Trumponomics Challenges Mainstream Fiscal Paradigms
As the Trump administration finalizes its plans to implement tariffs against foreign steel and aluminum, it’s clear that the president doesn’t mind ignoring economists — even within his own administration.
The Trump budget, first rolled out in January, shows a similar rejection of economic orthodoxy. Despite hawkish rhetoric about reducing the national debt during his campaign, the president’s budget for 2019 would add nearly $1 trillion to the debt. During a period of economic growth, that kind of deficit spending is raising economists’ eyebrows. Like the man himself, Trumponomics is decidedly unorthodox, and investors are uncertain about how the economy will react in the long run.
Ordinarily, governments run budget surpluses (or at least lower deficits) during growth years, as we did from 1998 to 2001. During recessions, governments use deficit spending to make up for low levels of spending and reignite the economy. So, when a government runs a budget deficit during a period of growth, economists worry about “overheating” the economy or pushing consumer spending too high, which could lead to a collapse.
That’s exactly what the president is doing. Heading into an economic peak, Trump plowed full speed ahead into a massive tax cut and plans to pursue his goals of beefing up the Pentagon’s budget and building up America’s infrastructure. These new spending programs, combined with lower taxes, are the major drivers in Trump’s budget deficit.
There are good reasons to think Trump’s deficits are poorly timed.
According to the Bureau of Labor Statistics, inflation rose more than expected in January. This may suggest that the economy is bound for overheating, as consumer spending picks up in response to the tax cuts. Similarly, the New York Fed reports a surge in credit card and mortgage debt in 2017. Rising inflation and demand for credit can be characteristics of an economy on the brink of recession — that is exactly what happened in 2007.
But the whole picture is more complicated. A single month in inflation does not a trend make, especially because the spike in January could be attributed to seasonal effects. Many investors aren’t ready to call a recession just yet, with many even expressing optimism.
This may partly be explained by some unique aspects of Trumponomics that fall outside our usual way of thinking about fiscal stimulus. Trying to pick apart the various kinds of fiscal stimulus in Trump’s budget may hold the key to understanding its novelty.
Fiscal stimulus is usually understood as an injection of money from the government into the “demand side” of the economy — that is, putting money in consumers’ pockets to get them to spend more. So understood, fiscal stimulus can only solve the short-term problem unique to recessions: low spending that forces companies to lay off workers.
Military spending, big border wall outlays, and tax cuts for households all fit this category of fiscal stimulus, since sending money to military personnel, construction workers, and households is nothing more than a transfer. These activities are economically neutral at best. Theoretically, they might stimulate demand in the short run, but it is impossible for such transfers to change an economy’s long-term growth prospects.
Yet two key elements of Trumponomics may have real implications for long-term growth. First, the tax overhaul reduced the corporate tax rate by about a third. Corporate tax reform, combined with Trump’s streamlining of many federal regulations, could reduce the costs of risky ventures for investors that could increase productivity — such as starting new businesses or trying new technologies or business models. If productivity increases alongside inflation, the economy experiences real growth, not just stimulated demand.
Second, some countries that have used deficits to finance infrastructure improvements have seen extraordinary yields in productivity — as much as a 1.5 percent bump in the GDP growth rate. So Trump’s trillion-dollar infrastructure idea, like the corporate tax overhaul, might belong in a different category of “fiscal stimulus” from the rest, targeting long-run growth rather than short-run demand.
In this way, Trumponomics’ focus on improving persistently low growth rates, rather than merely stimulating demand, could lead to long-term economic growth.
As always, there are infinite confounding factors that may prevent these policies from working or mitigate their effects. For one thing, Trump’s own budget may hamstring itself. Several studies show that even though higher military spending stimulates demand, it reduces business investment. Productivity growth through higher investment is the whole point of Trumponomics, but Trump’s plan for a bigger Pentagon budget could upset that goal.
The president will have to do a better job separating policies that contribute to growth and those, such as building the wall and boosting defense spending, that impede growth. If he does not, Trumponomics will turn out to be the failure his critics predict.
Albert Gustafson writes about economics and public policy for Young Voices Advocates. Follow him on Twitter @apgustafson for more about Trumponomics, public policy, and more.