Trump’s protectionist measures will not hurt US economy in 2017

Trump’s protectionist measures will not hurt US economy in 2017

In this debate series, GRI asked what will be the impact of President Donald Trump protectionist measures.  Nandini Rao argues these decisions will not hurt the US economy.

One month into his role, the new US president appears committed towards fulfilling his pre-election pledges of “America First” when it comes to trade. Since his inauguration, President Donald Trump has signed an executive order to pull the US out of Trans Pacific Partnership (TPP) and has expressed scepticism over the North American Free Trade Agreement (NAFTA). Several economists have warned that his protectionist measures may hurt in the long-term, but could in turn have positive effects for the US economy in the short-term.

An “import substitution” policy

One of the major arguments in favour of protectionism is that it can encourage “import substitution”. This would mainly involve the US government using tariffs to increase the price of imported goods or provide subsidies to incentivise companies to manufacture goods in the US rather than having them produced overseas and importing them. This could result in companies “reshoring” – a term broadly used to define movement of manufacturing from other countries back to the US. Even before his inauguration as President, Trump had strongly criticised US companies for locating production plants overseas and threatened to penalise them with border taxes if he was elected.

His high-profile targets included Carrier, Ford, General Motors and Toyota. Carrier is expected to receive a subsidy from the state of Indiana; in exchange, the company will retain 1,000 jobs in the state instead of offshoring them to Mexico. Ford announced that it was abandoning its plans to open a manufacturing plant in Mexico, and would instead increase investment to scale up production at a plant in Michigan. Toyota also announced plans to increase investment in the US. Moreover, even companies that have not been the direct focus of Trump’s rhetoric have been quick to jump onto the reshoring bandwagon. As an example of this, recent reports suggest that electronics major Samsung is considering investing in a new plant in the US, although the electronics company has not been singled out by Trump in the same way as Carrier and Ford have been targeted. As more companies favour reshoring over offshoring, and thereby expand manufacturing in the US, in the short-term, this could lead to higher domestic production and employment.

Growth in manufacturing jobs could spur private spending

Traditionally, manufacturing has been associated with the creation of low-wage or conventional blue-collar jobs. The chart below shows that people with lower wages are more incline to spend rather than saving. In this chart, the 1st decline comprises households at the lower end of the income scale while higher declines consist of wealthier households.


Source: Federal Reserve Bank of San Francisco

The figure shows that on an average, low-income households in the US spend more than they earn and save very little or nothing, while wealthier households spend relatively less; the latter also favour channelling some of their income towards savings.

Consequently, an increase in low-wage manufacturing jobs has the potential to stimulate consumption in the US economy, at least in the short-term. This would have positive short-term economic implications as consumption is a significant contributor to US GDP growth. This is very clearly depicted by the chart below.

Source: Federal Reserve Bank of San Francisco

Source: Federal Reserve Bank of St Louis

An increase in consumption may result in a “virtuous cycle” – companies could scale up production in response to the increase in demand. This would very likely make it imperative for the companies to hire more workers and invest in new capacity, which could result in more jobs being created.

Moreover, short-term GDP growth may also be supported by lower imports if Congress implements the “border-adjustment tax” which is currently being considered by some Republicans. This would involve taxes on imports of goods into the US, but would allow companies to escape paying taxes on goods they export from the US. Critics have argued that consumers may suffer from higher inflation as the prices of imports may rise. However, any inflationary effects may be partially offset by a stronger dollar since  the currency is likely to appreciate if lower imports translate into a lower trade deficit.

US capital more likely to remain in-country

The implementation of the border-adjustment tax or other similar measures may discourage mergers and acquisitions (M&A) motivated by tax inversion – these occur when a US company attempts to move to a different tax domicile by merging with a foreign company. Once the border-adjustment tax is enacted, US companies are less likely to channel funds out of the US to acquire overseas targets and may instead give their M&A activities a domestic focus which would provide a further impetus to growth. Companies may also choose to spend their excess profits on investing or rewarding shareholders with buybacks or higher dividends to incur lower taxes. Some of the resulting increase in wealth and incomes arising from buybacks and dividends may be a tailwind for consumption, and hence economic growth.

Finally, one criticism of protectionism is that it inspires other countries to implement copycat moves, which results in a “beggar-thy-neighbour” wave. The Smoot-Hawley tariffs, which were implemented by the US Congress in the 1930s, were followed by retaliatory moves from other major economies at the time, which resulted in a major slump in US exports. The tariffs are thought to have significantly worsened the Great Depression. Hence, Trump’s protectionist measures could potentially have negative long-term implications if other countries join in the backlist against free trade and take steps to penalise US exports.

However, in the short-term, a decline in US exports is unlikely to be a significant economic drag as the chart above shows that exports account for a relatively small proportion of US GDP growth. Moreover, any negative impact on growth from lower exports could very well be offset by positive contributions from greater consumption and investment, as companies shift production back to the US and create more jobs.

In conclusion, while it is debatable that Trump’s protectionist policies will make “America great again” in the long-term, they are unlikely to have a significant negative impact on growth in the short-term. Indeed, some of his policies could even boost short-term GDP growth and employment.

GRI Debates provide critical insight into the world’s most challenging political risk topics. Through well-balanced opinion based articles, GRI Debates offer a forum for deeper discussion into how major political decisions and security challenges affect markets, investment, and economic growth across the globe.

Categories: Economics, North America

About Author

Nandini Rao

Nandini has a Masters in Financial Economics from Saïd Business School, University of Oxford and a BSc (Honours) in Economics from Aston University. She focuses on monetary policy.