| || ||Kip Beckman |
Economic growth in the U.S. has averaged around 2 per cent per year since the end of the 2008–09 recession—one of the slowest recoveries from a severe economic downturn ever. Donald Trump contends that this rate of growth is simply not good enough for the United States. His administration plans to cut taxes, ramp up spending on infrastructure, get rid of burdensome regulations, and tear up what he says are unfair trade deals. Trump says these measures will lead to sharply higher growth than during the Obama years—closer to 4 per cent over both the short and longer terms.
To date, equity markets have bought into Trump’s argument, soaring since his election victory. However, the path to economic nirvana is fraught with risks. The uncertainties and potential obstacles related to Trump’s economic agenda have led us to be cautious concerning U.S. economic prospects. Our latest forecast calls for real annual GDP growth of 2.3 per cent for the next few years. Not bad, but a long way from Trump’s 4 per cent world.
Corporate and personal income tax cuts, along with higher spending on infrastructure, could stimulate growth. But they will take time to do their work, and they face several obstacles to being successful. Trump’s proposed cuts to personal income tax rates favour the wealthy. But rich people tend not to base their spending plans on their tax returns, and they may decide to save the additional income rather than spend it. The proposed cut in the corporate tax rate from 35 to 15 per cent could stimulate additional investment spending, but whether it could boost real GDP growth closer to 4 per cent is debatable. Furthermore, there are few shovel-ready infrastructure projects in place where work could start immediately.
Some of Trump’s plans regarding trade could easily backfire, which would offset any positive effects on the economy from tax cuts and higher government spending. His threat to slap a large tariff on imports from China would hurt lower-income Americans who depend on inexpensive imports from discount retailers. And if trading partners retaliate by implementing tariffs on U.S. exports, GDP growth could decline under a Trump administration.
Then there is the thorny issue of capacity constraints in the U.S. economy that are difficult to quantify until Trump’s plans are implemented. Many economists point to the unemployment rate, which is currently below 5 per cent, as evidence that the economy is operating at close to full capacity. In this situation, additional stimulus could lead to prices rising a lot faster than output. And the higher inflation could force monetary authorities to increase interest rates at a faster pace. That could depress economic growth.
The alternative view is that there are still large amounts of underutilized and unemployed resources in the economy. Proponents of this view argue that the low unemployment rate isn’t a sign of a healthy economy, but instead reflects the fact that many discouraged workers have left the labour force. Trump’s stimulus measures could jump-start the economy—but only if the economy is operating well below capacity.
Achieving 4 per cent growth over the longer term will be even more challenging. An economy’s potential growth rate is based on how many people are in the workforce and how productive they are. Labour force growth has slowed sharply over the past few decades due to the aging of the population. Similarly, productivity growth has weakened from the 3-to-4 per cent range that we saw during the computer revolution in the late 1990s and early 2000s.
Attaining consistently stronger GDP growth will require increasing the workforce and improving productivity. Those are challenging tasks (particularly when it comes to growing the workforce at a time when a growing share of the population is moving into their retirement years). Unless Trump can somehow convince women to have a lot more babies, the only way to realistically expand the workforce is to permit much higher immigration levels. But given his threats to deport millions of illegal immigrants, it is hard to imagine him embracing the greater immigration option. It will also be difficult to turn around productivity growth. Productivity guru Robert Gordon contends that productivity growth will not return to the levels that the U.S. enjoyed in the first half of the 20th century. The technological breakthroughs of the early 20th century—such as the rise of the automobile, the widespread use of electricity, and the introduction of air conditioning—had a larger impact on productivity growth than did even the computer and Internet revolution of the 1990s and 2000s. Annual productivity growth since 2011, on the other hand, has been less than 1 per cent.
The economist Larry Summers has examined the negative effects of declining population growth and weak productivity growth, and he concludes that we are in a period of “secular stagnation” in which 1-to-2 per cent GDP growth is as good as it gets. The dramatic slowdown in population growth has led to sluggish demand growth, and firms have responded by cutting back on investment spending. This has resulted in excess savings and lower interest rates. Summers’ views are controversial. Many economists disagree with his analysis. They point to other factors—such as the housing meltdown and its effects on U.S. financial institutions—as more likely explanations for the weakness in economic growth. But the sluggish growth and rock-bottom interest rates in the developed world since 2009 suggest that Summer could be right. At the very least, they imply that a healthy dose of skepticism is in order when assessing Trump’s promise to sharply increase growth in the U.S. economy.