Donald Trump’s election victory is bringing forth a lot of speculation on the next administration’s possible economic policies and their consequences. These exercises are fraught with uncertainty in part because Trump as a candidate spoke so little about what his policies would be. A few themes are likely to remain intact now that election posturing is finished and so some thoughts are worth considering. Some of the main items on the agenda supposedly will include: renegotiating trade agreements including NAFTA, curbing immigration, health care reform (again), deregulation (notably for small businesses), repeal of Dodd-Frank, tax cuts and most significantly fiscal stimulus presumably in the context of infrastructure spending. Some of this agenda, however modified, is likely to move forward in 2016 because America has voted for ‘change’. Recall that each of the previous 8-year US presidents (Reagan, Clinton, Bush and Obama) was replaced with someone who was diametrically different in some sense from their predecessor, so the populous expects and Congress must deliver something new.
The Trump agenda is a mixed bag of supposedly pro-growth policies for the short run that unfortunately could have very negative consequences for the economy’s long term potential, so let’s divide the discussion into two phases – the short view and the long view.
The Short View
Not surprisingly, much of the market’s initial reaction seems to focus on the short view, especially the prospects for infrastructure spending. Markets have responded by raising inflation premiums on long term bonds. Although a growing consensus of economists now believes infrastructure spending is a viable anecdote for secular stagnation, some caveats are noteworthy.
- When an economy is operating close to its potential, as is the case with the US economy today, an outsized initiative on infrastructure is ill-advised. The projects rarely provide jobs for the long-term unemployed or those who lack the requisite skills for such work. Moreover, the extra stimulus is likely to cause some inflation with a lag of about one year if it pushes the economy above potential. In a world where deflation still lingers, the risk is not so much a reversion to high inflation but rather the persistence of inflation from operating the economy ‘too hot’.
- Congress will likely set restrictions on what projects would qualify, typically limiting the ventures to so-called ‘shovel-ready’ initiatives under the guise that the spending would not be a permanent feature of the government’s budget. The flip side of ‘shovel-ready’ however is that little thought is given to the long-term payback from projects or to what would be high priorities in raising the nation’s potential output. Only a small portion of the ARRA funding in 2009 was devoted to ‘greenfield’ projects which were next to impossible to accomplish within the two-year window of the stimulus package. The result often that most of the money is spent on pet projects, local road projects and transfers to local governments. This approach would be antithetical to the notion of remedying secular stagnation.
- Waste is the Achilles’ heel of congressional legislation and infrastructure is no exception. Consider Japan’s ambitious building program of the 1990s that did nothing to augment potential growth but did implode the government deficit that remains today.