This article was originally posted on Real Clear Markets on February 27, 2017.
Is the great surge in the stock market since Trump’s election a promise of better economic times ahead? It is easy to see why Trump’s core economic proposals sharply raised stock prices and why they could help the expansion in the near term. The rest of the Trump program–the attacks on immigrants and trading partners–promise to hurt the economy both now and in the long-run.
President Trump inherited a healthy U.S. economic expansion that was already among the longest on record and showed little sign of ending soon. In the past three years, employment growth averaged 2.5 million jobs a year, reducing the unemployment rate to 4.8 percent. Some cautious private and government forecasts saw the economy as being very near its potential, or full employment, trend line. But based on the still very modest rise in core prices, and the recent improvements in labor force participation as labor markets tightened, there is room for unemployment to fall considerably more from present levels. And Trump’s proposals promise to help make that happen. They will reduce regulation, cut both corporate and personal tax rates, and increase spending on public works and defense. Taken together, these measures will provide fiscal stimulus at a time when the economy still needs it. Interest rates have risen in response and the Fed is now likely to raise policy rates more quickly than it would have.
The stock market should like these economic proposals for several reasons. Lower tax rates directly raise after-tax profits. Faster expansion from the fiscal push means higher profits. And reducing regulations cuts costs and raises profits. Banks, which are a clear target for deregulation, also benefit from higher interest rates that raise lending profits. No surprise their stocks have been the best performers in the market rally.
The impact of these budgetary policies in the longer run are more murky. Today’s Congress is likely to give the Administration most of what it asks for. And one big risk in this is that budgetary projections will be made based on dynamic scoring that assumes the programs produce large increases in productivity growth, and so project unrealistically fast growth in the economy’s potential output and revenues. The CBO and Finance Committee make professional assessments of these supply-side effects in estimating future budgetary impacts of tax changes. But the Administration will push for more generous estimates of future revenues that will make the tax and budget proposals more palatable at present. This will only put off dealing with long-run budget deficits and a rising ratio of debt-to-GDP that is projected as the population ages. The adverse effects of swelling debt will be someone else’s problem at some future time.
Much more immediate economic problems are likely to arise from Trump proposals on immigration and trade. We do not yet know much about plans for trade, though we can hope they are addressed through negotiations. But the moves against immigrants have begun. If the Administration follows through, they are almost sure to disrupt economic activity in the near term and to damage the economy’s growth prospects in the medium and long run.
In recent years, immigrants accounted for roughly half of the annual increase in the labor force. And labor force growth is a major determinant of how fast the economy’s GDP grows in the longer run. Nobody knows just how far Trump’s policies will go in deporting present workers and how much it will discourage prospective immigrants. But they are likely to substantially reduce the economy’s growth in future years. That means lower tax revenues down the road and greater burdens on remaining workers and retirees.
More immediately, reckless immigration policies will severely damage the agricultural industries that rely on immigrants to harvest crops. And throughout the economy, it will disrupt businesses such as restaurants, taxis, and others that rely largely on immigrant workers. This is a lose-lose proposition. And it can overwhelm whatever benefits there may be in the Administration’s taxing and spending proposals. Let’s hope it gets changed before it derails the economy.