I hesitate to get into this because I accept the liberal position that we ought not “normalize” the Trump candidacy by talking about the “policies” of a dangerously-unhinged, autocratic narcissist, as if they extend beyond demagoguery and satisfying the funding base. But thankfully my readership is tiny, so I can let it rip without much worry.
Greg Ip has a (gated) column in the WSJ pointing out some inconsistencies in Donald Trump’s plan to lift employment by imposing trade restrictions and delivering a large, deficit-financed fiscal expansion.
Greg points out that the fiscal expansion would probably balloon the trade deficit by reducing national savings, irrespective on what Trump did on the trade side. An iron accounting identity dictates that the trade balance accord with saving and investment propensities, which are presumably not affected much by tariffs.
… that is out of step with standard economics, which predicts that a country’s trade balance is determined by the gap between what it invests and saves, not by tariffs.
It also is at odds with experience. In the early 1980s, PresidentRonald Reagan’s tax cuts and military spending soaked up national saving while the Federal Reserve, determined to slay inflation, raised rates repeatedly. The budget deficit and high interest rates together sucked in foreign capital and sent the dollar up 49% between 1980 and 1985.
I am not so adamant on which aspect of the national income accounting identity is “causal” here, and I think Greg oversimplifies a bit, in an effort to highlight the main scenario.
If tariffs were imposed at a time of liquidity trap, they might “work,” in the narrow sense of reducing the trade deficit, accommodated by either a rise of national income and therefore savings or a collapse of capital spending.
Alternatively, even away from liquidity trap, you can imagine the confidence effects of a trade war collapsing capital spending even more than national income and savings in the US. That would allow the trade balance to “improve.”
You can actually imagine many scenarios there. Accounting identities can tell you when you are wrong but not when you are right. Respecting them is a necessary but not sufficient condition for being coherent.
But Greg’s article reminded me of something (I think) more fundamental about Trump’s economic “policy” that I have been meaning to comment on. The purpose of all this crazy is presumably to create jobs.
Data to August only
It may seem like a rather odd time to be focusing on jobs growth, given that the unemployment rate is now close to the natural rate and the Fed is seriously considering tightening policy intentionally to slow jobs growth.
Moreover, the roulette ball twirling around in Trump’s pumpkin has recently landed at “monetary policy is too easy,” so if anything Trump would presumably have the Fed step on the brakes immediately and hard.
But let’s not stop at a major logical inconsistency when a glaring one is right next to it. Trump likes to complain that the “true” unemployment rate is over 40%. I am not sure if he knows where this number comes from, but whoever put it in his head was probably thinking of the complement of the employment/population ratio, which is 60%.
The way to get the employment/population ratio higher and the non-employment rate lower, while respecting that there is a lower bound on the unemployment rate somewhere around here, would be to get the labor force participation rate higher. So Trump, witting or otherwise, is really talking about reversing out the recent decline of the participation rate.
Data to August only
We can imagine a couple ways this might be achieved, depending on the state of the economy. If the participation rate were depressed due to lack of demand – or because of the discouraged worker effect, as it is sometimes expressed – then booming demand and heating up the labor market might work.
However, there is no reason to believe a Trump presidency directly attacking business confidence and agitating for tighter monetary policy would likely deliver a demand boom.
And more to the point, the idea that the depressed participation rate reflects cyclical rather than structural factors has been pretty severely discredited in the past few years. I should provide evidence of this, rather than just assert it, so I guess you can just disagree if you like. My bad. I am not going to address that pretty fully resolved debate.
So that would leave structural policies to raise the participation rate. The range of possibilities here is pretty wide and involves carrots and sticks. For example, you could have government sponsored training programs to raise the skill level and thus market wages of people not currently in the labor force. Or you could withdraw the safety net to make non-participation more painful.
What Trump is actually proposing as what Greg Ip generously calls the “cornerstone” of his economic strategy is a huge, negative supply-side shock which would depress productivity, the market-clearing wage structure, and therefore the participation rate. I think this is the more fundamental sense in which is economic “strategy” makes no sense. But in fairness to Greg, there is an embarrassment of riches here.
And in fairness to Trump, Hillary Clinton is also very slippery on trade issues, although being dead wrong on this is not central to her platform. She is just a scheming panderer, which makes her superior here.
One final point, because I am a terrible nitpicker. This part of Greg’s article is wrong. Trying, again generously, to imagine a scenario where Trump’s policies might not be immediately self-defeating, Greg offers a possibility:
Perhaps interest rates wouldn’t go up, because Janet Yellen, the current Fed chairwoman, or whoever Mr. Trump appoints to replace her, wouldn’t be worried about inflation. Or as the Tax Foundation, a think tank, claims, foreigners would happily lend the U.S. all it needs at the current interest rate (a view the Congressional Budget Office doesn’t share).
The latter part is wrong because capital inflows would tilt lower the path of the funds rate ONLY to the extent that they encouraged trade drag, i.e. a larger deficit. This is the mid-2000s conundrum all over again, and that conundrum was not really. But I leave that as an exercise for
the reader Twitter. If not, as short-hand: go read Larry Summers.
Correction: At a point of maximum snakiness in a post yesterday, I called Jack Nicholson Jack Nicklaus. Instant karma.