Professor Warwick J. McKibbin
The proposed changes to economic policies under the Trump administration are wide ranging. If implemented, they are likely to have large and long-lasting impacts on the United States and global economies with a significant impact on the Asian region. As discussed below, these policies will affect the Asian region through trade flows and capital flows, through global interest rates and in the longer term on whether the global economy remains open for trade or descends into a protectionist recession.
Although still very uncertain, the best indicator of the Trump administration agenda can be gleaned from Candidate Trump’s “Contract with America”. The processes to implement that agenda have already commenced.
The main challenge with forecasting the impacts of a Trump administration is that, despite it having a clear agenda (promises made in the campaign are clearly intended to be kept), in practice whether many of the policies will be implemented will depend critically on the support of Republicans in Congress. In trade policy, the president does have substantial discretion, but anything that requires funding approval will need congressional support.
In evaluating what might or might not be implemented, there is great complexity because President Trump appears to be right wing on social, environmental and immigration policy and left wing on trade and economic policy. He does not neatly fit into a divided set of fundamental beliefs that inhabit Congress. Therefore, every significant policy shift will need to be negotiated through a divided Congress. It is problematic to assume that a Republican-dominated House and Senate will guarantee the Trump administration policies will be adopted.
In discussing each area of potential policy change, it is useful to consider each policy separately although many of them overlap in the important consideration of how they are funded.
A key economic issue relates to fiscal policy, both tax policy for corporations and households as well as expenditures including defence, infrastructure, government agencies and the big areas of Medicaid and social security. Both the size of the spending and tax changes and the impact on the overall fiscal deficit will matter for the US economy and for the spillover through trade and capital markets to the rest of the world.
Candidate Trump promised not to touch the large entitlement programs of Medicaid and Social Security, which takes a large part of the necessary spending reform off the table. His attempt to reform the Affordable Health Care Act of President Obama has so far been a failure. This divisive policy reform was probably not the best place to expend significant political capital in the first 100 days.
A significant increase in infrastructure spending ($1Trillion over 10 years) is proposed to be financed by tax breaks to the private sector. In practice the infrastructure that is needed in the United States is likely not to be the type of projects that would be funded if the private sector was given an incentive to bring them on stream.
It is likely, if the infrastructure spending goes ahead, it would need to be financed by higher debt. The same applies to the $50 billion to be spent on building a wall between the United States and Mexico. Greater spending on the military has support in Congress, but the current proposal to pay for it by massive cuts in the budgets of government agencies such as the Environmental Protection Agency and the State Department is unlikely to get through Congress. Therefore, more government debt is the most likely way to fund a military expansion.
Tax reform is even more problematic. Candidate Trump promised to cut tax on individuals from seven tax brackets to three. He also promised cutting the company tax rate from 35 per cent to 15 per cent. More recently, there has been support given to the plan proposed by the Republicans in Congress to not only lower the overall tax on business but to change from a tax based on the income of companies to a Cash Flow Tax with Border Adjustments known as DBCFT.
This DBCFT works in a similar way to a value-added tax with additional deductions for payroll taxes. Imports would no longer be tax deductible as an input and profits from exports would not be taxed. While this has academic support, and is attractive for many reasons, the process of moving the US economy from the current system to the new system would be very disruptive. Some companies such as Walmart would face heavy increases in tax burden (indeed the business model would need to change dramatically) while other companies that export would receive large reductions in their tax burden.
This policy would also make it very attractive for US firms to relocate to the United States as the advantage of earning income offshore would no longer be relevant. Both the border tax adjustments and the relocation of US capital back into the US economy would likely lead to a large appreciation of the US dollar.
The tax reform is unlikely to be revenue neutral. The large reduction in the tax burden on companies and individuals would need to be financed by a large rise in government debt as cuts to spending programs could not support such a shift. Supporters of this major tax reform argue that the revenue from tax cuts would be self-financing because of a stronger economy. As this was not the experience of the Reagan tax cuts in 1981 or the Bush tax cuts of 2001 and 2003, it is unlikely to be self-financing.
Each of these fiscal policies would tend to raise the US budget deficit and therefore increase future US government debt significantly. A combination of higher government spending, lower taxes and overall higher spending in the United States economy would cause an appreciation of the US dollar. Countries in Asia that export to the United States will benefit, but countries with large internal or external debt burdens will be hurt by higher borrowing costs.
What will also matter will be the reaction of the US Federal Reserve and how monetary policy responds to the changes in fiscal policy. At a time when the United States economy is near full employment and the Federal Reserve is already in a tightening cycle, the switch towards tight monetary policy and loose fiscal policy will look very much like the period from 1979 to 1985, which was a period of large capital flows into the US economy attracted by strong growth, rising real interest rates and a strong dollar. This change in global interest rates would further hurt economies with significant amounts of private, public or foreign debt.
Another key area of economic policy is trade policy. The Trump administration has strong views on proposed trade agreements such as the TPP and existing trade agreements such as NAFTA but also the entire conceptual framework of a rules-based global trading system with the World Trade Organization at its core. A trade war at this stage of the political cycle is unlikely.
There is substantial evidence that a world of rising tariffs and rising protection would cause a global recession and hurt the US economy. Our modelling results suggest that, while the United States would be hurt, Australia would incur even larger losses and trade-exposed countries in Asia even larger losses. We estimate that the fall in GDP in China would be double the fall in GDP in the United States if all countries raised tariffs on all goods equally.
Another area where policies will have economic impacts is in the goal to reduce regulation and in particular to free up land and ease regulations on oil and gas exploration. While it is debatable how much the supply of energy can change under a more liberal policy, this policy would likely reduce the prices of gas and oil, delivering a further positive stimulus to the US economy as did the fracking boom from 2009.
The problem for the Trump administration is that it would probably drive even more substitution in electricity generation out of coal-fired generation into gas-fired generation. The loss of coal jobs from 2009 to 2016 was mostly not due to President Obama’s climate policy but was largely market driven by the low price of gas.
Thus, the promise to bring back coal is not consistent with the Trump administration policy on oil and gas. Thus if coal is to survive as promised during the election campaign, a substantial redirection of coal production into export markets would be necessary. This would have important implications for countries like Australia, Japan and China directly in terms of the economic implications, but also indirectly through the impact on existing climate policies aimed to achieve the Paris Agreement climate targets.
Another major area of policy reform with significant economic impacts is the Trump administration’s policies on immigration. Pew Research estimates that in 2014, almost 5 per cent of the local US labour force was illegal workers. More interestingly, illegal immigrants made up 26 per cent of the workforce in farming and 15 per cent of the workforce in construction.
Removing all of these illegal workers would increase the costs of these key sectors and reduce the potential rate of economic growth in the United States by a significant amount. This would be a major negative supply shock at a time when demand in the economy was being expanded by spending increases and tax cuts. This would add further pressure on inflation and interest rates.
It is unlikely that the agenda of President Trump will make it through a divided Congress. If it did, the implications are most likely a very large stimulus to the United States economy with strong equity markets, rising interest rates and a sharply rising US dollar exchange rate. The problem for the Trump administration is that by expanding the budget deficit and borrowing to pay for the many economic transformations being proposed, the financing will largely come from foreigners.
This large capital inflow would be a key driver of the strong US dollar. The key implication is that US export-intensive industries would be under even more competitive pressures than they currently face from technical change. The Trump heartland would on balance be hurt by the Trump administration’s economic policies.
The unfortunate implications for Asia and Australia in particular is that rising trade deficits in the United States would be seen by some in the administration as proof of an anti-competitive world and while a trade war today is unlikely, the pressures for a trade war would accelerate in coming years. This would be the worst of all possible outcomes for the Asia-Pacific region.