President Trumps economic policies have so far received much less attention than his foreign and national security policies. The examination here and in a following article concludes that the economic policies are based on fundamental contradictions and are therefore bound to fail. This failure will be felt by Americans and by the rest of the world.
President Trump’s core constituency is believed to be employees (mostly males) in manufacturing and mining who feel that they have fallen behind. Much of the blame for this loss of income and status is levelled at foreigners.
As a candidate Trump responded to these concerns with an economic program that promised a fiscal stimulus, based on tax cuts, and increased infrastructure and defence spending; deporting illegal immigrants; and various actions to limit alleged unfair foreign competition.
At this relatively early stage, it is difficult to be certain, about how much of this economic program will emerge intact – especially as much of it is dependent on Congressional approval. Possible reactions by other countries to Trump’s protectionist policies are also uncertain. Nevertheless, the main lines of Trump’s economic program seem clear enough to support the following assessment of the likely outcomes.
In addition, there are two other points that might be noted at the outset. First, a strength of this assessment is that it draws heavily on two recent studies which have sought to model the likely impact of Trump’s economic policies on the US and global economies[i]. Second, it is convenient to present this assessment in two parts to be posted on successive days:
- The impact on the United States, and
- The impact on the Global economy and Australia in particular.
The US impact of Trump’s economic program
A fundamental contradiction in objectives
One of the most worrying features of President Trump’s economic program are the inherent contradictions in it. Furthermore, not only does the President seem to be unaware of these contradictions, so too do his key economic advisers. This stands in contrast to the national security team, where even if the President’s tweets seem out of control, the other members of the team are reputed to be competent.
The flaws in Trump’s economic program start from the mercantilist belief that exports are somehow “good” and imports are “bad”. In Trump’s eyes, the aim of a trade agreements is therefore to increase exports more than imports, and if this doesn’t happen it is a “bad” agreement. What Trump (and it would seem his principal advisers) have not understood is that the difference between the total of exports and imports is never determined by tariffs or export assistance. Instead this difference reflects the difference between domestic saving and domestic investment – indeed, the current account balance is identically equal to this difference between domestic saving and investment.
What this means is that action by the Trump administration to limit imports from countries such as China, Canada or Mexico, cannot reduce the trade deficit unless the deficit between US saving and investment is also reduced at the same time. Instead, the most likely outcome from such action is that imports from other countries will rise to offset the reduction in the targeted countries’ exports to the US (and this is supported by the modelling results reported in the two afore-mentioned papers). But even if total imports did decline, unless the gap between domestic saving and investment is somehow reduced, there will be no reduction in trade deficit, as this reduction in imports will be offset by an increase in the real exchange rate, and there will be less US exports.
In short, a better way to think of protectionist measures to limit imports is that they effectively represent a tax on exports and on consumers. Australians came to understand this a long time ago, and this was why we got rid of our tariff protection.
Trump’s fiscal package
But Trump’s economic program not only envisages action to limit imports; indeed, the most significant elements are on the fiscal side. The biggest change to the US budget comes from the proposed tax cuts, and Trump has asserted that these will pay for themselves through higher economic growth. This is contrary to all previous experience (eg the Reagan tax cuts in 1981 never paid for themselves), and again is not supported by the modelling, with McKibbin and Stoeckel finding that “The tax cuts are not ‘self-financing’.”
Overall on present estimates it seems likely that the Trump fiscal package will increase the budget deficit, and as there is no reason to think that private saving would increase to offset this reduction in public saving, the Trump fiscal package is bound to make the trade deficit worse. This will have to be covered by increased capital inflow, so real interest rates will have to rise. Indeed, the modelling reported by McKibbin and Stoeckel suggests that as a result of this fiscal package:
- US government debt would be double by 2040 what it would have been without the stimulus;
- America’s real interest rate could settle at nearly 100 basis points (1 percentage point) above the baseline to meet their extra borrowing requirement;
- The current account deficit (as a percent of GDP) is 5.7 per cent worse in 2018 than it would otherwise have been; and
- The capital inflow required to cover this deficit could cause the real effective exchange rate to initially appreciate by as much as 12 per cent above the baseline.
In short, there is a fundamental contradiction between President Trump’s proposals to stimulate the economy and to promote exports. The failure to understand this contradiction means that both elements of the strategy are doomed to fail.
In the short run the stimulus package could produce an upward spike in real GDP of the order of 1¾ of a percentage point, but by around 2022 real GDP would have returned to its base-line reflecting what it would have been without the stimulus package. Furthermore, because of the increase in capital inflow much of the increased output will be owned by foreigners or will be required to service the increased foreign loans. Consequently, even though Americans might be producing more, they would own less of it and their incomes would be lower.
Interestingly, deporting illegal immigrants impacts particularly on agriculture and durable manufacturing where these ‘foreign’ workers are concentrated. As a result, McKibbin and Stoeckel project that in 2020 the output from US durable manufacturing and agriculture could be below their baseline by 3.2 and 2.5 per cent respectively. While real GDP could be 1½ per cent lower than the base, thus offsetting the gains to real output from the fiscal stimulus.
Trump has proposed a significant increase in infrastructure spending amounting to an extra $1 trillion over ten years. There is little doubt that American infrastructure has been allowed to decay, and that more expenditure is needed. However, this proposed increase in infrastructure investment is meant to be financed by tax breaks; as such, it will mostly benefit the private sector, whereas the infrastructure that is needed is mostly in the public sector. It seems doubtful therefore whether the increased investment will deliver a return commensurate with the increase in public debt.
In sum, it is very hard to see how Americans will be better off as a result of President Trump’s economic policies. Indeed, Trump’s core supporters are even more likely to feel worse off. Nor will America be “Great Again”. Instead, it will principally be deeper in debt to foreigners, assuming they continue to be willing to bail America out.
At the same time, Trump may well provide a further catalyst for rising protection which will leave the rest of the world much worse off. Those issues will be explored in the second part of this series to appear tomorrow.
Michael Keating is a former Secretary of the Departments of Employment & Industrial Relations, Finance, and Prime Minister & Cabinet.
[i] For those who are interested the first study is reported in a Productivity Commission Research Paper, Rising protectionism: challenges, threats and opportunities for Australia (available on the Commission’s website); while the second study, Some Global Effects of President Trump’s Economic Program, is by two economists, McKibbin and Stoeckel, and is available at: https://cama.crawford.anu.edu.au/publication/cama-working-paper-series/11251/some-global-effects-president-trumps-economic-program