Saturday, March 18, 2017

Can Trump Deliver on Growth?

 by Roy C. Smith

“This is the winter of our [economic] discontent, made glorious summer by this son of [New] York.” Shakespeare’s opening lines from Richard III, modestly paraphrased, seems to explain the appeal of Donald Trump to his supporters.

Economic discontent? The average US GDP growth rate for the fifty years from 1950-2000 was 3.5%. But, the average GDP growth in the US over the past 16 years is 2%. The slowdown has occurred despite massive efforts by the government to stimulate growth through debt-financed fiscal and monetary interventions.

There is a huge difference between compounding growth at 2.0% instead of 3.5%. It shows up in lackluster performance of investment assets that are essential to pensions and health insurance funds and the states, municipalities, corporations and unions that sponsor them; it has reduced demand for labor to an extent that middle class incomes have been stagnant for decades; and efforts to spend-out-of-the-slump have increased debt-to-GDP levels to record heights thereby weakening the financial standing and capacity of the country.

No wonder, we have discontented voters. As my barber said to me yesterday, “I am a ‘deplorable’ (using Hillary Clinton’s term for a Trump supporter}, because my economic condition for my stage of life really is deplorable.”

Expectations of improved growth under this son of New York are still high – as seen so far in a 10% rise in US stock prices, a boost in consumer confidence, and sufficient increase in recent economic activity (low unemployment and rising consumer prices) to cause the Federal Reserve to raise interest rates a couple of times by small amounts. That’s good, but the hard data haven’t been so encouraging - fourth quarter 2016 GDP growth declined to 1.9%, and first quarter 2017 growth is tracking at only around 1.5%. Janet Yellen said she was “optimistic” about recovery because the Fed’s forecast of growth for 2017 and 2018 was 2.1%, which was better than the 1.7% average for 2016 and 2017.

Better, but hardly enough.

We are now five months since the Trump election, and little that we have seen so far encourages a picture of growth above 3% within the next two years. 

So far there have been a lot of executive orders requiring reviews of existing government programs with the idea of reducing regulatory costs. But as Mr. Trump’s executive orders on immigration have revealed, these can and probably will be challenged in courts and therefore take considerable time to affect meaningful change. Meanwhile, the effort to restrict immigration runs contrary to growth - we need more immigrants to prevent the US labor force from shrinking, which would reduce GDP growth.

Health care reform has also got off to a slow start, the Congressional Budget Office said 24 million Americans would lose health insurance over the next few years, but the plan would reduce the federal costs by $3.4 billion or so per year. The net effect would be an increase hardship and withdrawal of subsidies from about 7% of the population, resulting in a modest drag on growth. In any event, the plan will have to be revised to get by the Senate, which will also take time and divert focus from economic recovery.

Last week Mr. Trump announced his budget plans, which mainly consist of a 10% increase in military spending paid for by across the board slashes in everything except health care entitlements and social security. It is hard to see how such a budget would add to growth, but it is also hard to see what the real budget may yet be because the plan submitted is also unlikely to be approved without considerable change.

Next on the announced Trump agenda is corporate tax reform that is largely unnecessary. Yes, the US has a very high statutory tax rate for corporations (35%), but the average rate actually paid (27%, because of various deductions) is about the same as the world average. The $2 trillion in funds held abroad to defer taxes can still be loaned to US subsidiaries so domestic investment is not curtailed.

The Trump plan, however, will lower corporate taxes for those paying more than the average rate, but is meant to be “revenue neutral.” That is, it will be paid for by a complicated $100 billion “border tax adjustment” on imports, contrary to G-20 and WTO rules. This would be a considerable expense to large retailers and their customers, and to companies with global supply-chains. It too will be a highly controversial plan when Congress gets to it, and will take a lot of time and political capital to push through. But, it is hard to see how it would help increase US GDP growth.

The also promised cuts in individual tax rates, and a massive infrastructure spending plan promised during the campaign probably will be put off until later and probably not go into effect until 2018 or 2019, if ever. These will also be controversial because it is not clear that they are needed to boost growth or that they can be funded without adding considerably to outstanding government debt.  The relatively low rate of unemployment (4.7%) suggests the stimulus effect may increase inflation more than growth, and with government debt at 105% of GDP (the highest level since World War Two) there is little capacity or Congressional willingness, to increase it further.  

By contrast, the stimulative tax cuts of the Reagan administration, enacted in 1981, occurred when the unemployment rate was 8.5% and the government debt to GDP ratio was 32%.

Changes to the Dodd-Frank Wall Street Reform Act, which promise to reduce regulation on banks and free up lending, have been lost in the delayed Congressional schedule. It will probably not come up until 2018, meaning that any impact on growth will be at least two years away.

Discontent with the economic conditions of the country led voters to select Republicans to run the show. The President, a quirky son of New York with no experience in government, has now encountered some of the considerable difficulties of actually doing so, and most of his intended economic initiatives are stalled or in need of revision.

The President has not yet demonstrated a clear agenda for executing a credible economic recovery plan. Such a plan is certainly needed, but whether we will get one or not is hard to tell. In any event, indications now are that it will not have any effect for 2 to 3 years and will fall short of what is necessary to return growth to the 3% area.

The stock market has not curtailed its enthusiasm for Mr. Trump’s expected economic recovery. A great deal of new money has been flowing into US stocks since the election on the promise of greater growth. When the reality of reduced expectations finally catches on, then a major market adjustment will be inevitable.

Richard III reigned for only two years, during which he confronted two rebellions. At the end of Shakespeare’s play, Richard III cries out “a horse, a horse, my kingdom for a horse,” as he is killed in battle after an uprising led by Henry VII in 1485. The horse was unavailable, it has been said, for want of a nail to attach a horseshoe - a metaphor for good governance -- and as a result, a kingdom was lost.


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