Donald Trump’s boom will prove to be hot air
The economy has come roaring back under President Trump.” Thus reads a statement on the White House website. This claim needs sober evaluation.
The conclusion is that the economy has responded to a big fiscal stimulus roughly as the best forecasters predicted. That upsurge is unlikely to last. The big tax cuts have, as intended, hugely benefited owners of corporations. But they have certainly not paid for themselves. They have left the long-term fiscal position fragile, instead. That Republicans are happy with this is noteworthy. Given their posturing during the Obama era, it is also hypocritical.
Perhaps the simplest conclusion is that a fiscal stimulus works, even at a late stage in the economic cycle. According to Jason Furman, chairman of the council of economic advisers under Barack Obama and now at Harvard University, the stimulus was roughly 1.2 per cent of gross domestic product. A joint paper with Robert Barro, also at Harvard, published in March 2018, forecast that this would boost the rate of growth by 1.1 percentage points in 2018 and 2019. So far, this seems in line with outcomes.
Thus, the US economy’s trend rate of growth was 2.2 per cent from the first quarter of 2009 to the first quarter of 2017 — the years of post-crisis recovery under Mr Obama. Actual year-on-year growth has risen to about 3 per cent since the second quarter of 2018. Thus, the economy has indeed accelerated in the short term.
This acceleration has brought with it additional falls in unemployment. The unemployment rate fell from 4.7 per cent to 3.7 per cent between January 2017 and June 2019. That is the lowest since December 1969. Those low unemployment rates helped cause an inflationary upsurge in the 1970s. Will it be any different this time? Happily, a similar upsurge has not occurred so far. There has been a modest rise in the growth of average hourly earnings of private employees, from 2.4 per cent in the year to January 2017 to 3.1 per cent in the year to June 2019. But this rate has stabilised over the past year. In real terms, average weekly earnings rose just 1 per cent in the year to May 2019. If the tax cuts brought much to working people, it is certainly more via additional jobs than rising real earnings.
Yet participation in the labour market by men and women aged between 25 and 55 is still below past peaks. Prime-age male participation was 89 per cent in June 2019, against 96 per cent in early 1970. For women, it was 76 per cent in June 2019, against a peak of 77 per cent in April 2000. The decline in unemployment has to be put in this context. Labour force participation has fallen dramatically in the case of prime-age men. The secular rise in participation stopped two decades ago in the case of prime-aged women.
The main impact of the tax cuts in the economy is on post-tax profits, as one would expect. The effective tax on profits collapsed to 10 per cent in early 2018, from 19 per cent in the third quarter of 2016. This is another big fall in a history of declines: in the early 1950s, the rate peaked at 50 per cent.
The big economic justification for lower taxes on corporations is that it would raise investment. The ratio of real non-residential private fixed investment to GDP was 13.8 per cent in the first quarter of 2019. This is only 0.8 percentage points higher than in the last quarter of 2016. It is also well within the historic ratios. The paper by Profs Barro and Furman suggest that the changed tax treatment of corporations should have a modest upward effect on growth, largely through higher cumulative investment. But the impact would only be to raise GDP over 10 years by 0.2-0.4 percentage points. In a recent paper, Prof Furman suggests even this might be an overestimate, in terms of US real national incomes rather than GDP, once one takes the payments to foreigners needed to fund higher investment and fiscal deficits into account.
While the long-term effect on growth seems nugatory, the impact on the finances of the federal government is not. That may well be the main point, for congressional Republicans at least. Tax cuts do not pay for themselves. But they help “starve the beast”, in common Republican parlance. The ratio of federal receipts to GDP fell to 17 per cent in the first quarter of 2019, against 18.8 per cent two years before. The gap between receipts and spending also hit 5.5 per cent of GDP in the first quarter of 2019 at what must be close to the peak of the cycle. This could be justified if these deficits were funding investment. But they are doing no such thing. The fiscal incontinence of the Republicans will also have told Democrats that fiscal responsibility is senseless. That realisation will have big long-term effects.
Donald Trump’s main policy has been a regressive form of Keynesianism, masked as corporate tax reform. The latter delivered huge gains to shareholders. It has brought a strong short-term stimulus, which has had good effects on unemployment. Whether current unemployment rates are sustainable is unknown. But they cannot go on falling forever. The effects on long-term growth are likely to be modest, though running the economy this “hot” just might generate an upsurge in investment and so growth. Given the pressure on the Federal Reserve to keep pouring on petrol, this could end in tears, with higher inflation and interest rates and damaged fiscal and monetary credibility.
It is too soon to laud Trumponomics. But it is not too soon to note where the US is heading. It is hard to imagine anybody standing up for fiscal prudence. The choice is rather between rightwing and leftwing Keynesians. In the long run, that is likely to end badly. But that could be a very long run.