Trump’s Presidential Win May Provide a Boost to the Economy | Capital Group

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Trump’s Presidential Win May Provide a Boost to the Economy

By Darrell Spence
Capital Group Economist

The election’s net impact on the economy will be a function of the magnitude of policy changes and the timing of their implementation.

With Republican control of all three branches of the federal government, some changes could happen quickly. Tax cuts would provide a fairly immediate boost to economic growth. A surge in infrastructure spending would also be beneficial but would take longer to be implemented, as projects need to be mapped out and resources mobilized.

If implemented as suggested in his plan, President-elect Donald Trump’s tax and infrastructure proposals could boost growth, all else being equal. This could lead to a meaningful uptick in the economy in late 2017. However, these policies would come at the price of a significant expansion in the deficit and a resumption of the upward trajectory in the federal debt-to-GDP ratio, which had started to flatten out.

To the extent this leads to increased concerns regarding the sustainability of U.S. debt, and the surge in growth creates inflationary pressures, these policies could lead to higher interest rates, offsetting some of the beneficial effects of lower taxes and higher spending. At the end of the day, the net impact on the annualized GDP growth rate could be a boost of 1.0% to 1.5%.

A reduction in the regulatory burden could also be implemented fairly quickly, with positive implications for growth.

Trade Agreements Take Years to Negotiate

Trade agreements take years to negotiate, so it is unclear what renegotiations of current trade agreements would entail and how quickly they would occur. Tariffs would have a fairly immediate negative effect on growth. Tariffs increase the price of imported goods for U.S. consumers, thus cannibalizing their purchasing power. In addition, tariffs could provoke trading partners to retaliate with similar measures, hurting U.S. exports.

Implementing a 35% tariff on imports from Mexico and a 45% tariff on imports from China, as Trump has suggested, would increase the cost of imported goods from those two countries by $310 billion. This would amount to 1.7% of GDP and 2.4% of consumer spending, so the economic impact would be meaningful.

In addition, a trade war has the potential to disrupt established supply chains. Trump’s trade measures are unlikely to result in a relocation of production to the U.S. Even if they did, it would take a long time for the U.S. to see the benefits, and it would mean much higher prices for those domestically produced goods.

The Possibility of Rising Geopolitical Uncertainty

If the U.S. takes a less active role in foreign affairs, global geopolitical uncertainty would increase, which would likely result in higher risk premiums. Ultimately, it seems that the outcome of the election is likely to create:

  1. Stronger growth in the near term, leading to a continued upward drift in inflation.
  2. Higher interest rates.
  3. A wider deficit/higher debt.
  4. An increase in risk premiums, including potentially lower P/E ratios, until there is more clarification on trade policy.

Looking farther out, if action on trade policy follows Trump’s rhetoric, the outcome is likely to be an unwelcome combination of slower growth and higher inflation, with a reasonable probability of a recession starting in 2018.

Trump has called for major defense spending increases, which would probably include beefing up defensive homeland security as well as offensive capabilities. That could signal something of a reversal from the Obama administration, which allowed defense spending to decline. Of course, if growth for such expenditures picks back up, it would be welcome news to big defense contractors in industries like aerospace.

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Darrell R. Spence is an economist at Capital Group. He has 23 years of investment industry experience, all with Capital Group. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics. Darrell is based in Los Angeles.