12 minute read
When a new American president took office this winter, he was handed an American economy in decent shape. It’s a mixed situation of a positive historical trend (the long growth period under Obama), positive current conditions (full employment), and worrisome future risks (high trade deficit; inevitable end of current business cycle).
Economies go through cycles. They don’t grow monotonically forever. Because the US economy is in a longer-than-average period of expansion, after the 2008 Great Recession, at some point soon, output will slow down or contract. At the same time, the US trade deficit is unpalatably high relative to GDP. But, it’s hard to export more when the US dollar is high against other currencies.
It’s a tricky, liminal situation. Not the best time in economic history for a reckless ideologue to come on board. And, economists expect the situation to get trickier.
Most worrisome to economists is the prospect of collapse of the Yuan’s value when China stops artificially propping up its currency. Economists anticipated a capitulation in 2016, so today in early 2017 it’s that much more imminent. When the inevitable happens, Chinese products will suddenly get a lot cheaper for Americans, and the trade deficit will ratchet further upward.
Trump already had a deleterious impact on the economy before taking office. His xenophobic rhetoric is responsible for the 20% Mexican peso depreciation in 2016 — including the dramatic and nearly unprecedented single-day decline on the day after the presidential election. If you visit Mexico this spring break, you’ll only pay US$2.40 for the margarita that cost you US$3.00 last year. But it also means that jobs are more likely than ever to move to Mexico, where labor is now also 20% cheaper than it was before Trump announced his candidacy.
Trump’s economic plan
Trump advocates expansionary fiscal policy – something typically used to get out of a recession, not to prevent one. He intends to cut corporate income taxes, cut personal income taxes for high-income people, and simultaneously increase government spending. Doing this requires increasing government debt. (The debt amount is what “expands” in “expansionary” fiscal policy). More money going out plus less money coming in equals needing to borrow the difference (like if you switch to a lower-paid job but move into a higher-rent apartment, you’ll have to fund those decisions with a growing credit card balance).
This part of Trump’s proposal is a valid, historically-proven strategy to get out of a recession. But, we’re not in a recession. The economy is healthy and stable at the moment. Using expansionary fiscal policy to prevent recession or boost growth is a gamble… a gamble unacknowledged by its proponents…and a gamble made riskier by the other components of Trump’s plan.
At the same time, the anti-tax Trump also wants to impose a new tax: a “border tax” on imports. The economically-questionable theory is that such a tax would help pay for the proposed income tax cuts and spending increases, thus limiting the consequent debt increase. Nobody, particularly Republicans, wants to be responsible for increasing debt; so, the motivation for a border tax, though economically misguided, is politically understandable. It would also artificially reduce the trade deficit by keeping some imports out – thus giving the administration some optically-positive numbers to feed voters seduced by nativist rhetoric.
An import tax transfers tax burden from higher-income to lower-income Americans, by increasing the price of otherwise-cheap imported goods. Consumption taxes (of which an import tax is one example) disproportionately impact lower-income people by definition, since lower-income people have to spend (versus save and invest) a much higher portion of their wages on necessities than high-income people do. (With an import tax, the stuff you buy at Walmart gets more expensive.)
Trump presumably believes that the import tax would also create a disincentive to move US jobs to low-wage countries – not unlike the hope and inevitable folly of putting a dam in front of water running downhill. The theory is that a US company’s Mexican factory’s low labor costs would be partially erased by lower selling prices and/or lower sales volumes in the United States, thus making a new Mexican factory less financially attractive for that US firm.
But, ironically, it is Trump himself who strengthened the incentive for US companies to move jobs to Mexico – by substantially driving down the Mexican peso’s value through his inflammatory rhetoric. The import tax is Trump’s cure to a disease partly of his own making. One is reminded of Montsanto’s famously brilliant pairing of Round-Up herbicide with Round-Up-Ready seed: create a problem (seeds genetically-resistant only to Round-Up, which produce sterile crops, requiring new seed purchase every year) that only you can solve (selling Round-Up herbicide to enable cultivation of those seeds). Christianity, too, has often been described as offering “the disease and the cure”. It’s an effective tactic in many domains.
Simultaneously, while proposing expansionary fiscal policy, Trump also asserts he intends to deport 6%-8% of our labor force. With the labor market already tight, such action would create more upward inflationary pressure. It’s unclear if the administration – blinded by xenophobia and nationalist ideology – has connected the dots between immigration policy and economic performance. Consumers could face both higher real prices due to the import tax, plus higher nominal prices due to inflation – while we watch the wealthy enjoy tax windfalls.
Economists’ critique of Trump’s approach
- In our economy’s current situation, tax cuts lead to more job losses to other countries. Economists explain the potential chain reaction as follows:
- Tax cuts require additional government debt. (This is just arithmetic: Less money in + Same/more money out => Borrowing the difference)
- More government debt is a recipe for inflation. (Increased government spending on top of tax cuts exacerbates this effect. Deporting immigrant labor exacerbates it further.)
- Inflation drives up interest rates. Inflationary expectations force the Federal Reserve to increase interest rates, in order to maintain monetary equilibrium.
- Higher interest rates strengthen the US Dollar against other currencies. People want to invest where interest rates are higher, so they buy dollars. Dollars are in demand, so their value goes up. (And, a new import tax exacerbates this strengthening of the dollar — or at least fails to offset it as much as advertised.)
- A stronger dollar increases the already-too-high trade deficit. This accelerates job losses to overseas markets, as jobs by definition move from net importers like the US to net exporters like Germany, Mexico and China. Meanwhile, China’s currency value could crumble at any time, making the job-flight impact more pronounced.
- Tax cuts don’t drive long-term growth. Supply side economics and the “trickle-down” theory was debunked under Reagan. This has been settled science in economics for decades. Trump is gambling on a short-term kick (ignoring the long-term adverse consequences), plus generating talking points to satisfy the 90% of the electorate who has never taken a macroeconomics class.
- In the current situation, expansionary fiscal policy could trigger a recession. Temporary tax cuts plus deficit spending has been used successfully in the past to reduce unemployment and end a recession. For example, remember how President Obama did that to get us out of the worst downturn since the Great Depression? Thanks in part to Obama, today we’re not in a recession; in fact, we’re in month #91 of recovery and fast approaching the longest recovery in American economic history (which was the one presided over by Bill Clinton). The economy is considered to be at full employment. However, Trump’s domestic policies could trigger a recession, or make the inevitable business cycle ending worse than necessary. The probability of recession goes up in the event of any additional shocks, such as: decreased consumer spending (if Fed is compelled to raise rates sharply; if the Affordable Care Act is repealed, driving up living expenses for the most vulnerable population segment), increased trade deficit (due to economic changes inside major trading partner countries), decreased productivity (e.g., due to higher oil price). Today’s high business and consumer confidence is a mitigating factor in the likelihood of Trump’s plan steering us into a recession — but unabated reckless behavior in the Oval Office will eventually erode that.
At best, Trump’s “plan” amounts to a contrarian gamble. It’s unclear how consciously he’s placing the bet, especially given his habit of signing things whose legality and implementation consequences were not considered. If he and his advisors do comprehend the implications, why do they proceed? Ideology. Plus, obsession with short-term ratings and tweetable “wins”.
In sum, economists (those who are not ideological apologists) project that Trump’s approach will likely yield the following outcomes:
- Higher government debt
- Larger trade deficit
- Higher un-/under-employment
- Higher tax burden on lower-/middle-income people
- Higher healthcare costs for people without employer group insurance, the poor, and the elderly, due to repeal of the ACA
- Higher interest rates (This would normally have one positive feature of increasing the household savings rate – but not in this scenario where prices go up.)
- Higher stock market prices, due to rising interest rates (This one is good news for a few, but the 50% of Americans with zero stock market exposure gain nothing.)
- Greater income inequality (as a net effect of the above)
We can imagine economic situations that are relatively insulated against misdirected impulsivity at the helm, where the fundamentals make for resilience to bad policy. This is not one of those situations. We’re near the end of a growth cycle, with debt and the trade deficit already high, and our currency too strong. Donald Trump’s ideologically-driven defiance of economic best practices threatens to make the cyclical slowdown worse than necessary.
What should the administration do instead?
At this point in the economic cycle, the traditional recipe is to increase government spending without cutting taxes. Ideally, Trump would also cease his shooting-ourselves-in-the-foot rhetoric that has depressed the Mexican peso’s value. The legislature should refrain from deporting existing immigrant labor, and enact immigration reform that both gives our existing labor force a path to legitimacy and also tilts new immigration toward higher-skilled population.
We need our existing workforce to support real GDP growth. It is economically possible that an economy can achieve GDP growth that causes inflation and thus negates itself (like if your employer gives you a raise but increases your health insurance contribution by the same amount, so your monthly paycheck is unchanged — but your employer claims it helped you out, and out of ideological loyalty you accept that alt-fact without doing the math…).
As Hillary Clinton smartly said regarding Bernie Sanders’ economically-unviable headline-grabbing proposals: “It’s easy to diagnose the problem; it’s harder to do something about it”. So, too, it’s easier to diagnose the problems with such an obviously risky gamble as the Trump “plan”. The economists’ recipe for what should instead be done at this juncture is less headline-worthy than what the administration is doing.
Good solutions to complex problems typically involve numerous small, complementary measures, none of which reduces easily to a late-night 140-character rant. Economists, including those at the Federal Reserve, advise that Trump should focus on “domestic policy to improve productivity”. What does that mean?:
- Investment in infrastructure
- Investment in job retraining programs (not retrenchment regarding dead industries)
- Incentives for energy efficiency (not incentives for energy inefficiency, such as coal subsidies)
- Universal, affordable access to healthcare (not increased healthcare expenses and reduction in the insured population, from repealing the Affordable Care Act)
- Higher minimum wage
- Elimination of discriminatory hiring practices (not directing the Justice Department to soften enforcement of civil rights law, and not normalizing misogynist and racist behavior by example of the Oval Office). Fully leveraging our best talent — regardless of gender, age, race, disability, or sexual orientation — is critical not only on a moral basis considering the impact on individual lives, but also on an economic basis. For example, every individual under-employed female MBA stuck in low-paid work outside her field equates to a “productivity loss” in macroeconomic terms – and all of those losses add up across the economy as a whole.
- Support for new technologies and startup enterprises. In order to want to work in risky new technology and startup ventures, workers must be incentivized to bear that risk – including with affordable healthcare and generous government unemployment benefits.
- Reduction of barriers to growth, such as unnecessary regulation (not eliminating necessary regulation by the Consumer Financial Protection Bureau and Environmental Protection Agency, which protects Americans from personal financial crises, medical problems, and property losses)
Presidents get too much credit for good outcomes and too much blame for bad outcomes. Obama, for example, took the reins partway through the worst recession since the 1930s. It was a crisis not in any way of his making, and one which a president has limited power to fix. That limited power was deployed in manner lauded by economists: a massive stimulus program of government spending put a floor under the crash (combined with temporary tax cuts in an expansionary policy that was appropriate given high unemployment at the time). We got back to full employment relatively quickly and have since had continuous GDP growth for 7.5 years. Obama’s leadership made the economic crisis he inherited less painful than it otherwise would have been. Similarly, Trump has power to impact economic performance…but Trump’s leadership appears likely to make the economic future more painful than it otherwise would be.
There is also blame for current and future problems to be placed at the feet of the American people: our cultural obsession with cheap consumption. Retaining manufacturing jobs and keeping prices low are fundamentally opposing macroeconomic processes. We can’t have both. Our decades-long flight from quality has helped drive manufacturing jobs out of this country. (Economists explain that this phenomenon cannot be reversed. Those jobs are gone for good.) Every time you order cheap crap from southeast Asia off Amazon…every time you reflexively whine about how high-quality furniture or well-constructed clothing is “expensive”, rehearsing the now-fashionable anti-elitist rant about how regular people can’t afford to care about quality, functionality, longevity, lifetime operating cost – you are aiding and abetting the ever-deepening trade deficit. Nowadays, people often don’t consider the price/quality ratio of goods, but focus on price alone; it doesn’t seem to matter that they’re buying disposable stuff they’ll have to replace, that their purchases have a higher lifetime cost. In economics-speak, contemporary Americans have an astronomically high discount rate, when it comes to spending decisions.
Any way you cut it, President Trump will preside over the end of this business cycle, since business cycles are inevitable and this one is already longer than normal. Reasonable people hold out hope, however faint, that he’ll abandon (or that his incompetence will foil successful implementation of) the party-over-country, ideology-over-evidence arguments that constitute a recipe for making America’s economic future worse than necessary.
March 1, 2017