The Trump administration’s economic policy has its roots in his electoral campaign and in the promises made to voters dissatisfied with the economy, with inequality and with the stagnation of wages and salaries felt by a large segment of the population. As part of his diagnosis, Trump stressed the need for tax reform and for a decrease in the budget deficit which revealed a definitive downturn in production. With this in mind, Trump proposed a redefinition of the country’s trade agreements, both on regional and multilateral levels. Tax and trade reform would seek to strengthen growth, create jobs, and correct a budget deficit which had resulted from the “abuse” of the country’s trade partners within the context of the agreements currently in effect. Nearly a year after having taken office, the new administration has achieved concrete proposals. Its tax overhaul bill, centered on tax cuts for businesses and individuals, was approved by both chambers, and, at the close of the session, had nearly completed the legislative process. Several studies and analyses however, have concluded that the proposed reform is not self-financing and that it will ultimately cause an increase in public debt over the course of the next few years, something which will, in turn, also increase the country’s budget deficit. This behavior, a natural consequence of a macroeconomic model, will expose one of the policy’s inconsistencies: a decrease of the trade deficit –one of the current administration’s most important objectives– will not be achieved in the foreseeable future. Much has been stated about the incongruences and inconsistencies of the policy’s approach. However, on the eve of a sweeping tax overhaul, it makes sense to stop and examine a few of its aspects. Firstly, the country’s current account deficit will, with all certainty, increase as a result of the bill which is about to be put into effect by Washington lawmakers. Secondly, the country’s external imbalance has nothing to do with its trade agreements, which is why evaluating the former on the basis of the latter makes no sense.
A decrease of the trade deficit –one of Trump’s main objectives– will not be achieved in the foreseeable future
“Make America Great Again”: Fewer taxes… and an even larger budget deficit
At the time of writing, tax reform had enjoyed considerable progress but was as yet not a fait accompli. Two versions of the bill coexist, and need to be processed by both legislative chambers. In general terms, the bill’s central axis revolves around cutting the corporate tax rate to 20% from 35%. The tax burden on individuals would also decrease, although only for a 10-year period. Another aspect of the bill foresees a reduction in deductible expenses, on both federal and state levels, meaning that the decrease in the effective tax rate will not be as large as may be suggested by the decrease in the nominal tax rate. Also included in the bill are a series of measures that would have a range of redistributive effects on different sectors, businesses and individuals. Additionally, there are differences regarding the moment at which the tax cuts would come into effect. Becoming familiar with the details of the tax bill is important for its adequate evaluation. For the purpose of this reflection, particular interest lies in the measure’s macroeconomic impact and, more specifically, in its bearing on public deficit
The decisive elements have already been established, enjoy a shared consensus, and both versions of the bill are relatively similar. It is feasible, then, to continue with our analysis while forsaking a greater degree of precision, or for the reform to have actually come into effect. According to the initial proposal, the bill will be self-financed thanks to the economic boost generated by the bill itself (and to the increase in revenue associated with it). However, this notion is at the center of a great deal of controversy. Many studies anticipate that the reform will in fact stimulate economic growth, but that it will do so at the expense of a greater public deficit. An analysis by the US Congress Joint Committee on Taxation points out that the measures would raise federal budget deficits to 1.5 billion USD over the next decade, while additional tax revenue derived from growth would only reach 0.5 billion USD, which is to say, it would only account for a third of the expected amount. Were this to happen, an immediate consequence would be an increase in the current account deficit, a natural result of the macroeconomic model that links spending with the country’s internal savings capacity; if the latter is insufficient, it must necessarily draw from that which comes from abroad, which is the very definition of a budget deficit. It is a condition that is fulfilled on an individual basis for all economic agents, as well as on a collective basis: no one can spend without having the resources to do so. In a closed economy, without any connections to the world beyond its borders, aggregate expenditure would only reach that permitted by its internal savings. Any deficit would have to be compensated for with someone else’s surplus. If the government registers a deficit, businesses or households would require an equivalent surplus. When an economy has a relationship with that of other countries, its expenditure potential can increase, as long as there are external financing resources. In this case, there can be a federal deficit, as well as one in the private sector, if these can be financed by the external sector. Macroeconomics tends to describe it in the following terms: state sector balance + private sector balance = external sector balance.
The United States’ increased trade deficit is not the product of the trade agreements in effect, but rather an inevitable effect of its limited capacity for domestic savings
Chart 1 shows a simulation of what the proposed tax bill could imply for both public deficit and current account deficit. As has happened in prior episodes, an increase in the federal deficit also upsets the balance of the external sector. Since the private sector balance—the business and household savings-investment gap— tends to be rather stable, it is necessary to resort to foreign savings (current account deficit) in order to finance the growing public deficit. If we apply this logic to recent history in the United States, we reach the same conclusion: the existence and persistence of the current account deficit is the result of a greater expenditure with relation to the country’s domestic savings. Deficit is a consequence of macroeconomics; it is not the result of any trade agreement, whether regional or multilateral. A greater trade deficit, like the one that has existed to date, is not the product of the trade agreements in effect between the US and other countries (including the North American Free Trade Agreement), but rather an inevitable effect of a country’s limited capacity for domestic savings.
The periodic evaluation of the NAFTA can be one of the results of the negotiations currently taking place among the three countries
The Budget Deficit: A poor indicator in the evaluation of trade agreements
With the rise of Trump to the presidency of the United States, we are faced with a once unfathomable scenario: the country that has championed the open market economy, the staunch defender of capitalism and of corporate decision-making, the main architect of the global order that has defined economic relations since WWII, is casting doubt on globalization. And further: Trump has described the United States as the “loser” in current international trade due to –he would argue– a series of multilateral and regional trade agreements that allegedly benefit third parties to the detriment of US corporations and workers. The first actions were seen almost immediately after he came to office. In January, 2017, the United States chose to abandon the Trans-Pacific Partnership (TPP) and shortly thereafter put forth the need to renegotiate the NAFTA, with the aim of establishing a series of protectionist measures: a reduction of the current account deficit with partners; larger regional content (particularly that of the US) in one of the largest regional integration industries (motor vehicles); a redefinition of the institutions in charge of controversy resolution (in favor of United States tribunals); and limitations on certain agricultural imports whenever the US proved capable of satisfying the supply. Before proceeding, it is important to analyze the repercussions of the NAFTA on the United States’ commercial aggregates. Chart 2 shows the evolution of commercial activity between Mexico and the United States.
As can be observed there has been a considerable increase in commercial activity, both in terms of imports and exports. While there is a deficit with Mexico, there is also a level of activity six times greater than that which existed in the years prior to the agreement, not to mention the direct and indirect jobs created as a result. An increase in commercial activity is also an indicator of an increase in levels of specialization, in efficiency, productivity, competitiveness and wellbeing in the region. Chart 3 shows the evolution of the United States’ trade deficit with specific country groups: 1) those with which it has signed trade agreements; 2) those with which it hasn’t and, among these, 3) with China. The result is rather clear: the US trade deficit with partner countries remains more or less stable. The largest deficit is associated with trade with countries with which it has not signed any trade agreements and, in particular, with the Asian giant. Trade agreements do not explain the recent increase in the United States’ current account deficit.
While there is a deficit with Mexico, there is also a level of activity six times greater than that which existed in the years prior to the agreement, not to mention the direct and indirect jobs created as a result
The inconsistencies found in several of the Trump administration’s economic policies, are nothing new and have been broadly discussed. However, the progress made by Washington’s tax overhaul is a good opportunity to recall and underline one of Mexico’s positions within the context of NAFTA renegotiations: a country’s current account deficit is the result of macroeconomics. The most important elements when determining the reasons for this imbalance are internal factors linked to expenditure and the availability of domestic savings. Thus, the trade deficit is not a good parameter when evaluating the productive contribution of a given trade agreement, including the NAFTA. The periodic evaluation of the NAFTA can be one of the results of the negotiations currently taking place among the three countries (with a particular focus on the so-called “sunset clause”). Current account deficits respond to macroeconomic factors, not commercial factors, and it would be a mistake to attempt to explain these deficits using the wrong tool. The NAFTA, on the other hand, has proven to be beneficial to the economies of all three partner countries.