The days of US fiscal restraint, and of global trade growth outpacing GDP growth, are now over.
Donald Trump’s tough talk on combatting China’s ‘unfair’ trade policies have led some to fear that he will immediately slap a punitive tariff (which could be in the region of 30-45%) on all Chinese imports. This would trigger a major trade war, pushing up consumer prices and casting the American economy into recession. According to these fear-mongers, Trump is also likely to fill the two vacant seats on the board of the Federal Reserve with candidates sharing his criticism of current Chairwoman Janet Yellen, creating massive uncertainty in financial markets.
Others argue that, on the contrary, Trump’s inexperience with public offices will lead to four years of inaction in the oval office.
Both scenarios are possible, but the first signals from both the Trump camp and the Republican party suggest that he will refrain from the most dangerous policies but follow through with his agenda in broad terms, supported by solid Republican majorities in both the House of Representatives and the Senate.
As we shall see, this would fundamentally change the economic landscape for Europe.
From a macroeconomic point of view, the age of fiscal restraint in the United States is set to end. All of Trump’s policy proposals include an increase in government debt. Trump has consistently promised a strong increase in infrastructure investment and major tax cuts, without specific plans for how to pay for either.
It is not clear whether Trump will find a majority in Republican-controlled Congress for his infrastructure plans, but getting a majority for tax cuts should be a no-brainer. As under Republican presidents Ronald Reagan and George W. Bush, it is likely that the GOP will believe the rhetoric of supply-siders and hope that tax cuts will be ‘self-financing’ – that tax receipts will rise despite the rate cut, because of the economic growth benefits of lower taxes. But history teaches us that it is more likely that tax cuts will cause the deficit to balloon.
Higher government deficits tend to lead to higher interest rates, as some of the burden is taken from the Fed to keep interest rates ultra-low to stabilize the economy. This in turn has consequences for the rest of the world: The U.S. dollar is likely to appreciate.
At first sight, this sounds positive for Europe: a dearer U.S. dollar means better price competitiveness for EU companies and hence potentially more exports.
However, here, Trump’s macroeconomics will interact with his stance on trade, which has been relatively consistent and clear. Trump has promised to ditch the Transpacific Partnership (TPP), a free trade agreement already completely negotiated with a number of Asian countries, renegotiate the North American Free Trade Agreement (NAFTA) with Canada and Mexico and only accept future trade agreements which are “good for America”. In his speeches, he has repeatedly cited studies on how the U.S. trade deficit translates into jobs lost in the United States, and issued calls to label Beijing as a “currency manipulator” in order to impose punitive tariffs against Chinese goods.
This has two consequences for Europe: First, the United States’ benign neglect of its current account deficit will most likely be over. When the U.S. criticises China (which has a current account surplus of about 2.5 percent of GDP in 2016), the German finance ministry should be worried given the German current account surplus of almost 9 percent of GDP. The euro-area should be prepared to have its macroeconomic policy stance questioned for the same reason, even if its surplus is not as high as Germany’s. If the dollar appreciates and European car manufacturers gain ground in the U.S. market, Europe should be prepared to be confronted with protectionist measures (just as Japan was in the 1980s when the U.S. dollar surged on account of Reagan’s deficits).
If Europeans want to prevent a growing current account surplus (and hence limit the risk of a trade conflict with a Trump-led United States), they will have no option but to move away from austerity.
The second era that Trump’s presidency is likely to end is the longstanding trend of higher global trade growth than GDP growth. From World War II until 2008, global GDP grew about 8 times, while world trade grew by more than a factor of 30. In the 1990s that trend was driven by the WTO’s multilateral trade liberalization. Later, when multilateralism faltered, large regional trade agreement such as NAFTA and the European Union’s single market project propelled forward global trade..
Multilateral trade negotiations have long since ground to a halt. And given that President Trump will not put his weight behind WTO talks, they will be irrelevant for years to come. However, after the EU’s CETA debacle, regional trade integration has also likely reached its limit. Trump will almost certainly shelve TTP, and will not be willing to compromise on details of the Transatlantic Trade and Investment Partnership (TTIP). With support for TTIP already weak in Europe, this means the end of further transatlantic trade integration.
As it stands, Europe is ill-prepared to react to these developments. Given the disastrous CETA and TTIP debate, Europe is not in a position to launch its own global trade initiative. European initiatives for further WTO progress are set to be futile if the U.S., still the world’s largest economy, cannot be brought along.
As helpless as it sounds, the only thing Europe can do in response is to strengthen domestic drivers of growth. This means, first and foremost, designing a strategy which does not rely on external demand to get the economy going again and bring down unemployment. Reforms to speed up economic growth (such as cleaning up the banking system) will be part of it, but if Europeans want to prevent a growing current account surplus (and hence limit the risk of a trade conflict with a Trump-led United States), they will have no option but to move away from the austerity stance of recent years. By contrast, attempts to rely only on improved competitiveness to increase economic growth will lead to a larger European trade surplus and more potential for transatlantic conflict.