Regarding the Economy: It's the Uncertainty, Stupid!
WHY YOU SHOULD CARE
Because the devil’s in the details.
By Gregory Daco
Gregory Daco is head of U.S. Macroeconomics at Oxford Economics.
Much ink has been spilled over “Candidate” Trump, his policy proposals and his character. But very little is known about which political stances or specific policies President-elect Trump plans to adopt.
All we really know is that Trump’s presidency will be characterized by an unusually elevated level of uncertainty. From an economic perspective, we have some indications about his policy preferences but we lack details, and there remain substantial questions about feasibility, implementation and timing. In particular, recent efforts by his transition team to tone down Mr. Trump’s campaign promises — having Mexico pay for a border wall, repealing Obamacare or banning Muslims from the United States — indicate that there’s a high risk of a “trial and error” presidency that could undermine private-sector confidence.
There is no guarantee that Trump will find common ground in negotiations with members of his own party.
Trump will have the unilateral executive power to pull out of trade agreements, impose trade tariffs and reverse regulations. But for many of his major economic proposals (fiscal, immigration, health care), he will need to compromise with Congress. And while Republicans hold a majority in Congress, there is no guarantee that Trump will find common ground in negotiations with members of his own party.
Oxford Economics, a global leader in economic research and in advising corporate, financial and government decision makers, sees essentially three positive and four negative economic factors in a Trump presidency. On the plus side are promises of lower taxes, increased infrastructural investment and reduced regulation — all of which have buoyed markets in recent days. The negatives? Heightened political and policy uncertainty, increased trade protectionism, stricter immigration rules and fiscal orthodoxy in Congress (which would require spending cuts). Which way the scales will tip we don’t know for sure, and perhaps won’t for some time. So we have to envisage alternative scenarios for the U.S. and global economy: a baseline, an upside and a downside. As we obtain more clarity on policy direction and political orientation, we will be able to better gauge the direction of the economy.
The baseline assumes compromise between Trump and Congress, leading to a modestly expansionary fiscal package in exchange for targeted trade protectionism. In this scenario, Congress passes a budget resolution conference report with “reconciliation” that reduces corporate and income taxes, increases infrastructure spending and contains some modest and back-loaded spending cuts and revenue offsets over the next decade. Portions of Obamacare are repealed, including individual mandates, federal subsidies and Medicaid expansion, while financial regulation is dialed back (though Dodd-Frank isn’t entirely repealed). While private-sector activity benefits from lower taxes in the near term, government spending cuts, rising interest rates, trade protectionism and elevated policy uncertainty constrain growth to just 2 percent in 2017 and 1.8 percent in 2018. The Fed still raises rates in December, but only proceeds with one rate hike in 2017.
An upside would see tax reductions that are twice as large as in the baseline and much more inclusive for low-income families, and implementation of a substantial infrastructure investment program. Trump negotiates a relaxation of fiscal orthodoxy with conservative Republicans in exchange for a less protectionist trade stance and less stringent immigration rules than he campaigned on. Growth accelerates close to 3 percent in 2018, and the economy is 2 percent larger than in the baseline by the end of 2020, counting 2 million more jobs. The global fallout is also positive as the U.S. maintains strong trade relations and its trading partners benefit from stronger economic growth.
But the flip side could be that after a brief honeymoon period, Trump reverts to his highly protectionist and isolationist stances and doubles down on immigration. His refusal to negotiate with Congress means Republicans refuse any increase in the deficit. Trump imposes his proposed 35 percent and 45 percent trade tariffs on Mexico and China in the second half of 2017 and implements similarly broad trade restrictions against some emerging markets. Unsurprisingly, these countries retaliate with similar barriers to trade, leading to a substantial slowdown in global trade and slower economic activity.
Deportations of illegal immigrants and curbs on legal immigration would lead to a decline in the labor force of 1,000,000 people per year. Government shutdowns, debt-ceiling debacles and blockages on key appointments would become customary and lead to heightened domestic uncertainty. Globally, the anticipated recovery in growth is significantly undermined. Commodity and asset markets are also shaken — oil, equities and emerging market currencies weaken, accompanied by substantial movements in both policy rates and yields. Real GDP growth slows and the economy enters a recession by late 2018. By the end of Trump’s presidency, U.S. GDP has fallen to a level around 5 percent below the baseline and counts 4 million fewer jobs.
After most U.S. elections, voters know what to expect of their elected leaders. But with President-elect Trump, it’s a whole new era — one in which uncertainty alone could undermine economic stability worldwide.
- Gregory Daco, OZY Author Contact Gregory Daco