Political gains fade quickly as America nears a 'fiscal cliff'

Fiscal reform is the biggest challenge await President Obama in his second term. How he responds to this test of leadership will in large part determine his legacy.

President Barack Obama has won re-election by a bigger-than-expected margin, but he faces an uphill struggle to secure the US economic recovery and heal the country's broken politics. What lies behind this twin challenge is the greater task of reviving the spirit of hope in a nation scarred by the crisis of capitalism and fearful of decline. How Mr Obama responds to this test of leadership will in large part determine his legacy.

The biggest threat that hangs over the US economy is the "fiscal cliff", a combination of tax hikes and spending cuts that will automatically set in at the start of next year - unless Mr Obama can strike a historic debt deal that has so far eluded him. The US Congressional Budget Office has estimated that the combined effect of raising taxes and slashing expenditure could amount to a drag of up to $600 billion (Dh2.2 trillion) next year, or 4 per cent of national output.

Amid the fledgling domestic recovery and international uncertainty linked to the euro-zone turmoil and China's "hard landing", there's little doubt that this would push the US back into recession and pull down the world economy.

At the root of the "fiscal cliff" is partisan disagreement over US budget deficits and public debt, which stands at a staggering $16.3 trillion. Tuesday's elections seem to have deepened the divisions that have produced stalemate in Washington since the Democrats were trounced in the 2010 midterm elections. Mr Obama can rely on Democratic control of the Senate, but he will have to contend with a Republican majority in the House of Representatives.

This, coupled with an acrimonious contest and an increasingly polarised political climate since 2010, suggests that a bipartisan consensus is virtually out of reach. Mr Obama now has a renewed popular mandate but he faces a deeply divided country where "big government" liberals and "small government" conservatives hate each other with a visceral passion not seen since the dark days of the Nixon administration.

None of this was helped by the events of last summer, when America came perilously close to debt default and lost its much-vaunted triple-A credit rating. Now the same stand-off risks replaying the crisis that took the US and the rest of the world economy to the brink.

The trouble is that without a debt deal, the US faces a short-term slump and long-term decline. It is true that the housing market is slowly stabilising and unemployment has been falling for the past year, but America is barely growing.

Crucially, business investment in the short and medium term needs more predictability and executive leadership. By some estimates, US corporations are sitting on as much as $1.7 trillion of cash that is waiting to be spent.

In the long run, stable public finances are indispensable for a propitious investment climate. This includes long-term private-public partnerships for research and development as well as innovation, on which productivity and economic growth ultimately depend.

The best example remains the powerhouse of Silicon Valley where for decades business, universities and government have co-operated successfully for the benefit of the wider economy.

Currently, the US lacks a strategic approach to public expenditure as well as to science and technology. A bipartisan debt deal would be a first step in switching the US model from short-term profits that accrue to the few towards long-term investment that benefit the many.

How to get from here to there? To get a viable debt deal, Mr Obama needs to learn from his first-term mistakes, notably a lack of engagement with congressional leaders across the political spectrum. Part of the reason why no single Republican in the House of Representatives voted for "Obamacare" - his flagship healthcare reform package - is that the president left far too much of the legislative detail to Democrats.

Mr Obama may be cool and cerebral compared with the hotheads of the Republican Tea Party fringe, but he needs to bring Republicans around by speaking to their hearts as well as their minds.

Moreover, Mr Obama needs to confront his own base with tough choices on entitlement. The federal government needs to switch expenditure from wasteful consumption that perpetuates dependency to strategic investment that fosters prosperity for all. In particular, that means retraining the unemployed and promoting the productive activities of both high-tech manufacturing and industry on which growth and employment depend.

Specifically, Mr Obama would be well advised to reinstate the tax cuts for the middle classes who struggle to make ends meet. Likewise, he needs to find a way of reducing welfare for the more affluent - including the growing cohort of pensioners in swing states like Florida.

The challenge for Mr Obama is to turn his electoral victory into a larger popular mandate. To avoid deadlock, the president needs to make tough choices and exercise leadership through engagement with moderate Republicans.

Four more years can't mean business as usual. Lofty rhetoric alone won't work. Mr Obama needs to embrace transformative politics - otherwise he will betray the spirit of hope that first propelled him to the top and has now returned him to the White House.

Adrian Pabst is a lecturer in politics at Britain's University of Kent and a visiting professor at the Institut d'Etudes Politiques de Lille in France