to get slammed, he said, “It’s kind of hard for somebody in South Dakota to get very worried about it.”

President Obama has warned about the potential damage of allowing the cuts to go through. But if they do, much of the nation might not feel the impacts for a while, except in a few select areas, such as military-dependent South Carolina and nuclear-lab hub New Mexico.

In other areas, economists say, it will take a while for the furloughs and job cuts to take effect, though federal unemployment recipients figure to see their checks reduced immediately.

“You’re really going to see most of [the impact] in April and May, because it takes some time to take the gears of the government and throw them in reverse,” said Michael Hanson, senior U.S. economist at Bank of America Merrill Lynch. “It’s certainly not going to be this immediate bang on Friday.”

Where economists see silver linings from the sequester, they’re usually not immediate, either.

Rather, they stem from the hope that the sequester will reduce future budget deficits — and with them the odds of federal borrowing costs increasing several years from now.

“Should the sequestration be reversed or canceled,” Wells Fargo economists John Silva and Michael Brown wrote this week, “the result would support short-run economic growth at the cost of reducing the long-run rate of growth of the U.S. economy.”

In his testimony Tuesday, Bernanke warned that the opposite could be true, that the sequester, by reducing growth, could “lead to less actual deficit reduction in the short run.”

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