The Trump factor

The U.S. economy has been in an expansion period since 2009, but many American business owners have been less than thrilled with it.

It has been a long but slow economic growth period. The U.S. unemployment rate has dipped to 4.6 percent, down from 10 percent in early 2010 and the lowest since 2007. But part of the reason for the low unemployment rate is the labor force participation rate is also low, at 62.7 percent.

Job growth has been steady during the economic recovery, including the addition of more than 2 million private sector jobs in 2016. But U.S. GDP growth has been modest, growing only about 2.2 percent per year since the end of the Great Recession in 2009, then slowing to 1.1 percent in the first half of 2016. The economy picked up in the third quarter with 3.5 percent GDP growth, the highest quarterly growth since the third quarter of 2014. Fourth quarter GDP growth was expected to be about 2.9 percent, according to the latest forecast.

Former President Barack Obama’s supporters have credited his administration for working to pull the economy out of the recession and put it on a sustained growth path. But critics of Obama say many of his policies have hurt the economy and prevented the recovery from being far more robust.

When he ran for president, Donald Trump promised to enact significant pro-business policies that would boost the U.S. economy to a 4 percent GDP growth rate. He made a strong pitch to voters in small town and rural areas, communities that have seen little economic growth for years.

Many business owners were supportive of Trump’s promises to reduce taxes and lower regulations.

Now, as President Trump’s administration begins, he must lead a divided America. More voters actually picked his opponent, Hillary Clinton, but Trump won the Electoral College and therefore, the presidency. His inflammatory rhetoric on the campaign trail delighted many of his supporters, but outraged his opponents.

Trump is not only extremely controversial, but also a unique figure to assume the presidency. He is the first president who lacks any prior government or military experience. His business background is a mix of impressive achievements and dramatic failures. But his status as a political outsider appealed to many of his supporters.

Trump has long been known for his arrogance and big talk. The question now is, can he back it up? Will his policies lead to a much stronger U.S. economy than during the Obama years?

The new president should have the support of the Republicans in Congress to cut taxes and roll back regulations, including the promised repeal of Obamacare. But he also has called for a massive infrastructure program which could be a tougher sell to Congress.

Trump also has called for a dramatic shift in trade policy. Many of his Rust Belt supporters were attracted to this message. But some fear Trump could spark a trade war that would be devastating for the economy.

Many business leaders appear to be optimistic that Trump’s administration will have a positive impact on the economy. In a survey of its membership, Wisconsin Manufacturers & Commerce reported 78 percent of respondents were either optimistic (54 percent) or very optimistic (24 percent) about what a Trump presidency means for business. The November reading of the National Federation of Independent Businesses’ small business optimism index rose from 94.9 to 98.4 – its largest increase since 2009 – after Election Day.

When asked in an open-ended section of the WMC survey, “What is the most important thing President-Elect Trump should do in his first 100 days in office to grow the U.S. economy?” the most frequent responses from WMC members were related to reducing regulations, reforming the Affordable Care Act, lowering taxes and tapping domestic energy.

For more insight on what lies ahead for the U.S. economy in 2017, and what impact Trump’s policies could have, BizTimes Milwaukee recently conducted its annual macroeconomic interview with Michael Knetter, Ph.D., an economist and president of the University of Wisconsin Foundation. The following are excerpts from that interview.

Michael Knetter

President and CEO, University of Wisconsin Foundation

Past dean, University of Wisconsin School of Business

Former senior staff economist for former presidents George H.W. Bush and Bill Clinton

BIZTIMES: The long, slow economic expansion cycle continued through 2016. A year ago, you said that cycle could be “nearing the peak” and we appeared to be in the eighth inning of the cycle. Where do you think we are now on the economic cycle?

KNETTER: “We may be in the ninth inning of a game that might go extra innings due to a burst of economic optimism since the election. The economy appears to be near full employment, but we do have lower than normal labor force participation, suggesting there may still be capacity for continued growth in the workforce, in addition to gains from investment in capital and productivity increases.

“For a variety of reasons, the election results have created a wave of positive economic sentiment that has driven stock valuations, oil prices and the dollar higher. Most immediately, there seems to be widespread belief that a Trump administration will strike a different balance than the Obama administration in its approach to regulation of the economy. It seems fair to say people believe that Trump thinks consumers need less protection from businesses, as competition will regulate the actions of producers. Obama felt the market would not police producers enough and took a more active regulatory position that made it harder for firms to maneuver. The Trump victory has boosted the financial and energy sectors’ valuations most in the near term.

“Longer term, with Republican control of the executive and legislative branches for the time being, it is conceivable that we will see the passage of constructive tax and spending bills, but that won’t be as easy as people imagine.”

BIZTIMES: Will the economic expansion continue in 2017, or will it finally run out of gas? What do you expect for GDP growth in 2017?

KNETTER: “I do think that the shift in sentiment is strong enough that it will carry the economy forward through the balance of 2017. I think growth will be in the 2 to 2.5 percent range, which is quite good for this stage of an expansion when unemployment rates are already low. How much further we can go beyond 2017 will depend on whether inflation starts to rise and the Fed feels a need to tighten more and sooner. The stronger dollar may just be enough to keep inflation at bay.”

BIZTIMES: New president Donald Trump has promised to boost U.S. economic growth with aggressive pro-business policies. What are your general thoughts about the impact Trump’s administration will have on the economy in 2017?

KNETTER: “As noted above, I think his general bias toward a pro-business stance is already helping create optimism. It is as if the fog has lifted and we have seen the sunshine again. His administration can indeed help by adopting regulatory stances that are less onerous for business. Whether more help can come through fiscal or trade policy – or whether changes in those policies might actually hurt the economy as might be the case with trade – remains to be seen.”

BIZTIMES: Trump has indeed promised to make big changes in trade policy. He talks tough on China and is threatening companies that plan to move jobs overseas. He also is offering to help companies keep jobs here. He claimed victory when Carrier decided to keep hundreds of jobs in Indiana. What do you make of his approach to trade? Are we headed toward a trade war, and if so, what impact would that have?

KNETTER: “I think a trade war would be terrible for the economy. Prices of many products would rise, increasing inflationary pressures without increasing output in the short run. This is the worst case scenario for the economy: an adverse supply shock that raises prices without output actually going up. For that reason, I do not think we will end up in a trade war.

“Candidate Trump made a strong emotional connection with disenfranchised citizens in the upper Midwest, a region that has suffered considerable job destruction in manufacturing due to globalization and technological change. Unfortunately, I do not believe any policy changes will bring back the jobs in the places where (we) lost them. If larger barriers to international commerce do increase the possibility of making more ‘things’ in the United States, I suspect those things will be made in the South, where cost conditions have become more favorable and population has grown relative to the North. I think the Trump administration will ultimately reach that conclusion, if they haven’t already. They will then have to think about what to do to help these dislocated communities that helped deliver victory to Trump.  They might start by reading J.D. Vance’s book, ‘Hillbilly Elegy.’ It is a somber tale of the extent of cultural, social, moral and economic decay in some pockets of America that were once anchored by large manufacturing companies.”

BIZTIMES: Trump and the Republicans in Congress are determined to lower taxes, including corporate taxes. What impact will this have on the economy and the federal budget?

KNETTER: “Corporate taxes today make up about 10 percent of total federal revenues in recent years. They amount to about 15 percent or so of total corporate profits. Lower corporate taxes would make locating corporate activity in the U.S. more desirable, presumably leading to more output in the U.S. over time.  If taxes were cut in half, that would mean a boost of about 7 percent in corporate profits. Obviously, the lower rates would lead to a direct loss of about 5 percent of federal revenue. Whether job growth would cause enough offsetting personal income and (Federal Insurance Contributions Act) tax receipts to make up for the loss in corporate revenue is unclear. Since capital is more mobile than labor, I do think a shift away from corporate tax collections is probably, on balance, a good thing. I would also shift away from income and toward consumption taxes, especially by taxing things that we know are bad for us (e.g., alcohol, tobacco, marijuana where it is legal) or have negative side effects (e.g., fossil fuel consumption).”

BIZTIMES: The Republicans also plan to repeal Obamacare. What economic impact would that have if they do so?

KNETTER: “The impact of any repeal of Obamacare would depend on what is created in its place. The short-term impact would be negative, in my opinion, because it would create a new period of uncertainty about how the system would work and another messy transition. Longer term, the best way to improve American health care is to take actions that can increase the supply of needed health care employees (support education, training and access to medical professions for more people and avoid capping what people can earn) and force consumers to pay a share of the cost of any health care services they consume. It is not rocket science, but some of it is unpopular and Obamacare made little progress on either of these critical fronts (increasing supply or reducing demand through co-pay requirements).”

BIZTIMES: Trump also is promising a massive infrastructure program and says it will include private investment. Can he pull this off? What impact would it have on the economy?

KNETTER: “Whenever someone asks whether Trump can pull something off, we ought to all agree that at least we should give it a ‘maybe,’ at minimum. We have chronically underestimated him. It is hard to know exactly what would be contained in a massive infrastructure program. There is a belief that our roads, bridges, rail systems, ports and airports could all do with some improvements. This kind of work might boost employment for the very groups who were hardest hit by the Great Recession and the overall trend away from manufacturing. It might be possible to have public-private partnerships for many of these types of projects, provided that private participants could get some return through user fees, etc. It is certainly plausible that there could be a public-private effort to rebuild infrastructure.”

BIZTIMES: The Federal Reserve recently raised interest rates, a full year after it had done so previously. What impact will this have on the economy, and what do you expect the Fed to do in 2017?

KNETTER: “The market seemed to expect the December increase and two more for 2017. The Fed signaled that it might be more like three hikes in 2017 and the market seems to have shrugged that off. That makes sense, since the more aggressive Fed plans suggest that they believe the economy is in better shape than previously believed. I have no reason to doubt that three rate hikes in 2017 is a good prediction at this point. The wild card will be how the labor market and inflation are behaving throughout the year. If the labor market tightens and inflation rises more than expected, then the Fed may need to be even more aggressive, and that could slow things down.”

BIZTIMES: The stock market has been on a strong run and the Dow is nearly at 20,000. What should we expect from the stock market in 2017?

KNETTER: “I think the stronger dollar and higher interest rates are going to begin to take a toll on earnings. The unknown is whether there are any changes to tax policy that might offset these drags on earnings growth. In general, I think the post-election bump probably ate part of the gains we might have expected to come in 2017. So I look for modest returns on the order of 5 percent for the S&P 500 or the Dow.”

BIZTIMES:  Do you anticipate any changes to the low U.S. unemployment rate, the labor force participation rate or wage inflation?

KNETTER: “Unemployment cannot go much lower, but I expect the participation rate and wages to rise.”

BIZTIMES: Where do you think the Wisconsin economy is headed relative to other states?

KNETTER: “The fastest growing states in the U.S. economy have tended to be in the South, where population has grown faster, and in areas that have (research and development)-intensive businesses and highly educated workforces. I do not think our growth in population or jobs can keep up with southern states for many reasons. While some manufacturing jobs may return to the U.S., I do not see them coming to northern states in large number.

“That makes me very uncertain about what policymakers are promoting as our source of growth in the future. I hope we can focus on keeping good jobs, finding ways to create a few more, and worry less about total job growth in our state. We should try to focus on what we can do to boost per capita income (or average earnings) and quality of life for our citizens. Chasing arbitrary growth in the number of new jobs is a poor goal.

“To me, the deck feels pretty stacked against Wisconsin and it does not help when there is constant tension and criticism between the university system and the Legislature. We do not come across as a state that is focused on developing human capital at the highest level. That does not make me optimistic for Wisconsin. Hopefully, with this election behind us, we can do better.”