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The approaching end of President Donald Trump’s first year in office, another very robust employment report and a still strong stock market make it appropriate to revisit my year-old judgment that the American economy is enjoying a sugar high.
Sadly, the best available evidence suggests that signs of market and economic strength are largely unrelated to government policy; that the drivers of this year’s strong performance are probably transient; and that the structural foundation of the US economy is weakening. In this sense sugar high remains the right diagnosis — and tax cuts very much the wrong prescription.
Growth in the fourth quarter looks likely to hit 2.3 per cent, marginally higher than the consensus just before the 2016 election. Expectations for next year are only marginally greater today than they were before Mr Trump’s victory. So there has been no substantial lift in the economy. In fact, the US has trailed the global economy as other countries, notably in Europe, have seen greater upward forecast revisions.
The US stock market has risen by close to 25 per cent, largely due to increases in corporate profits this year. Yet performance is running behind Japan and Germany, belying the idea that the market is being driven by US-specific policy factors.
The suggestion that US fundamentals have improved is also called into question by the decline of the dollar, which has fallen by 8 per cent against the yen and 7 per cent against the euro since the Trump win. If something fundamental had happened to improve the business environment, we would have seen capital inflows and an appreciating dollar.
Of more importance is whether this growth is sustainable. From the supply side it is hard to imagine that an economy starting with 4.1 per cent unemployment can continue to create anything like 200,000 jobs a month when normal growth in the labour force is in the range of 60,000. From the demand side, this year’s growth was driven by a stock market rally that saw an increase of more than $6tn in household wealth. Even if the market holds its level, similar increases cannot be expected on a regular basis in the future.
Such poor prospects for sustained rapid growth are not surprising given the economy’s weak foundation. Despite record low capital costs and abundant corporate cash — both inducements to investment — productivity growth has been very slow.Even innovative companies such as Apple and Google cannot find enough high-return investments and so choose to engage in large-scale share repurchases. Given record profits and low capital costs it seems more plausible to blame poor performance on insufficient public investment rather than inadequate incentives for private investment.
This is a major issue. Given slow labour force growth, a substantial acceleration in productivity will be necessary to maintain the economy’s rate of expansion in coming years. Even if growth can be somehow maintained or accelerated, it is fundamental for a healthy economy that its benefits be widely shared. Unfortunately, the tendency has been very different in the US, where inequality has increased and much of the growth has been captured by a small share of the population.
There will be no meaningful and sustained growth in workers take-home pay without successful measures both to raise productivity and to achieve greater equality. Only in this way can we achieve healthy growth.
The tax-cut legislation now in committee on Capitol Hill exacerbates every important problem it claims to address, most importantly by leaving the federal government with an entirely inadequate revenue base. The bipartisan Simpson-Bowles budget commission concluded that the federal government needed a revenue base equal to 21 per cent of gross domestic product. In contrast, the tax cut legislation now under consideration would leave the federal government with a revenue basis of 17 per cent of GDP — a difference that works out to $1tn a year within the budget window.
This will further starve already inadequate levels of public investment in infrastructure, human capital and science. It will probably mean further cuts in safety net programmes, causing more people to fall behind. And because it will also mean higher deficits and capital costs, it will probably crowd out as much private investment as it stimulates.
The proposed tax cuts may prolong the sugar high. But they are no substitute for the new economic foundation we so desperately need.
The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary