Rex Tillerson, former chief executive officer of Exxon Mobil Corp and now US secretary of state nominee, for president-elect Donald Trump. Photo: Kevin DietschIf Australia does indeed catch a cold when the US sneezes, should we be preparing for a crippling dose of influenza when Trumpnomics takes hold?
In the months following the end of the US presidential campaign, the rhetoric of Donald Trump moved from boisterous statements on (mostly undoable) plans to build walls and ban Muslims to more practical announcements about economic policy.
This rhetoric reflects Trump’s understanding that the way to make America great again is through economic prosperity. Hence the need to articulate an economic plan, which, with this weekend’s inauguration, will soon become reality.
So what does this plan look like and what effects will it produce? How are we in Australia going to be affected by the new course of US economic policy?
Mission impossible: saving manufacturing
On the basis of what we know, the centrepiece of Trumpnomics is a restriction of international trade to protect domestic manufacturing (and possibly some other declining industries and sectors).
President Trump is threatening to implement a policy of import substitution, whereby tariffs and/or quotas will be imposed on imports of manufacturing goods produced abroad, even if by US corporates.
Import substitution is not a new idea. In the past, it has been used in many countries to drive industrialisation. While the circumstances and practical implementation of this policy significantly differed across countries, one thing was common: import substitution did not work.
In the countries that tried it, domestic industries failed to develop and the government (read: taxpayers) had to pick up the tab of what turned out to be a very costly experiment.
In principle, import substitution could work if manufacturing was suffering from a temporary loss of competitiveness. In this case, targeted protection would provide the sector with the necessary time to adjust to the new environment (or to respond to whichever shock caused the initial loss of competitiveness) and regain competitiveness.
But in the US (and in most other advanced economies), manufacturing is now structurally uncompetitive; it is a declining sector that tariffs and quotas would keep artificially alive for some time, but at the cost of higher domestic prices on manufactured goods.
Furthermore, if tariffs and quotas were accompanied by some sort of subsidisation of the manufacturing sector (eg tax discounts, direct payment of subsidies and transfers), the import substitution policy would also place a heavy toll on the federal budget.
Actions and reactions
Another undesirable effect of Trump’s import substitution plan is that it will trigger responses from other countries.
Here of course the mind immediately turns to China and the rest of east Asia. One option for China and other US creditors (possibly including Japan) would be to stop financing the US debt.
This could potentially lead to a financial crisis that would significantly reduce the long-term growth potential of the US economy.
However, this is not likely to happen because China and other countries hold large volumes of US debt. There is no rational reason why creditors would want to dump a good investment.
A more likely option would be for China to return to a policy of systematic devaluation of the renminbi.
This would make Chinese goods cheaper and offset to some extent the effect of the tariffs imposed by the US. If China devalued its currency, one would expect other emerging countries to do the same, with the risk that the global economy might be shaken by a domino of competitive devaluations.
The devaluation of the renminbi in response to Trump’s actions would be good news for Australian consumers but bad news for Australian exports. Consumers would enjoy cheaper goods from China and other countries whose currency loses value relative to the Australian dollar. Exports would become less competitive on international markets.
Service (including education) and tourism would suffer the most. To prevent that, Australia could also engage in some form of exchange rate management to devalue the Australian dollar. But this could lead to inflationary pressures at home.
Neglecting fundamental issues
Certainly, the jobs that are being lost in US manufacturing and other declining sectors are a matter of concern. However, rather than trying to save these jobs through a costly import substitution policy destined to fail, President Trump should think of more structural and dynamically efficient interventions.
As an entrepreneur, he should know that while some sectors and activities decline, others emerge. Workers who lose their jobs should be helped to move to the new, emerging sectors of the economy.
To this end, active labour market policies that support the requalification and upgrade of workers’ skills ought to be implemented via the federal budget. Unfortunately, there has been no mention of such policies in President Trump’s rhetoric.
The other big item in Trumpnomics is a combination of corporate tax cuts and investment in infrastructure. This package is becoming more and more popular across many governments.
Yet President Trump’s belief that more infrastructure and lower corporate taxes will stimulate private sector activity and economic growth is questionable.
Economic growth is essentially a process of innovation that leads to productivity gains and to the emergence of new sectors and industries. Infrastructure and tax cuts across the board do not automatically facilitate innovation and hence do not guarantee growth.
However, they do require to be financed. The most likely candidates for a cut in the federal budget are social welfare and public health and/or education. This in turn will increase disparities and inequality in income distribution.
As inequality increases, innovation becomes less likely because its main source (the “middle class”) progressively disappears. At that point, Trumpnomics will have achieved the opposite of what it was meant to achieve: less innovation and slower long-term growth.
In conclusion, Trumpnomics is more than likely to damage the US economy; and if the US economy is hurting the rest of the world is destined to feel the pain.
Professor Fabrizio Carmignani is Head of Department of Accounting, Finance and Economics at Griffith Business School.
This story Administrator ready to work first appeared on Nanjing Night Net.