Trump’s impossible economics

LONDON – Given Donald Trump’s nominees for key cabinet positions so far, it appears that the US president-elect is determined at least to try to deliver on many of his campaign promises. If so, the current news cycle may have come as a welcome surprise to those who have grown tired of elected leaders making promises they have no intention of keeping. But as a longtime student and practitioner of the dismal science (economics), I see no reason to believe that Trump’s policies will do what he and his supporters think they will do. 

For example, aggressively enforcing a country’s immigration laws might well be a good idea. But aggressively pursuing illegal immigrants who are already in the country is another matter, and if it is done in a way that discourages immigrants more broadly, the United States could lose one of the key advantages that it has over many of its advanced-economy peers. With demographic trends putting downward pressure on the populations of Europe, Japan, and many other countries, the US must be careful to not join them. Additional workers who can preserve the size of the labor force need to be found somewhere. 

Or consider Trump’s two other major campaign promises: significant tax cuts and new 10-20% tariffs on imports from the rest of the world, with the rate rising to 60% for goods from China. While it is easy to find economists who will disagree with each other on just about any economic-policy question, tariffs might be the one big exception. Few economists think they are a good idea, mainly because there is zero evidence that they can help reduce a country’s trade deficit. Worse, all the additional costs and other negative consequences that they produce are well known. 

Martin Wolf of the Financial Times demonstrates this clearly in a recent commentary. A country’s balance of payments, he explains, is an accounting identity (an equation that must always balance out). Thus, any deficit on trade (which typically dominates the current-account balance) must be matched by a surplus of capital inflows. That is how the overall balance becomes balanced. 

While the US could use tariffs to reduce its imports from country A, it will have to import more from countries B and C unless it also reduces the consumption, investment, or government spending that drives its demand for those imports in the first place. In fact, this is exactly what happened after the US imposed tariffs on imports from China during Trump’s previous term. The US continued to import the same goods, but from other countries, many of which increased their own imports from China. If Trump goes ahead and slaps punitive tariffs on those countries, too, the same pattern will have to repeat itself. 

There is no way around it: If the US truly wants to reduce its aggregate imports, it will have to reduce overall domestic demand; or more precisely, it will have to raise domestic savings relative to its investment needs, which in turn would mean receiving less net capital from abroad.

Now consider Trump’s promises to cut taxes and hand out various other goodies for those who helped elect him. Such measures, all else remaining constant, will boost domestic demand; and if they are applied together with tariffs, they will increase the cost of living. The inflation that soured so many voters on Joe Biden’s administration has eased, but Trump’s agenda could send prices soaring again. And that is before accounting for the retaliation by other countries, most of whom would introduce their own tariffs to hurt US exporters (as China and others did previously when they targeted US agriculture). 

What can other countries’ leaders learn from America’s bizarre experiment? With Trump’s unorthodox approach to politics now very much in vogue, we can expect to see more mini-Trump initiatives popping up around the world. But insofar as they are Trumpian, they, too, will fail to achieve their intended purposes. Since all other countries have the same balance-of-payments identity as the US, those with large trade surpluses necessarily export more capital relative to their current domestic investment needs. 

Faced with Trump’s return, wise foreign leaders would start thinking about how to tackle their countries’ own long-standing domestic economic challenges. Those with excess savings, for example, ought to consider how to boost investment at home or reduce the domestic savings rate. Given their own current troubles, Germany and China both would be well served by such a strategy. Not only would it boost their economies and increase the appeal of their leaders; it also would reduce their exports of capital to the rest of the world, including the US. 

Many other constructive policy changes could then follow. China, for example, could reform its financial sector and allow its currency to acquire more of the features that have been so central to America’s ability to attract capital from the rest of the world. Future US leaders might then be less cavalier about dictating terms to others, not least because others would no longer be so dependent on the US and its currency.

Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK treasury minister, is a member of the Pan-European Commission on Health and Sustainable Development. Copyright: Project Syndicate, 2024. www.project-syndicate.org