For decades, economists have studied and debated how much, if any, impact the President actually has on the US economy. 2018’s first official GDP figures are set to be released later this week, and with the economy on strong footing, it is likely Donald Trump will offer his own answer to this question by taking credit for the country’s economic health.
Public mindset often conflates the role of the presidency with managing the national economy, and candidates spend hours on the campaign trail dropping buzzwords like “jobs” and “unemployment” with little regard for the actual power of their office to significantly alter these figures.
But how exactly does the president affect our economy? Let’s take a closer look as we strive towards financial fluency.
The President and the Economy
History (and the Constitution) tell us that the president’s individual role in affecting macroeconomic health is quite limited. However, a landmark study on this debate finds that while the president may not be a major economic actor, the president’s party affiliation is a strong predictor of future economic health.
Sorry Republicans, but it turns out the US economy fares much better under a Democratic White House regardless of what metric performance is measured by.
GDP growth is accepted as the standard measurement of economic health, an important fact in your financial fluency knowledge, and under the time period covered, annualized real GDP growth in the US averaged 3.33%: 4.33% under Democrats and 2.54% under Republicans.
This means that over a 4-year presidency, the size of the US economy grows by an additional 7.16% on average, if a Democrat is in the White House.
This 1.79% annual spread is called the D-R gap, and it is strikingly large when speaking in terms of GDP growth in an economy as advanced as the US’.
Explaining the Gap
Blinder and Watson attribute most of this performance gap to a handful of phenomena: oil shocks, defense spending, productivity shocks, foreign economic growth, and consumer expectations. Surprisingly, they do not find fiscal or monetary policy to play any significant role in explaining the gap.
The “economy”, which can essentially be boiled down to concern about “jobs” and “unemployment”, consistently ranks among the most important issues for US voters. While the difference between unemployment rates under Democratic and Republican administrations is not significant, there is a large difference in the change of the unemployment rate. Under Democrats, the unemployment rate fell by 0.8%, while under Republicans, it rose by 1.1% on average.
Since Trump took office, the unemployment rate has fallen by 0.7% and currently hovers around 4.1%. So, there are technically more jobs under Trump, but whether he has done anything to create them is up for debate. With that said, many analysts believe the current health of the American economy can be largely attributed to Obama-era policies and the country’s natural recuperation from the Great Recession.
This argument seems to make sense, as Trump has struggled to pass legislation that would significantly alter economic indicators since he entered office. And, if he did, which it can be argued he did with the recent passage of the tax reform plan, it would likely take longer for such legislation to impact national figures.
What can the President do?
While Trump may not have put in place the foundations for a healthy US economy, he nonetheless presides over one. And when a president promises “corporate tax cuts” and “deregulation” in an already good economy, investor optimism soars, effectively resulting in the juicing up of the stock market.
The stock market is what economists call a leading indicator, meaning its performance can be used to predict what will happen to the economy at large shortly thereafter. For example, just before the financial crisis of 2008 brought the US economy to its knees, the Dow (DJI) plummeted.
By signaling to investors and companies that conditions will be more favorable to them in the future, Trump had been effective in pushing up the levels of major stock indices before the passage of the Republican tax plan. However, the stock market does not necessarily reflect the robust health of the US economy or the welfare of the average American, as most Americans don’t own any stock.
Nor do stock market gains offset the country’s national debt, despite what the President himself may believe.
It is interesting to note here that while Wall Street and corporate America generally support Republicans, and Trump promised big wins for big business, historically, corporate profit share of GDI (gross domestic income) is greater under Democrats.
“Although business votes Republican, it prospers more under Democrats.”
While it may take some time for the impact of Trump’s economic policies to become apparent, the effects of Trump’s hostility toward free-trade in his dealings with the international community materialized almost immediately.
The most recent GDP figures reveal a large boost in imports showing, in part, that Trump’s antiquated trade policies are not as relevant to the macroeconomy as he may have thought. In reality, the global economy does not believe in America First. It is void of national allegiance. But because America is so enmeshed in the global economy, we are subject to its order.
Regardless of who is in the White House, the average American doesn’t want to pay $1500 for a phone or $50 for a t-shirt, so businesses will continue sourcing these products from manufacturers in China and Bangladesh to meet this price point.
In today’s highly globalized economy, levying tariffs in a global order increasingly dominated by free-trade partnerships is much more akin to shooting yourself in the foot right before the beginning of a race than it is to safeguarding your population from changes in the modern economy.
Trump’s trade policies signal a shift away from our country’s previous stance on free trade, meaning the void left by the US’ lack of presence in international trade partnerships will be filled by other willing participants.
Countries like Australia and Canada have capitalized on the US’ withdrawal from TPP by taking significant market share from US beef producers. Meanwhile, China continues to undermine American soft power and is playing an increasingly instrumental role in fostering trade agreements with other countries. The losers? American producers.
Behind the Numbers
Trump’s trade policies may be an anachronism, but in all, the fundamentals underlying the US economy are strong.
Employment rates, the consumer confidence index, and the stock market are all hitting record highs. But we know from experience this rally can’t last forever.
While the robust health of the US economy will likely mask underlying risk factors in the short term, the rapid growth of asset and stock prices, coupled with huge corporate tax cuts and deregulation will likely contribute to an eventual overheating of US markets. At this point, which is notoriously difficult to figure out beforehand, a market readjustment will likely take place. Advice?
Keep your eyes on the Fed. By surrounding yourself with a greater understanding of the markets, you can continue to step closer to financial fluency.