Trump’s vote buying is leaving a fiscal time-bomb for his successors
By the time you read this column, the results of the US midterms may be known, giving some indication of what, if any, impact Trump’s fiscal and deregulatory stimulus has had on the ballot box. The US economy is booming, with its strongest rate of growth since the great recession, unemployment at a 50-year low and wages rising at their fastest rate in nearly a decade. Naturally, the US president thinks that’s all down to him. Equally naturally, his predecessor, Barack Obama, disagrees. “Let’s just remember when this recovery started,” Mr Obama said recently. “I’m glad it’s continued. But when you hear about this economic miracle that’s going on … actually, those job numbers are the same as they were in 2015 and 2016.”
So how effective has Trump’s juicing of the economy been, has it succeeded – as the president insists it has – in shifting the US on to a permanently higher growth trajectory, and are there lessons for others in the success the US economy is enjoying?
In an interview this week, Italy’s deputy prime minister, Luigi Di Maio, hailed Trump’s fiscal stimulus as a model that should be applied throughout the European Union. Is there any sense in which he is right? The short answer to these questions is not particularly, no, no and no.
Trump’s fiscal stimulus comes in two forms – the Tax Cuts and Jobs Act (TCJA) and the Bipartisan Budget Act (BBA). The first of these significantly added to household and business spending power, the second has enabled big unfunded increases in federal spending. Together, they are believed to amount to the biggest ever post-war fiscal stimulus, worth nearly $1 trillion over three years.
The impact has already been considerable. Yet it may not have been as big as Trump, and indeed much past economic research on the “multiplier” effects of fiscal stimulus, suggest it might be. Recent analysis by the Peterson Institute for International Economics argues that in an economy that is already operating at close to full potential, the multiplier effects are not nearly as large as traditional measures suggest. The conclusion is that the tax cuts and spending increases will add only 0.5 percentage points to GDP, instead of the 2.1 points that might normally be assumed.
Trump’s stimulus may buy votes in the midterms, but whether the economy will still be booming in two years’ time, when the president faces the electorate for a second term, looks far from obvious. If he loses the House, it’ll be political stalemate for the rest of his term, and curtains for any prospect of doubling down with further tax cuts.
What’s clear is that the US economy didn’t need this debt-fuelled booster, which can be seen as a cynical exercise in political manipulation.
If there had been no stimulus, the economy wouldn’t be growing quite as strongly as it is now, and you certainly wouldn’t be seeing the same degree of exuberance in stock markets and business confidence. But arguably, growth would also have been of a more sustainable, albeit slower variety. There is little direct comparison to be made between Trump’s stimulus and Italy’s budgetary declaration of war against the EU. Nevertheless, this they do have in common; both are a complete waste of money. Neither is likely to pay for itself by stimulating superior growth.
In a blog, Olivier Blanchard, former chief economist at the IMF, and Jeromin Zettelmeyer, former directorgeneral for economic policy at the German ministry for economic affairs and energy, argue that there will be virtually no economic dividend from the 0.8pc fiscal stimulus Italy’s new populist leaders have announced.
Remember “expansionary fiscal contraction”, the idea that underpinned post-financial-crisis austerity – that by reducing the deficit you would lower interest rates and underpin business confidence, causing the economy to recover? That turned out not to be true, particularly in Italy, which under instruction from the EU tightened fiscal policy by 3pc of GDP in 2012, but saw an almost equally ferocious fall in output.
Well, Italy’s latest act of rebellion may be the opposite – “a case of contractionary fiscal expansion”. That’s not just because the giveaway is so poorly targeted. Focused substantially on a reduction in the pension age and an increase in welfare, it will do little or nothing for the supply side of the economy. But it is also because in an economy with already very high public debt – 130pc of GDP – it threatens to raise market interest rates, cancelling out any positive impact on demand. And if the stimulus fails to boost growth, but adds to the deficit, it might trigger the same “doom loop” we saw at the height of the eurozone crisis, where there is a run on Italian debt.
The US is not Italy; it is a huge, substantially internalised economy with a global reserve currency that effectively obliges the rest of the world to fund its deficits. Italy enjoys no such “exorbitant privilege”. Bound by the euro, it can only create debt with the European Central Bank’s say so, and the ECB is not about to sanction the European-wide giveaway that Di Maio calls for. Britain sits in between; it at least has its own currency, which means it has the flexibility to behave more like the US. Even so, it couldn’t get away with what Trump is doing. As it is, the relatively modest 1pc of GDP fiscal expansion announced in the Budget is forecast by the Office for Budget Responsibility to generate just 0.3 percentage points of growth.
So this much we do share with the US and Italy – our budget giveaway is very unlikely to pay for itself with the required level of higher growth. The time for fiscal support is when recession bites and the economic weather gets tough, not now at the end of a long business expansion.
The bottom line is this: Trump’s fiscal stimulus is a complete waste of money that will add disastrously to debt – to be running a near-5pc deficit this late in the cycle is the act of a grossly irresponsible government; there may be more of a case for it in Italy, which is drifting back into recession, but Italy’s is an ill-targeted giveaway that threatens to resurrect the eurozone’s political and economic crisis; as for the UK, we too can ill afford the supposed end to austerity announced in the Budget. There will be a high price to pay for today’s profligacy. The West will be back in fiscal crisis before we know it.
‘The US economy didn’t need this debtfuelled booster, which can be seen as a cynical exercise’
All eyes were on Washington yesterday, where Republicans and Democrats were vying for control of Congress as votes were cast in the US midterm elections