By Pedro Sousa
The fact that we will see Donald Trump as President of the United States of America in January of 2017 is another massive signal of the anti-establishment period the Western world is going through. Trump ran and won based on a platform that was very unusual for a 21st century Republican candidate regarding his economic plan for the US. Unusual yes, but it resonated with plenty of economically anxious and frustrated American voters. Additionally, Trump’s economic plan hasn’t been all that clear and laid out with details and certainty. The President-elect used words and campaign rhetoric in a rather loose way that may be interpreted in somewhat distinct ways. For economists, this is what is interesting and challenging to follow and to predict. If one goes by what the presidential candidate Donald Trump stated, Trumponomics equals infrastructure and defense spending, tax cuts, deregulation and protectionism. This represents a huge risk factor for the US economy, for the global economy, and, may be the catalyst for the next global financial crisis. Trump will be in charge of the dollar – the world’s reserve currency -, the world’s largest economy, and its largest blocs of debt. His administration might reverse US-led globalization, destabilize the financial system, weaken US public finances and threaten trust in the dollar.
Congress and fiscal deficits
In such an unusual year for politics, it is important to remember some facts and context. Donald Trump was elected while running as the Republican Party’s candidate. Republicans, who now control the House and the Senate, have proudly branded themselves as the party of fiscal conservatism and defenders of the free-trade agenda for quite some time now. Yet, Trump ran on promises of economic stimulus – big surge of spending on infrastructure and tax cuts – and a platform of protectionism. It would be ironic if Trump carried out, with Republican support in Congress, precisely the sort of Keynesian fiscal stimulus Obama proposed in 2009, which was adamantly opposed by Republicans. In terms of timing, this type of action made much more sense back in 2009 than now. Trump is inheriting an economy that is almost at full employment with 3.2% Q3 GDP growth and 4.6% unemployment. The big surge of spending on infrastructure is a positive policy to bring to the table. However, to combine it with tax cuts and deregulation is not only wrong, it is dangerous, at a time when the US is already close to full employment.
The Tax Plan
The macroeconomics of Trump’s plan point to larger fiscal deficits, as a result of both higher infrastructure spending and corporate and personal tax cuts. Trump has pledged to invest US$1 trillion in infrastructure and to expand defence spending, including adding 42 ships to the navy. It is important to note that raising infrastructure investment has been prescribed by the International Monetary Fund (IMF) and by prominent economists to support job creation and growth in the near-term. Moreover, it was a component of both Clinton and Sanders’ economic plans. Ending austerity and pushing for public investment is a very positive development. It sends a much needed signal to the rest of the world, in particular to the European Commission. However, it is with the tax cut proposal that the proposal becomes misguidedly dangerous. Trump and the whole of the Republican party scathed Obama during the campaign about the increases in national debt. However, Trump’s larger fiscal deficits would necessarily add a substantial amount to the national debt. His tax proposals would shower huge benefits on already rich Americans. According to the Tax Policy Center, his plan would raise the after-tax income of those in the middle fifth of the income distribution by US$1,010 or 1.8%. The top 0.1 of the population would enjoy an average tax cut of nearly US$1.1m, or more than 14% of after-tax income. Trump’s personal and business tax cuts would lead to a rise in the federal debt by US$7.2 trillion over the first decade, according the Tax Policy Center. The cumulative increase in federal debt might be as much as 25% of GDP by 2026, which might open up large and permanent increases in fiscal deficits. It seems evident that Trump’s tax plans would above all benefit the very rich. Unlocking investment is the key to unlocking a virtuous cycle of domestic growth, as the IMF has argued. However, lowering taxes on the ultra-rich instead of rising them, will have harmful social and political effects if it increases inequality while letting the public finances explode and fostering an upward path of debt to GDP ratio.
Inflation and the Fed
With the US economy already operating close to potential, deficits will lead to higher inflation. More deficit-financed public spending would put upward pressure on economic activity and inflation, which would allow the US Federal Reserve to start tightening monetary policy by increasing interest rates faster than it intended to before the election. The Fed may need to suppress demand and increase interest rates to prevent the US economy from overheating. It is not clear what type of behavior President Trump will have towards the Fed and Chair Janet Yellen – who is not expected to resign before her term expires in February 2018. As a candidate, Trump criticized Yellen for being too dovish. Yet, President Trump, focused on growing the economy at 4%, might need all the help he can get. In a recent speech on Capitol Hill, Yellen cautioned lawmakers that if they spend a lot on infrastructure and run up the debt, and then down the road the economy gets into trouble, there would not be a lot of fiscal space should a shock to the economy occur, an adverse shock, that would require fiscal stimulus. Meaning, keep the powder dry so that lawmakers have more options whenever the next economic downturn comes along.
Forgetting the Global Financial Crisis
Another are of concern is financial regulation. As a supply-side measure, Trump has vowed to slash regulation that he sees as stifling lending and stunting the economy. This includes the 2010 Dodd-Frank Wall Street Reform Act and the Consumer Protection Act. For a lack of better words, this is extremely dangerous and negligent. The global economy is still suffering from the catastrophy that was the financial crisis rooted in Wall Street. There is a high level of anger towards the financial system that is seen rigging the economy in favour of the very wealthy members of society. As Yellen stated while giving her defense of Dodd-Frank: “We lived through a devastating financial crisis, and a high priority for all Americans should be that we want to see put in place safeguards through supervision and regulation that result in a safer and sounder financial system, and I think we have been doing that and our financial system as a consequence is safer and sounder and many of the appropriate reforms are embodied in Dodd-Frank. We wouldn’t want to go back to the mortgage lending standards that led to the financial crisis.” Most analysts believe Trump would like to replace Dodd-Frank with a hazardous return to the pre-crisis free-for-all, which would enhance a possibly bigger crisis – with no economic gunpowder to use.
On trade, a protectionism stance was a significant political card in this US presidential election, one that the Trump campaign used in an effective manner. Trump’s argument of the need to reestablishing a level playing field is not necessarily incorrect, in theory. After all, both Bernie Sanders and Hillary Clinton opposed the TPP, as an example. The economic peril with Trump is how he goes about it. Trump has promised to renegotiate America’s trade deals, such as the North American Free Trade Agreement (NAFTA) and has threatened to use tariffs as high as 45% on Chinese goods. Pulling out of NAFTA would threaten the supply chains that many US corporations rely on. Imposing tariffs on a major scale would be a significant blow to US growth and make a recession more likely. Trump’s threats, if implemented, would perhaps increase the demand for domestic goods, and increase output. However, it would spark a global trade war with China and could well plunge the world into a recession similar to the depression of the 1930’s. It would yield higher prices for consumers and fuel inflation, as well as punish companies that depend on Chinese imports and American exporters who have in China an important export market. On the supply side, it would disrupt production and decrease productivity, and global supply chains would be put in to question. Making sure that trade deals benefit the middle class and redistribute the gains of free trade is what is required. Something not likely to be accomplished with Trump’s trade threats.
A perilous economic mix
All in all, among the uncertainty, flip-flopping and mixed signals, it appears that President Trump’s economic plan will be an attempt of trickle-down economics with a taste of economic nationalism. Perhaps, and more disconcerting, it will be a doubling down on trickle-down economics that hasn’t trickled down. The combination of infrastructure investment but with tax cuts mostly targeting the very rich, at a time where US economy is operating close to full potential, means Trump might overheat the American economy while running up the debt and increasing income inequality. The willingness to return to strong booms and busts cycles is extremely risky. The possible short-term gain brings with it the severe risk of long-term pain. While Trump’s proposals could boost US economic growth in the near future, his other policies would offset those positive impacts over the long-run. Some are already looking at the prospect of stagflation – a scenario in which prices rise alongside unemployment while the economy slows -, which could quickly set in if import prices rise and the immigrant labor force contracts.
Failure in sharing gains
President Trump’s economic policies risk furthering the anger towards the government and politicians simply because they do not address the source of discontent in the correct manner. The lack of redistribution of GDP growth and trade gains is still going to be the key problem. If there is one lesson to take from this anti-establishment 2016 year is this: there is a need for domestic policy to ensure that the gains from trade and growth are widely shared. Domestic tax and transfer plans have not been capable of adjusting market income to a more equal household disposable income. This becomes even more imperative at a time when technology, automation, and the digital divide, are expected to disrupt labour markets. Plenty of economists have concluded that the growth that Trump foresees is not possible to achieve. But even if you give Trump 4% GDP growth a year, if the gains of trade deals and growth continue to go to a small percentage of the population, anger and frustration will only grow to higher levels. This is the ongoing global debate about income inequality. Falling incomes are corrosive for GDP growth and could also be fuelling social and political disgruntlement. A US economic boom has to deliver growth in household incomes, which is not guaranteed under Trump’s plan. Midwestern voters complained that they were the losers of globalization. Now they risk becoming the losers of economic nationalism. The recycling of corporate balance sheets towards households is well overdue. However, lower corporate taxes, lower personal taxes on the rich, and financial deregulation will increase the share of output going to capital. Corporate tax cuts may well simply increase corporate profitability — cue the equity markets’ euphoria, rotating from bonds to equities — without any major consequence on investments, as companies, in general, have already abundant cash on hand. A negative combination of inactive wealth, stagnation of the real median income, sluggish productivity and continued loss of manufacturing competitiveness fed the American anger at the “establishment” and put Trump in the White House. Said anger will be further enhanced under a worst-case scenario for Trumponomics and send economic shockwaves around the world. This is the macroeconomic threat of Donald Trump’s plan.