Focus Article: The Economics of Mr Trump

Transcription

1 Economic Briefing Report December 2016 Page 1 Focus Article: The Economics of Mr Trump Financial markets reacted strongly to Donald Trump winning the US Presidential election. Markets globally saw wide swings as initial uncertainty forced share prices, interest rates and the $A down and the $US gold price up. Then, and much quicker than expected, markets started looking at the possible impacts of implementation of the President elect s policies as currently understood. While these policies are only set out at a very high level and under the general moniker of Make America Great Again, they are expected to impact across a broad front. The US Share markets appear to be now anticipating higher profits (whether from stronger US economic growth and/or from an increased profit share). In contrast, US Bond markets are anticipating higher inflation and increased real bond yields. This is against the backdrop of the US economy strengthening with US GDP growth also appearing since the June quarter to now be in a cyclical upswing with the initial driver consumer spending, which could be expected to lift with likely continuation of wages growth becoming real and employment growth lifting. Exports have also risen, and while the latter seems to be soybean led, US net energy exports are now likely to be growing. And even the US labour market is getting closer to effective full employment, with unemployment currently at 4.9 per cent; and lifting growth in private sector wages, particularly in manufacturing (albeit with very substantial regional variation). These contradictory responses from the financial markets reflect some significant contradictions in the proposed agenda, for example proposing measures that will boost growth (increased infrastructure and defence spending, the short term effect of the tax cuts) with those that will shrink the US economy (the large scale deportations of undocumented immigrants, the longer-run impacts of unfunded tax cuts); and measures to support US firms and employees facing competition from imports (moving away from future trade deals, threatening to impose tariffs on China and Mexico) with measures that will hurt exporters and those competing with exports (the proposed massive increase in budget deficits will increase interest rates, and the reduction in labour supply from large scale deportations and an increase in military employment will increase wages). Overall, if implemented as proposed, the full set of economic policies would result in lower company and personal income taxes; increased US business investment, including in fossil fuels; substantially higher US Federal Budget deficits and debt as a share of GDP; a substantial lift in military employment and capital spending; a reduced labour force; higher inflation; appreciation in the US dollar; and (likely) lower GDP growth. Higher inflation and increased Federal Government borrowing would see further upward pressure on longer term US interest rates that have already been rising since late July. These rises have already impacted Australian interest rates, private and public, while Mr Trump s win has reduced expectations of further cuts in the Australian cash rate. The foreign policy changes, particularly in the USA looking to reduce its foreign military presence and changing its relationships with Russia and China, can be expected to increase uncertainty (reducing investment) and see increased military spending globally. There is also the broader impact of the world s largest economy effectively saying, in attempting to meet the concerns of the electorate about increasing economic

2 Page 2 Economic Briefing Report December 2016 inequality, the age of austerity with reduced public sector Budget deficits is over. The focus is now on a combination of Keynesian expenditure pump priming, particularly on big employment generators such as the military and infrastructure; Supply Side tax cuts; and protectionism. Similar electoral forces at play in the USA are well evident in Europe and Australia. Budget deficits are already rising. What the Trump ascendancy may do is provide more impetus to these types of policy changes elsewhere. In broad terms, this trio of expectations of higher profits, inflation and interest rates saw jumps in the share prices of growth sensitive companies, including in resources. There were falls in some interest rate sensitive stocks such as Infrastructure and Property but rises for the Banks. This is on a view that the ending of the current very low interest environment should assist their interest margins while possible changes to liquidity and capital rules proposed by Mr Trump could cut costs. There are a number of specific themes/ ideas under Make America Great Again. At this stage there is not a lot of detail. Once the policies get to be fleshed out and the argy bargy starts in the US Congress, changes will be made and timings altered. The background and style of Mr Trump and the nature of his win against the Republican establishment and other US elites point, however, to most of these getting up and we should be prepared for their possible impacts on different investments and portfolios. Tax Plan A very large cut in the company tax rate from 35 per cent to 15 per cent and reductions in individual income tax rates to 12 per cent, 25 per cent and 33 per cent, this cutting in at $US112,500 or the equivalent of $A148,000 for single tax payers. Currently the latter range from 10 per cent to 39.6 per cent (although the effective tax rate is generally much lower than the headline rate). Estate taxes would be removed as would some tax benefits. While most individual tax payers would get a cut in tax payable, the highest gains in dollars and as a per cent of tax paid go to those households in the top 1 per cent of incomes (e.g. those earning over $846,000), reducing the potential impact on consumer spending from the tax cuts as higher income households tend to spend a smaller share of any income gain. The exact cost of the tax plan is subject to some debate, with the Tax Foundation estimated the ten year static (e.g. before any benefits to investment levels of hours worked) cost of between $4.4 trillion and $5.9 trillion, with the Centre for a Responsible Federal Budget estimating the cost at between $9.3 trillion and $11.6 trillion and the Tax Policy Centre estimated a cost of $9.5 trillion. It is possible that there would be some offsetting gains in tax revenue if the tax changes resulted in the hoped for increase in private sector investment but these will be smaller than the direct impact. The company tax cuts would increase after tax profits, which should increase demand for equities in the US and benefit after-tax cash flows and returns for Australian companies with operations in the USA e.g. Brambles, BHP Billiton and CSL. The personal income tax cuts would reduce (but not eliminate) the bias in favour of long term capital gains, now taxed at 15 per cent, and so likely see increased pressure on US companies to pay more dividends. This would make US shares more attractive to Australian investors, even without the benefits of the local franking credits. A USA company tax rate of 15 per cent, along with the scheduled cut of the UK company tax rate to 17 per cent by 2020, may put pressure on the Australian Government to cut the local rate from 30 per cent, possibly with the offset of removing the franking credits.

3 Economic Briefing Report December 2016 Page 3 Infrastructure Increased infrastructure spending by the Federal Government, the States and the private sector through a deficit neutral plan, with the claim that this would be funded by redirecting Federal Government spending away from US globalisation policies to fund infrastructure tax credits for private sector developers of assets. However, annual total US spending on foreign aid is $34 billion so cuts in this budget cannot make the proposal deficit neutral, suggesting that it will either be partly deficit financed, or of a smaller scale than proposed. The policy statement also hopes that reductions in regulatory and approval costs will further fuel private sector infrastructure spending. The Trump Infrastructure Plan notes the aim of filling a $US1,000 billion infrastructure funding gap. Over ten years this would represent a 10 per cent increase per annum on current spending on nonresidential and non-defence structures by the private sector and US Federal, State and Local governments. Most of this spending would stay in the USA and could directly lift US economic growth by up to 0.5 per cent, ignoring the costs of funding the tax credits. Due to the nature of the funding mechanism tax credits allowing investment to be more rapidly offset against future profits the proposal will only increase investment in those assets that can be transferred to private ownership and on which user charges such as tolls can be levied, e.g. bridges, roads, ports and rail are the most likely beneficiaries. As the decision making process will be driven by what can maximise returns to the owners, infrastructure investment is likely to be targeted at areas where there are concentrations of higher income potential users of the infrastructure, rather than where the infrastructure investment will be most beneficial. For Australian businesses this represents opportunities in the construction, funding and management of the new infrastructure, e.g. Lendlease, Macquarie Group, Magellan Financial Group and Transurban Group. Longer term there may be risks to some Australian companies as US sectors as diverse as coal, oil, gas, cereals, beef and manufacturing get quicker and cheaper access to global markets. National Defence Defence spending is slated to lift substantially and more of it is expected to be spent in the USA. The latter is a likely result of having less personnel stationed offshore of a 13 per cent larger Army and significantly increased spending on ships, submarines, aircraft, missile defence, cyber warfare capabilities etc. Effectively all of the hardware spending would be in the USA. Currently, US Federal Government Defence recurrent spending represents around 3.3 per cent of total US spending, with Gross Investment another 0.8 per cent. The Trump policies see savings through cost cutting and increased efficiencies in the Pentagon and reduced profit margins for Defence contractors. Net spending seems likely to rise as a share of the US economy, providing a further boost of perhaps 0.4 per cent per annum, to expected US economic activity, before taking into account the cost of funding the spending increase (either spending cuts elsewhere or higher interest rates due to higher debt), and the reduction in the labour force available to the private sector. The extent to which the increased defence spending represents a boost to the economy will depend on how much other elements of the Trump plan depress GDP (the worse other elements of the plan are the better the impact of defence spending) or reduce the labour force (the greater the reduction in the labour force the more likely an increase in defence employment is to be wholly offset by decreased private sector employment).

4 Page 4 Economic Briefing Report December 2016 It also seems likely proposed changes to US foreign policy such as withdrawing forces from Europe and Asia would increase regional uncertainties and boost local arms spending. Much of this could flow through to US arms manufacturers. International Trade and Foreign Policy Trump policies on international trade regarding renegotiating or not ratifying free trade agreements, e.g. the North American Free Trade Agreement (NAFTA) and the yet to be signed Trans-Pacific Partnership Agreement (TPP), and increasing local procurement rules for public sector spending would boost US economic activity in the short to medium term. This would likely be associated with likely higher US inflation and slower global trade and economic activity outside the USA. Further multilateral trade and investment arrangements to reduce restrictions appear dead. Bilateral arrangements are now the focus, although this is more a strengthening of recent trends than a break. China is to be declared a currency manipulator, which would involve imposing a tariff of 45 per cent on all Chinese manufactured goods. This would increase the cost of consumer goods originating from China, but potentially also, given the globally integrated nature of supply chains, increase the cost of many US manufactured goods. And if China were to retaliate and/or lodge a dispute with the WTO then the impact on global trade, and on global growth, might be much more significant. On Foreign policy, Mr Trump is aiming in his words to make America respected and great again. NATO and Asian allies will be expected to discuss a rebalancing of financial commitments of US military support. Strengthening the USA economically and militarily will enable it to improve relations with China and Russia. To Mr Trump, Globalism is a false song and the US should not be trying to spread universal values. To him, strengthening Western values and institutions will be more effective in getting reforms than military interventions. These policies represent significant change across a broad front. They can be expected to increase tensions on global security and trade and investment arrangements, building on already rising concerns about how the USA reacts to a rising China and more belligerent Russia; of rising protectionism in recent years; and slowing world trade growth. For Australian companies, the main adverse consequences would be from a likely slowdown in the Chinese economy due to lower exports to the US, reducing demand for Australian iron ore, coal, base metals, and energy. Were the reduction in exports to the US large enough to trigger a financial crisis in China (which has high leverage across much of the corporate sector as well as the urban middle class) then the impact on Australian exports would be much larger. Australian firms exporting agricultural products to the USA and anticipating freer access under the TPP would also be affected. As a small potential offset, those Australian companies, particularly in IT and other services, operating within the USA may well benefit. Energy Mr Trump aims to reduce energy costs and make the USA energy independent but the focus is on markets rather than Government intervention. He sees energy independence as a strategic economic and foreign policy goal. Barriers to responsible coal, oil and shale energy production will be reduced or eliminated, including making more Federal land available. Nuclear power is seen as part of the long term energy mix. Mr Trump seems likely to drop USA climate change goals, do away with the Clean Power Plan and US involvement in the Paris climate agreement, increasing the eventual cost of keeping increases in global temperatures to manageable levels, and

5 Economic Briefing Report December 2016 Page 5 resulting in large numbers of preventable deaths due to pollution. Carbon taxes will be off the agenda. It appears environmental and renewable energy policies will become principally the responsibilities of the States. Commentators see the latter and broader Republican interest as continuing to see strong support for renewables. This policy mix seems likely to increase US fossil fuel exploration, development and production activity and so keep prices lower for longer. The US has become an exporter of LNG and processed petroleum products and can be expected to increase both. Thermal coal exports are likely to be more limited due to States environmental concerns. The expected changes are likely to be positive for Australian mining services and oil and gas businesses operating in the USA but dampening prospects for local gas exporters (e.g. a net negative for the Australian economy). Healthcare Mr Trump s stated policy objective is to repeal the Affordable Care Act (commonly known as Obamacare) removing healthcare coverage from around 20 million people (although some recent statements have suggested he may be softening on this). It is also likely to reduce the recent trend of health care cost control, returning the US to its previous trend of healthcare costs increasing at a rate above GDP. There are also potentially significant regional impacts, with those poorer states which accepted the Medicaid expansion as part of the Affordable Care Act and consequently receiving a substantial fiscal transfer which would now cease. Long-term, significantly reducing access to healthcare is likely to reduce potential GDP as a greater number of Americans will be unable to work due to ill-health and some will die prematurely from treatable conditions. Immigration The policies look to new immigration controls, including the wall on the border with Mexico, and rapid deportation of illegal immigrants, i.e. within two years. This is part of the prioritising the jobs, wages and security of the American people. It is not clear whether it would be possible to implement this proposal, as the highest previous number of deportations in the US was 400,000 in The American Action Forum, a right wing think tank, estimates the cost to the US Federal Government would be $US400 billion to $US600 billion over at least 20 years to remove the estimated 11.3 million undocumented immigrants who include 10.3 million workers. That represents about 3.7 per cent of the US population and 6.4 per cent of the US workforce. The Forum estimates doing this in two years would require an additional 117,000 public employees, 16,000 chartered plane flights, 28,000 bus trips and increase the number of detention bed spaces from 34,000 to 348,800 bed spaces. For investors, the Forum estimates the economic impact would be a deep recession with the US economy smaller by 5.7 per cent than if the action was not taken. The Forum quotes estimates by the Bipartisan Policy Centre that doing the deportations over 20 years would have a similar impact on potential economic growth. The most severe impacts would be on the industries that depend most on cheap immigrant labour, such as agriculture, construction and hospitality, where undocumented immigrants are estimated to make up 16, 12 and 9 per cent respectively of their labour force. In conjunction with the other policies outlined above, this action could be both inflationary and reduce potential economic growth. Mr Trump has signalled some pullback in the numbers planned to be deported, perhaps to 5 to 6.5 million. However, that would still be a significant reduction in the

6 Page 6 Economic Briefing Report December 2016 US labour supply at a time when there would be substantial increases in demand on the workforce from an expanded military and infrastructure construction. This would come as wages growth, particularly in manufacturing, is already lifting. Higher food and housing prices from a reduced labour force could also be expected to see added pressure on wage demands. Overall impact The exact impact of the policies outlined above is difficult to estimate without details on how they would be funded, and how they would be implemented. However the Centre for a Responsible Federal Budget estimates that the combined effect of Mr Trump s pledges during the election campaign over ten years would be to increase US Government deficits (and therefore debt) by between $10.7 trillion and $15.5 trillion (increasing the debt to GDP ratio by between 56 and 80 percentage points), and this estimate does not include the direct cost of additional immigration enforcement and deportations. Looking at the broader potential macroeconomic impacts for the US, Moody Analytics estimates that if implemented as proposed, Mr Trump s election promises would have the net effect of reducing average annual GDP growth from over his first term (e.g ) from 2.6 per cent under current policy settings to 0.6 per cent, and employment growth from 1.2 to -0.1 per cent. Inflation would average 3.4 per cent rather than 2.7 per cent under business as usual, and interest rates would also be higher with 10 year treasury yields expected to be 7 per cent in 2020 under Mr Trump s proposals compared to 4 per cent under current policy settings. This would adversely impact public sector debt interest loads and funding capacities. For Australian firms and workers, if you are employed in selling luxury goods, or in selling to the US defence, healthcare or infrastructure sectors then the combined effects of these policies are likely to benefit you, as they are if you own equity in American firms or earn income from bonds or bank deposits. If you export to rest of the world (including service exports such as tourism and education), or have debt then these policy settings are likely to make you worse off. And if you are aged under fifty then four years of the US increasing its greenhouse gas emissions are likely to make you worse off as well. Extract from: South Australian Centre for Economic Studies (SACES) (2016), Economic Briefing Report, University of Adelaide, December. This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Major extracts or the entire document may not be reproduced by any process without the written permission of the Executive Director, SA Centre for Economic Studies, University of Adelaide. Disclaimer: This study, while embodying the best efforts of the investigators is but an expression of the issues considered most relevant, and neither SACES, the investigators, nor the University of Adelaide can be held responsible for any consequences that ensue from the use of the information in this report. Neither SACES, the investigators, nor the University of Adelaide make any warranty or guarantee regarding the contents of the report, and any warranty or guarantee is disavowed except to the extent that statute makes it unavoidable.