“Trumponomics” in a Nutshell: a Keynesian Revival

Keynesian fiscal stimulus:

Trump’s ascend to presidency comes at a time when the economic recovery since the end of the Great Recession has been modest by historical standards. Since World War II, the US economy has had various business cycles. Average GDP growth in the expansion periods before 1990 was four per cent, which then slowed down to 3.5 per cent, 2.7 per cent and about 2 per cent during the Clinton, Bush and Obama administrations, respectively (Source: the Bureau of Economic Analysis (BEA)).

Trump’s promise of 3.5 per cent GDP growth on the back of one trillion US dollar infrastructure spending, and tax cuts of 4.4 trillion US dollar, all without raising the deficit, seems ambitious. Indeed, the steeping Treasury yield curve (a barometer of long-term inflation expectations) triggered by the recent bond sell-off shows that financial markets expect the aggressive pro-growth policies to require future borrowing and Treasury bond issuance.

Planned tax cuts and higher public spending signify that Keynesian fiscal stimulus policies are back ‘en vogue’. Effectiveness of Keynesian stimulus policies, which rely on the trade-off between inflation and real output, were criticised by Nobel laureates Lucas and Sargent (1979)^[1]. They argued that if a policy were used in the past with limited success, economic agents would anticipate this result and update their response accordingly. This in turn would reduce the impact of the policy on real output.

The large tax cuts (the top tax rate  25 per cent instead of 39.6 per cent on individual income and 15 per cent instead of 35 per cent on the corporate tax rate) coupled with tremendous public spending will support consumer spending in the short run. Excluding the potential tax revenue from economic growth resulting from lower tax rates, the federal deficit may increase by 10 trillion US dollars over the next decade. Increased borrowing inevitably leads to higher interest rates in the future, crowding out consumer spending and investment, thus neutralising any initial benefits. Furthermore, companies may channel some of the repatriated cash from Trump’s planned tax holiday on foreign earnings, to share-buy backs or dividend pay-outs instead of investing. The share of investment in GDP since the Great Recession has shrunk to 15.5 per cent from its (pre-financial crisis) post-war average of 17.4 per cent (Source: BEA). In the spirit of the Lucas-Sargent critique, ‘micro-foundations’, such as the willingness of companies to invest in new projects, may determine the effectiveness of Trump’s pro-growth policies.

Trade:

It is too soon to assess Trump’s trade policy at this point. However, he has already pledged to withdraw from the Transpacific Partnership (TPP) and replace it with "fair bilateral trade deals". It remains to be seen if his renegotiation of the NAFTA between the US, Mexico and Canada will lead to the introduction of big tariffs on imports from China and Mexico. In the past, he expressed his intention to impose a  45 per cent tariff on Chinese imports and a 35 per cent tariff on Mexican imports  that would make overall imports at least 14 per cent more expensive, and result in higher inflation. As the undocumented immigrants living in the US make up 5.1 per cent of the labour force, Trump’s deportation policies may also add to rising inflation through higher domestic wages.

Currently, most US imports originate from China (20.8 per cent), followed by Mexico (13.5 per cent). (Source: US Census Foreign Trade Statistics). Roughly 80 per cent of Mexico’s total exports go to the US, making Mexico’s economy vulnerable to a protectionist policy. A raising of tariffs  and a possible retaliation by China and Mexico could potentially trigger trade wars and a de-globalisation process that would have broad negative consequences such as lower global efficiency and loss of welfare.  

Despite the US being an important export destination for Switzerland (14 per cent of total exports), Trump’s trade policy is unlikely to have a significant direct effect on Swiss exports, given their low substitutability with US production. However, the weakness in world trade with the general cooling down of global economic activity poses downside risks for Swiss exports.

Since the election, the prices of steel and copper have rallied owing to Trump’s infrastructure plans. Coal prices have also surged, thanks to his pledge to revive the declining coal industry. Global coal trader Glencore should benefit from this shift in energy policy. Both the increases in metal prices and the revival of coal trade may positively impact the merchant trade component of Swiss GDP.

Health care:

Trump’s presidential campaign had focused on the repeal of the Affordable Care Act, a.k.a. ‘Obamacare’. As the probability of new legislation controlling the pricing of drugs seems much lower, this is potentially beneficial for the pricing power of Swiss pharma companies. However, the net effect on pharma revenues is unclear, as a repeal of Obamacare would challenge affordability of medication for a large number of people, who would lose their health insurance coverage.

Financial regulation:

Trump pledged to dismantle some core elements of the Dodd-Frank Act, (a legislation passed in 2010 to make Wall Street safer), such as the ‘Volcker Rule’, which restricts deposit-taking banks from proprietary trading. It is likely that his domestic de-regulation efforts will have far-reaching consequences for the EU and Swiss banks. The Basel Committee is already under pressure from European policymakers to soften the new capital rules for banks. As European banks anxiously wait for the package called Basel IV, it is too early to say if Trump’s deregulation policy would also influence the Basel Committee or Swiss Financial Market Supervisory Authority FINMA to consider more lenient capital requirements for banks.

[1] Robert E. Lucas Jr. and Thomas J. Sargent (1979) “After Keynesian Macroeconomics”, Federal Reserve Bank of Minneapolis, Quarterly Review, Vol: 3, No:2, pp 1-16