Questionably Good Policies, but Certainly Bad Timing
The last several months have seen interesting polices coming from both the GOP led legislative arm of government and the Trump Administration that should leave policy analysts, partisan affiliations aside, perplexed.
The GOP in December of last year muscled through Tax Reform, a nod to their base of their desire to implement their economics of choice - supply side economics - which posits that a reduction in taxes and regulation on businesses would lead to a revitalized economy in which we experience both wage and job growth.
Recently the Trump Administration has opened up his war chest on protectionism, a nod as well to his base in keeping with his campaign promises - slapping tariffs on foreign washing machines, and solar panels and cells, and has outlined plans, to impose tariffs on foreign steel and aluminum products.
President Trump is intent on following through with this despite the strong opposition from key administration officials, GOP leaders, and US political allies who have threatened to retaliate on our exports. Trump has instead doubled down, stating that trade wars are good and easy to win, he further added that if the EU had plans to retaliate then escalation would only occur as more tariffs would be placed on their US exports, citing automobiles.
Also on the policy chopping block have been many environmental regulations and now financial regulation in the form of repealing the Dodd-Frank act.
The point of this blog post is to put these in context. While politics may require that policies are proposed to follow through on campaign promises, and indeed to implement an ideology that is believed to be best for the economy, economic analysis from a strictly non-partisan perspective does seem to suggest that the timing is just way off, notwithstanding whatever the already tenuous promises these policy measures offer.
While perhaps long overdue, the actual form of the tax reform that became law, though following a Republican ideology, begs the question of the need for policies that put more money in the hands of the public, when the economy is currently in an expansion, the stock market, at the time breaching historical records, and unemployment is below its natural rate.
Conventional wisdom would have called for tax-spending reform that yield budget surpluses or reduce the growth of the deficit, not policies that do otherwise. Instead we have huge tax cuts and an infrastructure spending plan, both of which look to increase the deficit by leaps and bounds over at least the next decade.
This has perhaps been flogged repeatedly in prior blog posts, but what is perhaps also very interesting is an AP report released yesterday stating that the steel industry is doing very well such that even prior to the Trump tariff announcement the industry had both added more than 8000 jobs in the last year, and had seen prices reach their highest levels since 2011.
The AP report further notes that industry profits had approximately quadrupled in 2017, from the year prior, and quotes the US Steel CEO, David Burritt, as saying "We're seeing increased demand from our customers and have rescheduled some projects to ensure that we can make enough steel to support our customers' needs".
For whatever justifiable reason for tariffs and whatever beliefs the outcomes will be, it appears the picture painted of a struggling industry, with job losses couldn’t be further from the truth. In fact the latest numbers from a non partisan consulting firm, The Trade Partnership, as the AP reports, suggests that the net impact of the Trump steel and aluminum tariffs would be job losses close to 150,000.
The proper role of government in the economy is perhaps at the core of partisan political ideologies, but it is also at the core of economics. So please read on...
In keeping with the fundamental pursuit of economics being efficiency in the allocation of an economy’s scarce resources, we tend to favor unfettered markets as it can be demonstrated that the allocation from such markets, given the caveat of competition and rational participants, would be efficient.
In practice and with nontrivial outcomes, markets fail to be perfectly competitive when, among other reasons, there are externalities involved, and when there is asymmetric information present. From a traditional economics perspective these situations tend to justify government regulation.
With respect to the presence of pollution, global warming, and in the management of natural resources, economists see these as cases involving externalities, in which markets will allocate resources inefficiently. Environmental regulation is required and preferably using market based policy interventions, to restore allocative efficiency.
The Trump administration has come down hard on environmental spending and in particular climate change programs, seeking to axe them all. Economists however see climate change as a prime externality problem and given the global context see the solution as requiring urgent global coordination.
The world, as per the Paris Agreement under the United Nations Framework Convention on Climate Change, is already on a trajectory moving toward cleaner energy production, coordinating on independent, yet mutually beneficial, mutual cost-sharing programs, to which we were an early signatory to the Agreement. To discard this for partisan preferences on coal production seems ill timed.
Rather than being leaders in the production of cleaner forms of energy, it is perhaps a similar story that is being repeated here, as was narrated recently in a Bloomberg report, with the steel industry. They failed to innovate, failed to keep abreast with market trends, and are now struggling to compete in the world market.
If the Obama Administration Clean Power Plan is believed to be flawed, as some economists do due to its heavier reliance on direct regulation as opposed to market based instruments, there are many right leaning proposals to choose from, including perhaps a 2017 ‘Conservative Case for Carbon Dividends’ proposed by a group of renowned economists along the lines of a conservative ideology. Rolling back environmental regulation whole-sum is just plain wrong.
Financial Market Regulation
With respect to financial regulation. Many analysts point to the Financial Modernization Act passed by the Clinton Administration in 1999 as being the culprit behind the Great Recession we were embroiled in less than a decade after. What did the Act do? It repealed most of the Glass-Steagal Act, put in place in the aftermath of the Great Depression, in 1933 to provide financial regulation to forestall outcomes that made the Great Depression, what we call it today.
What are the Trump Administration and Republican led Congress doing now? Aiming to repeal parts of the Dodd-Frank Act that was put in place to prevent the too big to fail problems that drove the financial crisis and Great Recession of 2007-09. Interestingly the advancement in the Senate of the Crapo bill has strong bipartisan support, with several Democrats, (some of whom incidentally are up for reelection in November) backing the bill.
The thing is financial regulation is in place because as much as we may tout the Efficient Market hypothesis, there is too much evidence beyond anecdotes on the presence and prevalence of asymmetric information in the financial market. Worse, there is even reason to believe that market agents in financial markets are not all that rational in their choices, as we would like them to be.
Who does not like the Dodd-Frank Act? Big banks and many other lending institutions. Why? The regulatory requirement to demonstrate financial health, and healthy lending practices. The Crapo bill in effect does what the Financial Modernization Act did - introduce into the financial market incentives for overly risky lending, and reduced accountability.
Deja vu all over again?
It appears we are destined to repeat history but in a more perverted sense, as we are not trying to correct perceived problems but with bad policies as was the case with the Smoot and Hawley tariffs during the Great Depression, or with the overly confident Financial Modernization Act that felt we were unduly restricting credit generation and access with outdated regulation. Instead, policymakers on both sides, being driven by partisan loyalties and lacking political will, are intent on halting the current expansion and hurtling the economy into a recession that could be of historically epic proportions.
What happens when conventional tools to fight a recession are already maxed out?
We already have tax cuts in place, and projected increases in government spending. We currently have a bloated Federal Reserve, with its balance sheet still at unprecedented high levels even though its been shrinking that over the past year. The federal funds rate is still uncharacteristically low and not too far off from zero. So rate reductions are still constrained. Worse, we may not have options to borrow being readily available as in the past. With tariffs, we reduce foreign holdings of US dollars and their ability to purchase US debt.