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President-elect Donald Trump talks with people as they take a tour of Carrier Corporation in Indianapolis, IN on Thursday, Dec. 01, 2016.
President-elect Donald Trump talks with people as they take a tour of Carrier Corporation in Indianapolis, IN on Thursday, Dec. 01, 2016. Photograph by Jabin Botsford—The Washington Post via Getty Images
Commentary

Trump’s Deals May Unintentionally Damage the US Economy

Dec 21, 2016

As the new Trump Administration seeks to deliver on promises of domestic growth, some of President-elect Trump’s controversial moves could undermine that goal as he has created uncertainties around U.S. economic policies.

Although Inauguration Day is about month away, Trump has already promised major overhauls, from tax codes to trade regulations, and has pointedly singled out corporations that he views as running counter to his policies-in-the-making. The latest involved Lockheed Martin Corp., which Trump has criticized over the costs of the F35 fighter jet. Shares of the aerospace and defense company fell, as he reportedly described the jet’s costs as “out of control.”

Trump also has taken on Carrier Corp. and Ford Motor Co. over plans to move some production to Mexico. In the case of Carrier, Trump led the state of Indiana to offer $7 million in tax breaks to help keep 1,000 jobs in Indiana instead of going to Mexico. Meanwhile, Ford CEO Mark Fields told Bloomberg that the automaker is willing to work with the Trump administration, provided that the right policies are in place, such as fuel efficiency regulations.

My point here is not to weigh the merits or legality of particular moves by the Trump administration or any other politicians. Rather, I want to highlight a potential cost of political gamesmanship: an increase in political risk and economic policy uncertainty. When companies are uncertain of how they will be treated under government policy — whether because they fear being singled out or because of pressure on a particular industry (such as manufacturing and keeping jobs in the U.S.)— that can undermine a company’s business strategies.

Increased economic policy uncertainty can harm macroeconomic performance, according to research I conducted at Northwestern University’s Kellogg School of Management, along with Nicholas Bloom of Stanford University and Steven J. Davis of the University of Chicago Booth School of Business.

The rationale is simple: Large corporate expenditures are typically at least partially “irreversible” because of the magnitude of the cost and effort involved (i.e., building a multi-billion-dollar factory). If that investment is profitable under one tax regime, but not under another, any uncertainty will likely prompt the company to put off making that investment until the uncertainty is resolved, which reduces output and stymies job growth.

The effect of this uncertainty could hinder the goals of the Trump administration, which has promised to boost the U.S. economy by overhauling trade agreements, and which has taken a strong stance on swaying corporate decisions around on where to locate production facilities. For example, the president-elect has stated he will seek to impose tariffs of up to 35% on goods coming into the U.S. from American companies that decide to relocate production outside the country. Trade lawyers are already weighing in on the potential implications, saying any executive action of this type by the Trump administration would likely spark legal challenges, which could lead the new president to pursue tax legislation in Congress instead.

Economic policy uncertainty is not a new phenomenon. Our research began by developing an index of economic policy uncertainty (the EPU index) for the U.S. and a number of other major economies and to determine its evolution since 1985. The primary component of the EPU index reflects the frequency of articles in 10 leading U.S. newspapers that contain the following words: “economic” or “economy”; “uncertain” or “uncertainty”; and one or more of “congress,” “deficit,” “Federal Reserve,” “legislation,” “regulation,” or “White House.”

In recent years, our index has spiked during tight presidential elections, significant military action and terrorist attacks, the 2011 debt ceiling dispute, and other major battles over fiscal policy. Using archives for six major U.S. newspapers, events back to 1900 were also examined, including the outbreak of World War I and the rash of policies undertaken by President Franklin D. Roosevelt during the Great Depression.

More recently, there have been multiple periods when the EPU index was high: The 2008 global financial crisis and the recession that followed, and the unparalleled intervention by the Federal Reserve and other central banks to try to promote economic stability and jumpstart growth. Most recently, global uncertainty has surrounded the Brexit vote for the U.K. to exit the European Union and what “transitional arrangements” might materialize; the defeat of Italian constitutional reforms and the resignation of Italy’s prime minister; and the upcoming elections in France, which has extended its state of emergency following the November 2015 terrorist attacks in Paris.

The EPU index also has a high degree of correlation to other measures of uncertainty, such as the “VIX,” which measures volatility in the S&P 500 stock index using options trading patterns. As our research found, the VIX and the EPU index often move together. January 2017 may be one of those times of VIX and EPU correlation as some investors are expecting more volatility because of uncertainty around Trump’s economic policy positions.

Given that Trump has been an unconventional candidate with no prior political experience, some degree of uncertainty is to be expected. But excessive uncertainty over the future path of economic policy can undermine the economic policies the new administration is seeking to put in place. While some of the Trump administration’s proposed reforms may be good for economic growth, administering policy on a case-by-case basis makes it more difficult for firms (and households) to plan for the future.

Pursuing measures aimed at one or a few companies in either a punitive or beneficial fashion may prompt firms to wonder who will be next, hindering investment and causing firms to expend more effort on lobbying for favorable treatment. The incoming Trump administration might be better advised to provide greater clarity and neutrality around its economic and trade policies. While that may make for less dramatic political gamesmanship, it may prove far more effective for pursuing goals such as maintaining U.S. manufacturing and promoting economic growth and stability.

Scott R. Baker is a professor at Kellogg School of Management at Northwestern University.

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