Will Trumponomics Work?

Probably not. But we’ll get quite the pop over the next couple years.

When he takes office in January, Donald Trump is proposing to rev up American output with a massive jolt of spending. Splashing out hundreds of billions of dollars to build bridges and repair roads while simultaneously cutting taxes, he aims to pump over a trillion dollars into the US economy.

He’ll get his way, at first. Despite their evangelical frugality whenever there’s a Democrat in the White House, Congressional Republicans are legendary spendthrifts when they have one of their own in the Oval Office. They’ll go along enthusiastically with tax cuts and, if there’s any pushback on the infrastructure-spending plans, the new President may even find a few allies among Democrats, who’ve been pushing for this sort of thing for years.

All this stimulus should give the economy a jolt, creating jobs. In addition, should Trump also succeed in his goal of reforming corporate taxes, a lot of US corporations that have been stashing accumulated profits overseas will begin repatriating those cash-piles. Parking their money in the stock market, raising dividends or investing in plant, they will thereby give the market a big jump while pouring money into the country.

This ‘wealth-effect’ will then create further demand in the economy, creating a virtuous spiral of growth. Moreover, even if Trump doesn’t build a wall on the Mexican border, hostility to minorities will, at the margins, probably constrain the labour market, limiting competition for jobs and thereby driving up wages. Higher wages will mean more spending, further supporting the economy.

So far, so good, you might think. But things then start to get a little complicated. If wages rise faster than labour productivity, this will either crimp profits or stoke inflation. Either way, the stock-market rally will reach its limits. If inflation rises, so too will interest rates. This upward trend in interest rates, of which we’ve already begun to see early signs, will be reinforced by the huge build-up of debt.

The national debt will increase substantially, in fact. Ordinarily, this would cause a surge in interest rates, as the government must attract lenders who have options elsewhere. In fact, just since Trump’s election, US bond yields have risen by a half percent, in apparent anticipation of what’s coming. And since the government competes for loans with everyone else in the economy, from banks to impulse-shoppers with credit cards, rising bond yields drive up interest rates across the board. Ultimately, this can choke off spending and investing, slowing or possibly reversing growth.

However, Trump’s economic team are calculating that the rise in interest rates will be limited, and only temporary. They are counting on the stimulus to raise growth sufficiently to offset rising debt. Think tanks close to the incoming administration are producing studies that use ‘dynamic modelling’ to show that net debt ratio will barely budge. If bond markets buy this, interest rates should stay tame.

However, this scenario relies on a gamble: that all this public investments will in fact raise productivity sufficiently to pay back the debts. That is questionable. Outside of a short blip in the 1990s, the long-term trend in US productivity growth has been downwards. Moreover, the 1990s leap appears to have been not the result of new technology, as was supposed at the time, but of what might be called bloody Taylorism. The very aggressive globalisation of the Clinton presidency, during which American firms enjoyed ever greater freedom to move production offshore, meant that firm-managers could wield the threat of out-sourcing to demand more from their workers. Given that a key part of Donald Trump’s economic strategy is to reverse or at least limit such out-sourcing, labour-productivity may well continue its long slow-down.

Sure, a new invention may come along and revolutionise American productivity. But that is a leap of faith. What isn’t is the impact of out-sourcing: if you take existing technology and apply it in low-wage settings, you can obtain a huge rise in output. Take a country I know well, Jamaica. Despite its relatively low wages, labour productivity has been falling there. Walk into most any factory and you see why – processes and machines are, in some cases, decades old. Merely importing best practices would therefore cause tremendous increases in productivity. This fact will continue to provide an irresistible lure of capital from the rich countries — including the capital American firms repatriate.

So Trumponomics is a gamble. If it pays off, Donald Trump will be an American hero. If it doesn’t, America will eventually wake up to the fact that it has just enjoyed a debt-fuelled binge without altering underlying trends. At that point the virtuous spiral will turn vicious, the scale and severity of the resulting drop being proportionate to the rise we observe in the next few years. Should that come to pass, Donald Trump will then become one of the great villains of US history.

Image: The River Cam, seen from Garret Hostel Lane Bridge

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