Is Taiwan the Next Hong Kong?
China Tests the Limits of Impunity
The United States is in its 11th year of uninterrupted economic expansion, unemployment has hit a historic low, and growth, while decelerating, still hums along. Yet anxiety about the next recession seems to mount with each new tariff or tweet that President Donald Trump lobs at China as part of his trade war—and for good reason. The president’s policies are clearly hurting tradeable sectors of the U.S. economy, especially manufacturing, which must contend with the double whammy of U.S. tariffs on imported inputs and Chinese tariffs on exports of finished goods. U.S. producers of vehicles, electronics, and agricultural goods, among other things, are all scrambling to disentangle their supply chains from China. But doing so is costly and complicated, and many of them are suffering as a result.
The trade war may not be enough to tip an otherwise healthy U.S. economy into recession. But if it does, the United States will be in a uniquely bad position to fight its way out again. The country is almost certain to enter the next downturn with historically high levels of public debt. That is worrying because governments in this position have historically failed to apply enough fiscal stimulus—that is, boost the economy through increased government spending as well as indirect measures like tax cuts—to counteract recessions. At the same time, short-term U.S. interest rates are already relatively low, meaning there will be limited room to cut them—the other main tool that governments have to battle downturns.
Both problems—the trade war and the lack of preparedness to offset its potential downsides—share an important commonality: they are self-inflicted wounds, own-goals resulting from fateful policy mistakes that have been at best unchecked and at worst supported by a majority in the U.S. Congress. By definition, all recessions are market failures. But the next one may be a government failure as well. And a government that causes a recession is probably not a government that should be trusted to lead a recovery. Arsonists make lousy fire chiefs.
For all the gathering recessionary angst—recent Google trends show searches for “recession” approaching the heights of the last downturn—the U.S. economy is still on relatively solid ground, at least for the time being. Unemployment is low, real wages are rising, and while job growth has slowed it is still strong enough to fuel robust consumer spending.
Still, the trade war has taken a toll on manufacturing, which has contracted by two percent this year. Since the beginning of 2019, the sector added just 44,000 jobs, compared to 170,000 over the same period last year. The overall impact on the economy has been limited, because manufacturing now accounts for a much smaller share of the U.S. economy than it did in the past (11 percent today compared to 27 percent in 1950). But the effects of the trade war can be felt beyond the manufacturing sector. With so much policy uncertainty, a wide range of American businesses are delaying or deferring investment. According to the most recent GDP report from the Commerce Department, business investment fell by 0.6 percent in the second quarter of this year. That is a relatively small decline in a historically volatile measure, but it is consistent with business surveys that show trade policy uncertainty deterring investment.
In an increasingly interconnected global economy, trouble in any of the world’s major economies is likely to be felt in the United States.
The trade war could shave as much as a full percentage point off of U.S. GDP growth by early 2020, according to a recent estimate by Federal Reserve economists. In recent quarters, growth has averaged around two percent, meaning that the trade war could end up cutting the U.S. growth rate in half. One percent growth isn’t a recession, which is typically defined as two consecutive quarters of declining growth. But it is slow enough that unemployment will start to rise, and if some other economic shock occurs—a bursting credit bubble, a lasting government shutdown, a much larger than expected escalation of the trade war—the economy could tip into recession.
There are also global repercussions to consider. Germany, Europe’s largest economy and among the continent’s most export-oriented, may already be in recession—in part because of Trump’s trade war and in part because the German government, as is its wont, has eschewed the countercyclical spending that the economy needs. South Korea, Japan, and China, all of which are more trade-dependent than the United States, are experiencing slower growth. And because the U.S. economy is linked to all of these countries, not just through trade but through financial markets, there is a risk of a negative feedback loop. In an increasingly interconnected global economy, trouble in any of the world’s major economies is likely to be felt in the United States.
Whether the trade war or some other negative development sets off the next recession, the United States is clearly unprepared to mount a commensurate fiscal and monetary response. On the fiscal side, the problem is not an economic one; it’s a political one. Among the most reckless decisions of the Trump administration was to push through a huge, regressive, deficit-financed tax cut. In addition to deepening inequality, the tax cuts will deprive the U.S. Treasury of $1.9 trillion in revenue over the next ten years, thereby pushing up national debt levels.
As a result, the United States is likely to enter the next recession with a debt-to-GDP ratio that is more than twice its historical average (around 80 compared to 35 percent). With debt and deficit levels already at historic highs, Washington might feel that it has limited ability to counter a recession through stimulus. That has indeed been the historical pattern: governments that enter downturns with high debt levels implement fewer Keynesian-style countercyclical policies than governments with low debt levels. The result is that many more people end up suffering job and income losses than when robust fiscal responses are enacted.
And the cruel irony is that austerity often delivers all pain and no gain, failing to bring debt and deficit levels down. Too little stimulus during a recession will mean slower growth and a deeper and longer recession, all of which risks increasing debt levels. On the contrary, even with relatively high debt levels, stimulus spending helps to restore growth, which in turn boosts government revenues and makes debt and deficit reduction possible. (This is especially true when a government’s borrowing costs are low.)
Especially if the next downturn is deep and lasting, waiting for the administration and Congress to act will likely impose severe burdens on economically vulnerable people and delay the beginning of a recovery.
It is impossible to know for sure whether this or any future U.S. administration would choose austerity over stimulus when the latter is clearly needed, but the recent track record is concerning. Even with a (slightly) more functional government under President Barack Obama, the U.S. pivoted from stimulus spending to deficit reduction well before the private sector was ready to grow on its own. The result was a recovery from the 2007–08 financial crisis that was initially quite weak. Given the rabid partisanship and deepening gridlock that has taken hold since that time, the risk of an inadequate fiscal response has only grown.
The problem of political will extends beyond standard stimulus or bailout packages. In the last recession, the U.S. government offered workers extended unemployment compensation, enhanced nutritional support, and subsidized employment programs. It also offered fiscal relief to state governments, a vital measure for those that are legally required to balance their budgets. None of these responses will automatically kick in when the next recession arrives. On the contrary, they are considered discretionary programs, meaning that Congress must affirmatively vote for them and allocate their funds. Especially if the next downturn is deep and lasting, waiting for the administration and Congress to act will likely impose severe burdens on economically vulnerable people and delay the beginning of a recovery.
Central banks face a different set of constraints. Unlike some of the governments they serve, the central banks in advanced economies remain for the most part highly functional and politically independent. Although Trump has waged a vicious campaign against Federal Reserve chair Jerome Powell, the institution, to its credit, appears to have largely blocked him out. But that doesn’t change the fact that the Fed’s main weapon against recession—the federal funds rate, currently between 2 and 2.25 percent and trending downward—could well be too low when the next downturn hits for rate cuts to make much of a difference, especially if the next downturn is relatively deep. In the past, the Fed has cut short-term interest rates by five to six percentage points during recessions. For the next one, it will very likely have less than half that space to maneuver. (The Fed has shown a historical distaste for negative interest rates.)
True, in the last crisis, central bankers did more than slash short-term interest rates; they used large-scale bond purchases, or quantitative easing, to reduce longer-term interest rates not under their direct control. But at the end of the day, all of their efforts are designed to lower the price of credit. And as the recent history of advanced economies makes clear, very low rates—even negative ones—can be insufficient to get flagging economies moving again. In addition to the credit-creating effect of monetary policy, economies in recession need the demand-inducing effect of fiscal policy. By themselves, neither fiscal policy nor monetary policy is adequate. Together, they constitute a potent anti-recessionary one-two punch.
In the next recession, however, the United States risks being able to rely on neither. The Trump administration is whipping up economic headwinds with its trade war while its tax policies squander resources that would be more productively deployed in the next downturn. And with interest rates already low, the Fed will have limited ability to reignite growth. The United States has recovered from previous downturns through bipartisan political planning, cooperation, and policy solutions that were up to the task. This time, the country will be stuck with own-goal economics, and the prognosis isn’t good.