Trump's Budget proposals don't add up

One of the basic themes of Mr Donald Trump's election campaign was that the United States was being ripped off by foreign countries and that his administration would reduce our trade deficit.

Yet the Budget policies he is now proposing would be sharply at odds with that goal. By advocating an expansive budget through tax cuts and infrastructure spending, Mr Trump's plan would most likely lower national savings and propel the US dollar ever higher, creating the very conditions to widen rather than to narrow the trade deficit.

Mr Trump seems to be overlooking a matter of basic arithmetic. While a country's trade balance is the difference between its exports and imports, it is also the difference between the amount it saves and invests, as can be derived from rearranging the components of its aggregate demand equation. If a country saves more than it invests, it will run a trade surplus. Conversely, a country that saves less than it invests will run a trade deficit.

Seemingly oblivious to this basic maths, Mr Trump is proposing far-reaching and seemingly unfunded cuts in corporate and household tax rates. Worse yet, he is simultaneously proposing large increases in public infrastructure and military spending. He is doing so in the unrealistic hope that these policies will cause the economy to accelerate from its present 2 per cent growth rate to between 3 and 4 per cent. And he is counting on such faster economic growth to generate additional tax revenue.

Should a significant pick-up in economic growth not materialise, the net effect of these tax cuts and public spending policies will almost certainly lead to a significant widening of the Budget deficit and to a corresponding decline in public savings. That would lead to a significant widening of the trade deficit as the country's overall savings rate would decline.

A further basic weakness of the Budget proposal is that it would add stimulus to the economy at the very time that it is at or very close to full employment. That policy is bound to raise concerns about inflation and to push the Federal Reserve to raise interest rates more than it is contemplating in order to meet its inflation target.

One of the distinguishing characteristics of the global economy now is the divergence of monetary policy stances among the world's major central banks. The Fed is embarked on a path of raising interest rates at a time when the European Central Bank and the Bank of Japan are still engaged in aggressive rounds of quantitative easing in an effort to kick-start their moribund economies.

Forcing the Fed to raise interest rates at a faster pace than it is contemplating will only serve to widen the difference between it and the other major central banks. This would more than likely put further upward pressure on the dollar.

Since the November election, the US dollar has already appreciated significantly to its strongest level in the past 14 years. The last thing the country needs if it is to reduce its trade deficit is a further dollar appreciation. Such an appreciation would make our exports across the board more expensive in foreign markets and make our imports cheaper in US dollar terms. That would hardly seem to be the way to reduce the country's trade deficit.

A real concern is that, as the US external deficit widens because of a reckless Budget policy approach, Mr Trump will double down on his interventionist and protectionist approach to trade matters. As we saw in his recent intervention with Carrier Corporation, this seems to be his preferred way of dealing with trade issues. If he does go down that path, he will risk inviting trade retaliation by our trade partners, which could lead the global economy down the road to the beggar- thy-neighbour policies of the 1930s. As surely even Mr Trump must know, trade wars are no solution.


•The writer, a resident fellow at the American Enterprise Institute, was a deputy director in the International Monetary Fund's policy development and review department.

A version of this article appeared in the print edition of The Straits Times on December 21, 2016, with the headline 'Trump's Budget proposals don't add up'. Print Edition | Subscribe