Greater infrastructure spending is welcome, but anti-free trade policies could lead to an economic downturnby George Magnus / November 14, 2016 / Leave a comment
It’s not been a week since Donald Trump was elected US president, and both the mainstream press and my corner of social media—an echo chamber, admittedly—are in full cry about the end of the world as we know it. The truth is that we just don’t know what will happen.
In his first major TV interview, Trump pulled back from the total repeal of Obamacare that he had said would be a priority, suggesting some key provisions could be retained. Among the possible cabinet appointees, including that for Treasury Secretary, are people with links to Wall Street and both Bush administrations, and dyed-in-the-wool Republican stalwarts. That’s pretty establishment by any standard.
For now, the impressions formed during the campaign are giving rise to dark thoughts, but we don’t know what a Trump presidency is going to look like and, probably, neither does he. On the basis of what he has said, is there any good news regarding the US economy?
Financial markets have changed compared with the initial aftermath of election night. They like the idea that Trump will propose to Congress (both houses will remain under Republican control) a large down payment on a $1trillion infrastructure programme and a big rise in military spending, plus the more widely advertised reductions in taxation of persons and companies.
Anthony Scaramucci, founder of SkyBridge Capital and a member of Trump’s economic advisory council, wrote in the Financial Times on Saturday: “Global economies are fighting deflation largely because of a post-crisis movement towards fiscal austerity. While easy monetary policies have exacerbated the income divide, central bankers handcuffed by political dysfunction have had little choice but to provide extraordinary accommodation. We can close the wealth gap in America by replacing emergency-level interest rates with fiscal stimulus.”
Wow—and this is from the right of the political spectrum, not the left. If true, it’s a genuine game-changer, and one that other countries, including the UK, look likely to follow.
Next month, the Fed, which has been calling for a stronger fiscal support role for a while, may well raise interest rates for the second time since the financial crisis, the first being exactly a year ago. If markets remain becalmed, and Trump’s first State of the Union speech and Budget validate that fiscal role, US interest rates will surely rise further next year.
For finance geeks, what this means is that the 35-year-old bull market in bonds—whose values change in the opposite direction to interest rates—is over. Investors have already begun to back US equities in general, and seek out the sectors expected to benefit from Trumponomics.
For everyone else, the question is whether Trumponomics will work. Many commentators think that income inequality lies at the heart of the current social unrest. But Trump is an unlikely standard bearer of income redistribution. Perhaps though, those commentators are looking through too narrow a lens. Populism in America, and the UK and elsewhere for that matter, is a complex animal, which cannot be reduced to income inequality and race alone. Rather, it is a virulent reaction to the perception of collusion between finance, corporate and political interests over the last couple of decades, with the financial crisis being the last straw. These interests have been perceived as not only talking down to a lot of people but also shutting them out from sharing the economic benefits of rapid globalisation.
If change is the bottom line, how might Trumponomics help, or hinder?
People will welcome greater infrastructure spending in the US, which is badly overdue, and it would have multiplier effects on demand and jobs through the economy. The American Society for Civil Engineers has estimated that the US needs to spend $1.4 trillion more on infrastructure over the next decade. The Trump team think that programmes should be funded at generational lows in borrowing costs and via new private-public partnership arrangements.
More military spending and tax cuts also fulfil a Keynesian function in the economy, but whereas the former will be argued on the basis of security, Trump’s tax cuts, principally benefitting higher income groups, are gratuitous and ideological. The US economy isn’t sub par or performing historically poorly because of high personal taxes on the better off. The reason the US economy is in this state is mainly because of the slowdown, almost a stall, in the growth of the working-age population, and disappointing productivity growth.
Trump’s proposals to change company taxation offer a slightly different view. He wants to bring the corporate tax rate down from 35 per cent to maybe 15 or 20 per cent, offer a one-time, lower charge to induce companies to bring home the estimated $2.5 trillion of corporate balance sheet cash held overseas. The argument is that this will get US companies to pay taxes and do more with their cash balances at home. If they do, then this should be to the benefit of the Treasury and the economy.
Trump hasn’t said much about anti-trust, or what we would call pro-competition, policies, except with regard to the communications and media sector. But it would be logical for Trump to introduce measures to bring greater competition into the US economy. It fits the Republican script, it would be seen as a “blow” against large corporate vested interests, and it would most likely help to spur competition for labour and some upward pressure on wages. During the last 30 years or so, American finance and commerce has become heavily concentrated, with the top four to five firms in many sectors accounting for a rising share of revenues and profits.
Interestingly, Jason Furman, President Obama’s Chair of the Council of Economic Advisors, recently co-authored a paper showing that the income disparities of managers and janitors within firms had been much more stable over time than those between firms. Put another way, lack of competition was a key reason for growing income disparities, and stifled labour mobility between states and cities as well as between firms. Here then is a good example of how governance changes could, if Trump’s administration wanted to, energise the US company sector and wage formation without costing very much at all.
If these constitute potential upsides to Trumponomics, there are two major clouds that loom over the next four years, trade and deficits.
Trump’s vehemently anti-free trade rhetoric has included the threat to rip up or change NAFTA, the North American Free Trade Association agreement, including the possibility of levying tariffs on Mexico. He has threatened China with heavy tariffs as a punitive measure for the now redundant charge of manipulating its currency, and opposes the Trans-Pacific Partnership (TPP) trade agreement that was central to President Obama’s pivot to Asia. Even now, China is trying to get Asia-Pacific countries to sign up to the Regional Comprehensive Economic Partnership, its own version of America’s TPP.
If Trump proved to be a real isolationist, walking away from open trading agreements, and imposing trade barriers, he might imagine this that would protect American workers and bring jobs home. But empirically we know this just tends to lead to retaliation, higher inflation and costs, and job losses. We do have cause to worry that without America to defend and promote a liberal international trade and investment regime, economic damage and impoverishment would spread through the global economy.
The other major concern about Trumponomics is about a mishandled fiscal expansion and unfunded tax cuts that would entail a substantially wider fiscal deficit and more rapid expansion of public debt. The bipartisan and independent Committee for a Responsible Federal Budget has calculated that what little we know of Trump’s programmes, including repeal of Obamacare, could add about $3-4 trillion to the outstanding level of public debt, now standing at $14 trillion. By 2026, federal debt would rise from 80 to over 105 per cent of GDP. increasing the US ratio of debt to GDP from about 77 per cent to at least 105 per cent. Once debt levels exceed 90-100 per cent of GDP, economic growth becomes seriously impaired.
The major risk then is that after an initial boost, the US becomes mired again in rising public deficits—remember debt will be rising anyway in the 2020s because of Medicare and social security spending. Since the external deficit would probably deteriorate as well, the likely scenario is of economic instability, higher inflation and interest rates, a falling currency, and then an economic downturn. And if Trump is keen to push for deregulation, including of banking and finance, that instability might be accentuated.
Trump’s economic policies, such as they are today, are a hybrid. Parts of them are pro-growth in the form of infrastructure renewal if managed well, a shift to letting macroeconomic policy walk on two legs again by engaging with fiscal policy, and company-friendly fiscal and regulatory policies. If anti-trust governance were also part of this, so much the better. But other parts might be strongly anti-growth in the form of anti-trade, and of fiscal follies that start well, but end badly for the economy. As with everything else about Trump, we have to hope that good advice and judgement prevail, but those dark clouds you see aren’t a figment of your imagination.