In Dave Cote’s mind, the case for optimism is clear. The CEO of industrial giant Honeywell believes that the U.S. economy is poised for a surge under the Trump administration. President Trump’s pro-growth plan to lower corporate taxes and streamline regulation, says Cote, has energized the business world. “I’ve talked to dozens of big- and small-company CEOs since the election,” says Cote. “And I’m seeing a big improvement in animal spirits. Before, the attitude was, ‘Things will muddle along, so we’ll muddle along with it.’ Now the herd is saying, ‘Things are looking up. We don’t want to miss out on this, so it’s time to ramp up investment.’ ”
Such a shift in momentum can be powerful, asserts the veteran executive. “We needed some kind of a spark,” says Cote. “And the spark was the change that occurred because of the election.”
Indeed, it’s not just Fortune 500 CEOs who have viewed the U.S. economy as primed for a breakout since Donald J. Trump’s surprise victory on Nov. 8. Small-business optimism has spiked. In its December survey, the National Federation of Independent Business registered an astounding 38 percentage-point jump from November in the portion of business owners who expect better conditions going forward—from 12% to 50%.
The most obvious scorecard of confidence in Trumponomics, of course, is the stock market. And the huge Trump Rally in equities clearly indicates that investors are betting that the new President’s policies will recharge corporate earnings. Since Election Day, the S&P 500 has risen more than 8%, adding some $1.4 trillion in value, and the manufacturing-heavy Dow Jones industrial average breached the historic 20,000-point threshold and kept climbing. After Trump said in early February that he was going to “announce something phenomenal on taxes in the next two to three weeks,” the indexes leaped again to close at new highs.
The market rally assumes that the Trump administration can make good on its early promises to raise America’s annual growth rate by gigantic proportions—from the dreary 2% of recent years to a robust 3% to 4%. That may just be doable, say a number of veteran economists, if Trump can deliver lower regulations and taxes without derailing the economy in some other way. “It’s not in the bag, but it borders on the likely,” says Allan Meltzer, a legendary monetary-policy specialist and onetime Reagan adviser.
That’s what could go right. But there is much that could go very, very wrong.
Even many of Trump’s ardent supporters in the business community fear that core elements of his platform could steer the economy in a far darker direction. The biggest risk is trade. Trump is advocating protectionist policies that could reverse the decades-old march toward open borders that has enriched both the U.S. and its partners, potentially igniting a global trade war. As he vowed he would on the campaign trail, Trump has already killed the Trans-Pacific Partnership—the trade agreement negotiated by the Obama administration that would have lowered barriers to U.S. exports with Japan, Australia, and nine other nations.
Conservative economists who support the tax and regulatory portion of his agenda are extremely wary about his instincts on trade. Trump has threatened Mexico and China with tariffs ranging from 20% to 45%—a strategy theoretically intended to lower our trade deficits with the two largest exporters to the U.S. that could backfire bigly. “The big risk to his success is a trade war,” says Douglas Holtz-Eakin, the president of the American Action Forum and a former director of the Congressional Budget Office under George W. Bush.
But Trump’s protectionist proclivities are hardly the only concern. His harsh anti-immigration stance is another downer for growth—with the potential to drive away or deport millions of workers who are the bedrock of the farming and construction industries, as well as to surrender the U.S.’s dominant position in the global talent wars by restricting visas for engineers and programmers who help power America’s R&D.
Therein lies the promise and peril of the Trump economy: Put simply, America has never witnessed such a contradictory mix of free-market and antigrowth policies in the White House. Or a President who operates in such an unorthodox and unpredictable way.
Bolstering the case for pessimism is Trump’s hair-trigger temperament and penchant for launching scorched-earth attacks on a daily basis—including on world leaders from whom the self-declared master dealmaker will need cooperation to deliver the export-boosting concessions that are the centerpiece of his “America First” economic plan. In addition to antagonizing China and Mexico, the President has lambasted Chancellor Angela Merkel for “ruining Germany.” He even berated Prime Minister Malcolm Turnbull of Australia, a close U.S. ally, in a heated phone conversation.
Yet those incidents were but minor controversies in the chaos of the Trump administration’s first few weeks. The Twitter-happy President lashed out at the “so-called judge” who suspended Trump’s controversial immigration ban on people entering the U.S. from seven Muslim-majority nations, as well as the federal appeals court judges who upheld the ruling. Trump also found time to go after department-store chain Nordstrom after the retailer dropped his daughter Ivanka’s clothing line because of falling sales, tweeting that she had “been treated so unfairly.”
So much meshuggaas emanating from the Oval Office has raised very real questions about execution risk on all issues, including the economy. The hastily imposed Muslim ban in particular infuriated congressional Democrats, limiting chances for compromise even in areas like fixing roads and bridges, an initiative with bipartisan support. Although Republicans control both houses of Congress, it’s unclear how much of the Trump agenda will actually become law. For example, financing his reductions in corporate levies depends heavily on the passage of an extremely complex “border adjustment tax,” or BAT, that the Senate Republican leadership has yet to endorse.
“After the election, we were looking for areas of common ground, such as an infrastructure program,” says Rep. John Delaney, a Maryland Democrat. “But now with the way the administration is behaving, the way they throw things out, people in Congress have gotten a lot more pessimistic. You need reliable parties at the table to negotiate a big, complicated tax and infrastructure plan. You have to ask, Are they going to be serious?”
Trump’s sudden shifts in policy—and the difficulty in ever ascertaining whether he is bluffing or serious about his more dire threats—are causing widespread uncertainty. And if business hates anything, it’s uncertainty. “I think things are moving in the right direction, but I’m seeing lots of nervousness,” says Tom Barrack, chairman of real estate investment manager Colony Capital and one of Trump’s closest friends. “I’m seeing totally polarized views on what’s going to happen, from one camp believing things are going to be great, and an opposing camp predicting disaster.”
Some of Trump’s proposals are already undermining his principal goals. His tariff threats against Mexico, for instance, have helped push the peso down 10% against the dollar since Nov. 8. That’s made U.S. exports of everything from auto parts to appliances a lot more expensive across our southern border, slowing the exports that Trump vows to grow.
Both Trump’s conflicted policy and his erratic execution have caused some on Wall Street to have second thoughts. For example, Ray Dalio, founder of the world’s biggest hedge fund, Bridgewater Associates, praised Trump’s policies in an essay on LinkedIn shortly after the election. In late January, he hedged his position in a note to clients and warned that he had become “more concerned that the damaging effects of President Donald Trump’s populist policies may overwhelm the benefits of his pro-business agenda.” In early February, Goldman Sachs sent a note to clients warning that “risks are less positively tilted than they appeared shortly after the election.”
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Danger is also lurking in the buoyant stock market. The big gains since the election have made pricey shares even more expensive, driving the trailing price/earnings ratio of the S&P 500 to 25 in mid-February—well above the historical average of 16. That leave equities extremely vulnerable to deep declines if investors begin to sense that Trump can’t deliver the GDP gains that he’s promising.
It’s important to remember that it is still early days for the Trump administration. There’s plenty of time for the new President and his advisers to refine their approach to governing and, in economic matters, to deliver his promised reforms. Speculating on the odds of that happening, however, is a fool’s game. For now, we can focus only on what he has said he wants to do.
To better understand the specifics—and the unknowns—of Trump’s policies and how they’re likely to drive or slow the economy, Fortune interviewed dozens of economists, policy experts, former government officials, and business leaders.
What does Trump think of the turmoil he has caused so far? “I talk to him every day,” says Barrack. “He thinks it’s a revolution, and all the tumult is normal. He’s not bothered at all by all the divisions in Congress and the electorate.”
The near future of the American economy will depend on which side of the scale predominates under Trump: free-business initiatives or protectionist policies. Corporate tax cuts and regulatory relief will weigh heavily on the plus side. But an upheaval in trade would swamp all the potential gains from slashing regulations and taxes.
Trump’s team appears divided on trade. Commerce Secretary nominee Wilbur Ross and White House National Trade Council chief Peter Navarro are in the protectionist camp, while Treasury Secretary Steve Mnuchin and top economic adviser Gary Cohn, the longtime No. 2 to Lloyd Blankfein at Goldman Sachs, seem wary of disrupting free-trade agreements. Keep in mind that Trump’s pledge to protect workers from cheap, job-killing imports from China and Mexico was a key factor in helping propel him to the White House.
As quickly as things appear to be moving now, it’s important to remember as well that negotiating big trade deals is a lengthy process. If Trump can significantly boost growth in the next two or three quarters, America will be in a far better mood. With payrolls and wages waxing, the pressure to build trade barriers will abate, and Trump could declare victory by trumpeting relatively minor concessions. That’s probably the best-case scenario for achieving a healthy balance of policies. “If Trump can achieve consistent 3% to 4% expansion in GDP, nothing else matters,” says Gary Hufbauer, an economist at the Peterson Institute for International Economics and a stern critic of Trump’s views on trade.
Trump has a realistic shot at reaching that ambitious goal, though it will require implementing his unambiguously pro-business policies and mostly scuttling the rest. The President inherited a so-so economy that grew at just 1.6% in 2016 and has expanded at an average of 2.3% annually since the nadir of the Great Recession in mid-2009. Although the unemployment rate is now just 4.9% and the economy has created 11 million jobs in the past seven years, roughly an equal number of working-age Americans have ceased looking.
Many economists argue that a small pool of employable labor and an aging population, capped by low levels of immigration, have helped create a “new normal” that confines America to a plodding GDP growth rate of 2% or so. Trump isn’t buying it. In the view of his economic team, the roadblock is a dearth of capital investment. They argue that Obama hobbled business with a host of expensive regulations in banking, energy, and manufacturing that forced CEOs into a defensive posture, in which they shunned risk taking and hoarded cash.
Whatever the reason, it’s undeniable that capex in the U.S. has languished and that a healthy dose of new investment is absolutely essential to lifting America’s growth trajectory. The crucial measure of capex, private nonresidential fixed investment, stalled in the third quarter of 2014. Since then, spending on new plants, labs, and research facilities has increased less than 0.5% a year, adjusted for inflation, creating a substantial drag on GDP.
Trump wants to jolt the U.S. economy back into action. He predicts a virtuous cycle in which his tax plan allows companies to raise their profits from new investments, driving them to boost spending. Then new machinery and tech breakthroughs will raise worker productivity and, hence, wages and employment. At the same time, lifting burdensome regulations should also recharge capex across the economy.
So let’s go deeper into Trump’s plan to jump-start things. His three big pro-growth initiatives are corporate tax reform, regulatory reduction, and infrastructure renewal. We’ll start with taxes.
Trump aims to greatly enhance the competitiveness of the U.S. economy by radically lowering the corporate rate. America’s 35% federal corporate tax rate is the highest of any major developed nation, at least statutorily. In practice, U.S. corporations take advantage of so many write-offs that the effective tax rate is much closer to par with that of other advanced economies. Still, tax reform has a great potential to juice GDP. The Organisation for Economic Co-operation and Development (OECD) has identified heavy corporate levies as the most antigrowth of all tax categories.
Two plans are now in competition. The first is the relatively general platform that Trump issued during the campaign and hasn’t updated. The second is the more comprehensive House Republican proposal. The two are remarkably similar, with one huge exception: The House plan includes a complex, controversial measure called the border adjustment tax, or BAT, which has the potential to raise a massive $1 trillion in tax revenue. More on that in a moment.
On personal taxes, both plans go big on simplification, reducing the number of brackets from seven to three and lowering the top rate from 39.6% to 33%. And on the business side, the House and Trump plans would both greatly reduce the corporate tax rate. Trump proposes a top federal rate of 15%, one of the lowest levies in the developed world. The House champions a maximum of 20%.
Both plans also propose another historic tax break for businesses, one aimed at raising investment. They would allow companies to write off 100% of all capital investments in the first year instead of expensing them gradually over three to 20 years or more, as required under current law. “It’s crucial because when companies depreciate a $1 million investment over 10 years, they’re really getting a tax break of maybe $750,000 because of inflation,” says Kyle Pomerleau, an economist at the Tax Foundation, a nominally “nonpartisan” think tank with a free-market tilt. “If they write it off in year one, they get the entire $1 million as a deduction.” That difference substantially raises the future returns on new plants and equipment.
The crucial difference between the two plans is the BAT—a revolutionary new border tax that resembles the VAT, or value-added tax, levied by virtually all of America’s trading partners. The BAT, however, is a different animal.
How does it work? Whereas the VAT is essentially a sales tax that’s eventually tacked onto the price of a product or service, the BAT is more complicated. It would raise and lower corporate income taxes, increasing levies on importers and providing big credits to exporters. Today importers pay a 35% rate on their profits. Under the BAT, they would pay the new rate—let’s call it 20%—on the entire revenue they collect selling, for example, Japanese cell phones or French perfume in the U.S. That would more than double the taxes paid on a $30,000 car with a 20% profit margin—from $2,100 to $6,000.
By contrast, U.S. exporters would get an added deduction for the full revenue collected on the products they sell abroad. So they would go from paying 35% on their profits in Germany or Japan to receiving a big rebate. Supporters of the BAT claim that it will cause an already-strong dollar to further strengthen, lowering the cost of imports, so that foreign nations would sell the same volume of goods in the U.S. as they do now, and that the big rebates would exactly offset the drag on exports from the higher dollar, leaving foreign sales unchanged as well.
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The House bill pairs the BAT with what’s called a “territorial” tax regime. Today U.S. companies pay the 35% rate on all income, earned anywhere in the world. Most other major nations impose their national tax only on profits booked at home. The Irish subsidiary of a French drugmaker pays tax only in Ireland on the products it sells in Ireland. The House plan would change the U.S. from an outlier by adopting the global standard of a territorial tax.
The combination of a BAT and territorial tax has important virtues. U.S. companies would no longer have an incentive to switch their headquarters to low-tax nations through notorious “inversions.” And because import revenues are fully taxable, it would no longer make sense for importers to manipulate pricing to inflate the “costs” of goods sent to the U.S., a common practice for reducing profits, and thus lowering U.S. tax payments. Nor would U.S. companies have any reason to park hoards of cash in foreign subsidiaries, where $2.5 trillion in unrepatriated profits sit today.
The BAT is a levy the likes of which the U.S. has never seen—and there is understandable resistance to introducing such an intricate new system. Trump himself has been waffling on the idea, stating in late January that the BAT was “too complicated,” then seeming to endorse it two weeks later. Big retailers such as Walmart, Target, and Rite Aid are adamantly opposed to the BAT, arguing that we don’t really know if the dollar would appreciate enough to offset the tax levies on clothing and furniture from China. Nor has the Senate Finance Committee or Majority Leader Mitch McConnell endorsed the BAT.
If the BAT isn’t enacted, it’s likely that either one of the two pillars of Trump’s tax overhaul will have to go, or that both the immediate expensing of capex and a corporate tax rate cut will be scaled back to lower the cost of reform. On paper, the BAT is crucial to making the numbers work.
The president’s assault on regulations has two major parts: His pledge to repeal and replace the Affordable Care Act and the campaign to roll back costly red tape that hobbles energy producers, banks, and manufacturers. The promise on Obamacare is a kind of microcosm of the Trump agenda: Favoring markets rather than mandates is sound policy in theory. But the unknowns about timing and the details of what Trump will propose are creating tremendous uncertainty among patients and providers.
Although both Trump and House Speaker Paul Ryan claim that replacing the ACA is their top priority, the Republicans and the administration haven’t agreed on a plan, nor on a deadline for when a replacement bill will be introduced. It’s simply not clear if Trump will keep his pledge not to disrupt coverage for the 20 million people who gained coverage via Obamacare. “Whether he will stabilize Obamacare for now or blow it up by getting rid of the individual mandate or cutting payments to insurers that cover losses is still unknown,” says Larry Levitt, a senior official at the Kaiser Family Foundation.
Right now, the stability scenario looks more likely. The administration is actually moving to strengthen the ACA. It’s imposing new regulations that maintain a stronger balance between healthy and sick folks in the insurance pools. The goal is limiting enrollment periods to cure an Obamacare syndrome: a flood of patients who game the system by signing up only when they’re seriously ill and dropping coverage as soon as they recover.
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Still, health care providers are fretting that when it finally arrives, Trumpcare will savage their businesses. Under the ACA, the nation’s hospitals agreed to big reductions in payments from seniors and the poor through Medicare and Medicaid in exchange for the expanded coverage that would bring them far more paying customers and reduce uncompensated care. That arrangement has greatly bolstered their finances. But if Obamacare is repealed and the Medicare and Medicaid payments aren’t restored to their old levels, America’s hospitals will face enormous losses. A study by industry groups puts the figure at a staggering $200 billion.
Outside of the ACA, Trump is beginning a regulatory rollback unmatched in generations. The field is vast and varied, and estimates of the annual costs of federal red tape range widely, from the Office of Management and Budget’s estimate of $250 billion to the Competitive Enterprise Institute’s $1.8 trillion. Whatever the true figure, the number and burden of new rules rose sharply during the Obama years. From 2009 to 2016, Obama implemented about 300 regulations costing more than $100 million annually, compared with 120 during the George W. Bush years.
Trump has pledged to eliminate 75% of existing federal rules. In reality, that won’t come close to happening. It can take years of public hearings and lawsuits to eliminate regulations already on the books. Still, he’s already wielding his pen as a giant eraser.
On Jan. 30, Trump issued an executive order requiring that in the future, any executive branch agency or department must eliminate two rules for every new one it issues. In addition, the regulations added and repealed can’t add to the agency’s total cost of regulation, a rule that will be enforced by the OMB. He has also imposed a moratorium on the 2,596 proposed-but-not-implemented regulations.
Infrastructure renewal should be a prime area of cooperation between Trump and the Democrats. But the two sides have highly divergent approaches, especially on funding. During the campaign, Trump called for $550 billion in federal spending. The new administration hasn’t proposed a specific plan. But Trump is on the record advocating that most of the spending be channeled into partnerships between government and private companies. In a position paper written for the campaign, Ross and Navarro proposed granting tax breaks equal to 87% for up to $187 billion in equity that companies invest in infrastructure projects. The idea is that those public-private partnerships would leverage that equity into $1 trillion in new infrastructure spending and that payroll taxes on newly created jobs and contractors’ profits would cover the full costs.
In practice, the Ross-Navarro plan won’t nearly do the job. Many of America’s roads and bridges don’t have tolls or any source of revenue, and projects that do are mostly owned by the government. The partnerships could finance pipelines or private water systems. But they won’t work for most of our crumbling highways, commuter rail networks, and the aging electrical grid, all of which are in desperate need of funding. “For the vast majority of projects, direct public funding is needed,” says Marcia Hale, president of Building America’s Future, a group that champions a bold offensive on infrastructure.
Trump’s public-private concept contrasts sharply with a new proposal from New York’s Chuck Schumer, the Senate minority leader. Schumer wants to spend $1 trillion in federal funds—aided by a tiny dollop of private money—on projects stretching from bridges to schools and veterans’ hospitals. His counterpart, McConnell, trashes the Schumer plan as far too expensive.
A possible compromise is a bill sponsored by Rep. Delaney, which gets around the spending issue by tapping the proceeds from repatriation of foreign profits. Both the House Republican and Trump tax plans mandate that companies bring back all of their approximately $2.5 trillion in profits parked abroad. It’s not a choice; they have to do it.
Delaney would use the proceeds of $170 billion for grants to states, municipalities, and federal agencies. That seed money could then be augmented by matching funds and bond offerings to finance $1 trillion in new projects and renovations. The bill has a number of Republican cosponsors and broad bipartisan support. It’s not clear that Trump and McConnell will embrace the Delaney plan. If they don’t, a standoff on infrastructure will loom.
Three Key Economic Policy Questions
- Will Trump go to BAT?
One Republican tax-reform plan calls for a complicated new levy called the border adjustment tax. It could raise $1 trillion to offset corporate tax cuts. But U.S. retailers hate it.
- What’s the right way to finance an infrastructure building boom?
Trump has advocated public-private partnerships, which aren’t practical for many projects. The Democrats are pushing a $1 trillion federal public-works campaign. A possible compromise: Use the tax windfall from repatriating stranded overseas profits of U.S. companies to fund the much-needed investment.
- Is Trump serious about starting a trade war?
WHEREVER I go these days, at home or abroad, people ask me the same question: what is happening in the American political system? How has a country that has benefited—perhaps more than any other—from immigration, trade and technological innovation suddenly developed a strain of anti-immigrant, anti-innovation protectionism? Why have some on the far left and even more on the far right embraced a crude populism that promises a return to a past that is not possible to restore—and that, for most Americans, never existed at all?
It’s true that a certain anxiety over the forces of globalisation, immigration, technology, even change itself, has taken hold in America. It’s not new, nor is it dissimilar to a discontent spreading throughout the world, often manifested in scepticism towards international institutions, trade agreements and immigration. It can be seen in Britain’s recent vote to leave the European Union and the rise of populist parties around the world.
Much of this discontent is driven by fears that are not fundamentally economic. The anti-immigrant, anti-Mexican, anti-Muslim and anti-refugee sentiment expressed by some Americans today echoes nativist lurches of the past—the Alien and Sedition Acts of 1798, the Know-Nothings of the mid-1800s, the anti-Asian sentiment in the late 19th and early 20th centuries, and any number of eras in which Americans were told they could restore past glory if they just got some group or idea that was threatening America under control. We overcame those fears and we will again.
But some of the discontent is rooted in legitimate concerns about long-term economic forces. Decades of declining productivity growth and rising inequality have resulted in slower income growth for low- and middle-income families. Globalisation and automation have weakened the position of workers and their ability to secure a decent wage. Too many potential physicists and engineers spend their careers shifting money around in the financial sector, instead of applying their talents to innovating in the real economy. And the financial crisis of 2008 only seemed to increase the isolation of corporations and elites, who often seem to live by a different set of rules to ordinary citizens.
So it’s no wonder that so many are receptive to the argument that the game is rigged. But amid this understandable frustration, much of it fanned by politicians who would actually make the problem worse rather than better, it is important to remember that capitalism has been the greatest driver of prosperity and opportunity the world has ever known.
Over the past 25 years, the proportion of people living in extreme poverty has fallen from nearly 40% to under 10%. Last year, American households enjoyed the largest income gains on record and the poverty rate fell faster than at any point since the 1960s. Wages have risen faster in real terms during this business cycle than in any since the 1970s. These gains would have been impossible without the globalisation and technological transformation that drives some of the anxiety behind our current political debate.
This is the paradox that defines our world today. The world is more prosperous than ever before and yet our societies are marked by uncertainty and unease. So we have a choice—retreat into old, closed-off economies or press forward, acknowledging the inequality that can come with globalisation while committing ourselves to making the global economy work better for all people, not just those at the top.
A force for good
The profit motive can be a powerful force for the common good, driving businesses to create products that consumers rave about or motivating banks to lend to growing businesses. But, by itself, this will not lead to broadly shared prosperity and growth. Economists have long recognised that markets, left to their own devices, can fail. This can happen through the tendency towards monopoly and rent-seeking that this newspaper has documented, the failure of businesses to take into account the impact of their decisions on others through pollution, the ways in which disparities of information can leave consumers vulnerable to dangerous products or overly expensive health insurance.
More fundamentally, a capitalism shaped by the few and unaccountable to the many is a threat to all. Economies are more successful when we close the gap between rich and poor and growth is broadly based. A world in which 1% of humanity controls as much wealth as the other 99% will never be stable. Gaps between rich and poor are not new but just as the child in a slum can see the skyscraper nearby, technology allows anyone with a smartphone to see how the most privileged live. Expectations rise faster than governments can deliver and a pervasive sense of injustice undermines peoples’ faith in the system. Without trust, capitalism and markets cannot continue to deliver the gains they have delivered in the past centuries.
This paradox of progress and peril has been decades in the making. While I am proud of what my administration has accomplished these past eight years, I have always acknowledged that the work of perfecting our union would take far longer. The presidency is a relay race, requiring each of us to do our part to bring the country closer to its highest aspirations. So where does my successor go from here?
Further progress requires recognising that America’s economy is an enormously complicated mechanism. As appealing as some more radical reforms can sound in the abstract—breaking up all the biggest banks or erecting prohibitively steep tariffs on imports—the economy is not an abstraction. It cannot simply be redesigned wholesale and put back together again without real consequences for real people.
Instead, fully restoring faith in an economy where hardworking Americans can get ahead requires addressing four major structural challenges: boosting productivity growth, combating rising inequality, ensuring that everyone who wants a job can get one and building a resilient economy that’s primed for future growth.
Restoring economic dynamism
First, in recent years, we have seen incredible technological advances through the internet, mobile broadband and devices, artificial intelligence, robotics, advanced materials, improvements in energy efficiency and personalised medicine. But while these innovations have changed lives, they have not yet substantially boosted measured productivity growth. Over the past decade, America has enjoyed the fastest productivity growth in the G7, but it has slowed across nearly all advanced economies (see chart 1). Without a faster-growing economy, we will not be able to generate the wage gains people want, regardless of how we divide up the pie.
A major source of the recent productivity slowdown has been a shortfall of public and private investment caused, in part, by a hangover from the financial crisis. But it has also been caused by self-imposed constraints: an anti-tax ideology that rejects virtually all sources of new public funding; a fixation on deficits at the expense of the deferred maintenance bills we are passing to our children, particularly for infrastructure; and a political system so partisan that previously bipartisan ideas like bridge and airport upgrades are nonstarters.
We could also help private investment and innovation with business-tax reform that lowers statutory rates and closes loopholes, and with public investments in basic research and development. Policies focused on education are critical both for increasing economic growth and for ensuring that it is shared broadly. These include everything from boosting funding for early childhood education to improving high schools, making college more affordable and expanding high-quality job training.
Lifting productivity and wages also depends on creating a global race to the top in rules for trade. While some communities have suffered from foreign competition, trade has helped our economy much more than it has hurt. Exports helped lead us out of the recession. American firms that export pay their workers up to 18% more on average than companies that do not, according to a report by my Council of Economic Advisers. So, I will keep pushing for Congress to pass the Trans-Pacific Partnership and to conclude a Transatlantic Trade and Investment Partnership with the EU. These agreements, and stepped-up trade enforcement, will level the playing field for workers and businesses alike.
Second, alongside slowing productivity, inequality has risen in most advanced economies, with that increase most pronounced in the United States. In 1979, the top 1% of American families received 7% of all after-tax income. By 2007, that share had more than doubled to 17%. This challenges the very essence of who Americans are as a people. We don’t begrudge success, we aspire to it and admire those who achieve it. In fact, we’ve often accepted more inequality than many other nations because we are convinced that with hard work, we can improve our own station and watch our children do even better.
As Abraham Lincoln said, “while we do not propose any war upon capital, we do wish to allow the humblest man an equal chance to get rich with everybody else.” That’s the problem with increased inequality—it diminishes upward mobility. It makes the top and bottom rungs of the ladder “stickier”—harder to move up and harder to lose your place at the top.
Economists have listed many causes for the rise of inequality: technology, education, globalisation, declining unions and a falling minimum wage. There is something to all of these and we’ve made real progress on all these fronts. But I believe that changes in culture and values have also played a major role. In the past, differences in pay between corporate executives and their workers were constrained by a greater degree of social interaction between employees at all levels—at church, at their children’s schools, in civic organisations. That’s why CEOs took home about 20- to 30-times as much as their average worker. The reduction or elimination of this constraining factor is one reason why today’s CEO is now paid over 250-times more.
Economies are more successful when we close the gap between rich and poor and growth is broadly based. This is not just a moral argument. Research shows that growth is more fragile and recessions more frequent in countries with greater inequality. Concentrated wealth at the top means less of the broad-based consumer spending that drives market economies.
America has shown that progress is possible. Last year, income gains were larger for households at the bottom and middle of the income distribution than for those at the top (see chart 2). Under my administration, we will have boosted incomes for families in the bottom fifth of the income distribution by 18% by 2017, while raising the average tax rates on households projected to earn over $8m per year—the top 0.1%—by nearly 7 percentage points, based on calculations by the Department of the Treasury. While the top 1% of households now pay more of their fair share, tax changes enacted during my administration have increased the share of income received by all other families by more than the tax changes in any previous administration since at least 1960.
Even these efforts fall well short. In the future, we need to be even more aggressive in enacting measures to reverse the decades-long rise in inequality. Unions should play a critical role. They help workers get a bigger slice of the pie but they need to be flexible enough to adapt to global competition. Raising the Federal minimum wage, expanding the Earned Income Tax Credit for workers without dependent children, limiting tax breaks for high-income households, preventing colleges from pricing out hardworking students, and ensuring men and women get equal pay for equal work would help to move us in the right direction too.
Third, a successful economy also depends on meaningful opportunities for work for everyone who wants a job. However, America has faced a long-term decline in participation among prime-age workers (see chart 3). In 1953, just 3% of men between 25 and 54 years old were out of the labour force. Today, it is 12%. In 1999, 23% of prime-age women were out of the labour force. Today, it is 26%. People joining or rejoining the workforce in a strengthening economy have offset ageing and retiring baby-boomers since the end of 2013, stabilising the participation rate but not reversing the longer-term adverse trend.
Involuntary joblessness takes a toll on life satisfaction, self-esteem, physical health and mortality. It is related to a devastating rise of opioid abuse and an associated increase in overdose deaths and suicides among non-college-educated Americans—the group where labour-force participation has fallen most precipitously.
There are many ways to keep more Americans in the labour market when they fall on hard times. These include providing wage insurance for workers who cannot get a new job that pays as much as their old one. Increasing access to high-quality community colleges, proven job-training models and help finding new jobs would assist. So would making unemployment insurance available to more workers. Paid leave and guaranteed sick days, as well as greater access to high-quality child care and early learning, would add flexibility for employees and employers. Reforms to our criminal-justice system and improvements to re-entry into the workforce that have won bipartisan support would also improve participation, if enacted.
Building a sturdier foundation
Finally, the financial crisis painfully underscored the need for a more resilient economy, one that grows sustainably without plundering the future at the service of the present. There should no longer be any doubt that a free market only thrives when there are rules to guard against systemic failure and ensure fair competition.
Post-crisis reforms to Wall Street have made our financial system more stable and supportive of long-term growth, including more capital for American banks, less reliance on short-term funding, and better oversight for a range of institutions and markets. Big American financial institutions no longer get the type of easier funding they got before—evidence that the market increasingly understands that they are no longer “too big to fail”. And we created a first-of-its-kind watchdog—the Consumer Financial Protection Bureau—to hold financial institutions accountable, so their customers get loans they can repay with clear terms up-front.
But even with all the progress, segments of the shadow banking system still present vulnerabilities and the housing-finance system has not been reformed. That should be an argument for building on what we have already done, not undoing it. And those who should be rising in defence of further reform too often ignore the progress we have made, instead choosing to condemn the system as a whole. Americans should debate how best to build on these rules, but denying that progress leaves us more vulnerable, not less so.
America should also do more to prepare for negative shocks before they occur. With today’s low interest rates, fiscal policy must play a bigger role in combating future downturns; monetary policy should not bear the full burden of stabilising our economy. Unfortunately, good economics can be overridden by bad politics. My administration secured much more fiscal expansion than many appreciated in recovering from our crisis—more than a dozen bills provided $1.4 trillion in economic support from 2009 to 2012—but fighting Congress for each commonsense measure expended substantial energy. I did not get some of the expansions I sought and Congress forced austerity on the economy prematurely by threatening a historic debt default. My successors should not have to fight for emergency measures in a time of need. Instead, support for the hardest-hit families and the economy, like unemployment insurance, should rise automatically.
Maintaining fiscal discipline in good times to expand support for the economy when needed and to meet our long-term obligations to our citizens is vital. Curbs to entitlement growth that build on the Affordable Care Act’s progress in reducing health-care costs and limiting tax breaks for the most fortunate can address long-term fiscal challenges without sacrificing investments in growth and opportunity.
Finally, sustainable economic growth requires addressing climate change. Over the past five years, the notion of a trade-off between increasing growth and reducing emissions has been put to rest. America has cut energy-sector emissions by 6%, even as our economy has grown by 11% (see chart 4). Progress in America also helped catalyse the historic Paris climate agreement, which presents the best opportunity to save the planet for future generations.
A hope for the future
America’s political system can be frustrating. Believe me, I know. But it has been the source of more than two centuries of economic and social progress. The progress of the past eight years should also give the world some measure of hope. Despite all manner of division and discord, a second Great Depression was prevented. The financial system was stabilised without costing taxpayers a dime and the auto industry rescued. I enacted a larger and more front-loaded fiscal stimulus than even President Roosevelt’s New Deal and oversaw the most comprehensive rewriting of the rules of the financial system since the 1930s, as well as reforming health care and introducing new rules cutting emissions from vehicles and power plants.
The results are clear: a more durable, growing economy; 15m new private-sector jobs since early 2010; rising wages, falling poverty, and the beginnings of a reversal in inequality; 20m more Americans with health insurance, while health-care costs grow at the slowest rate in 50 years; annual deficits cut by nearly three-quarters; and declining carbon emissions.
For all the work that remains, a new foundation is laid. A new future is ours to write. It must be one of economic growth that’s not only sustainable but shared. To achieve it America must stay committed to working with all nations to build stronger and more prosperous economies for all our citizens for generations to come.
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