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Labour And Capital In The Age Of Trump

By: Erik Weisman

Published: March 13, 2017

On the heels of the U.S. presidential election, the ‘Trump reflation trade’ buoyed equity markets as investors focused on the potentially growth-enhancing aspects of the president’s agenda, particularly infrastructure investments, tax reform, and regulatory rollbacks. A general consensus emerged that these business-friendly reforms would spur economic growth and, ultimately, ‘good’ inflation.

Now that Trump has assumed office, focus has begun to shift to parts of his agenda that could prove to be growth depleting, accompanied by ‘bad’ inflation. In the early days of his administration, President Donald Trump’s attention has been focused squarely on international trade and immigration, which has created concern among investors that aggressive revisions to existing trade and immigration policy could make the United States a less inviting place for both labour and capital. Additionally, there are general concerns that whatever fiscal policy emerges from the new administration will take longer to unfold and be smaller than the markets have priced in to date.

Executive Orders

Trump has been quick to sign a flurry of executive orders, withdrawing from the Trans-Pacific Partnership, advancing his plans for a wall on the U.S./Mexico border and implementing a number of immigration restrictions. Talk of import tariffs, aimed at some of the America’s largest trading partners, has also taken centre stage.

These policies have the potential to hamper U.S. economic growth. Given the declining growth rate and aging U.S. labour pool, cutting off the flow of immigrants could lead to a drop in both economic potential and dynamism. Immigrants coming to the United States tend to be young, and the vast majority of them flow directly into the work force. For example, Hispanics, who make up the majority of migrants, are both younger than the U.S. median and participate in the labour force at a higher rate, says the Pew Research Center. Recent studies examining developed world labour markets suggest that as work forces age, they become less productive, vibrant, and entrepreneurial. Additionally, concern is growing that the H-1B visa program will be reformed, making it more difficult for U.S. technology firms to recruit highly skilled workers from overseas. Demographically, the U.S. has until now fared better than most developed countries given previous immigration levels. But a significant shift in policy could eventually see the U.S. economy slide back into the pack with the rapidly aging and sclerotic eurozone and Japan.

A realignment on trade policy could also negatively impact growth, both in the U.S. and globally. President Trump has threatened to impose a 20 per cent tariff on imports from Mexico, ostensibly to fulfill his campaign pledge that Mexico will pay for a border wall. Over the decades, the U.S. Congress has ceded a great deal of power to the executive branch in the international trade arena and thus Capitol Hill would not be a near-term impediment if the administration chooses this policy path. Such a tariff could have severe effects on the Mexican economy and would likely negatively impact U.S. multinationals with operations south of the Rio Grande. Furthermore, Mexico is the third largest trading partner of the U.S., accounting for approximately 13 per cent of trade. If U.S.-imposed tariffs on Mexican imports lead to a significant deterioration in trade between the two countries, not only could hundreds of thousands of jobs ‒ in both countries ‒ be at risk, but the prices of many goods sold in the U.S. would likely rise.

Canada To Fare Better?

While Canada has increased trade with Asia in recent decades, the U.S. remains its principal trading partner, accounting for three-quarters of its exports and two-thirds of its imports.  Should the U.S. withdraw from the North American Free Trade Agreement (NAFTA) ‒ which the Trump administration can do by merely giving Mexico and Canada six months’ notice ‒ some believe trade between the U.S. and Canada would be less severely impacted than that with Mexico. This is due to the fact that the U.S. and Canada entered into a free trade agreement in 1988 that was superseded by NAFTA in the mid-1990s, but was left in place, and would come back into force if NAFTA was abandoned. The free trade agreement is critical for Canada as virtually all of its two largest exports, autos and energy, are destined for U.S. markets.

In any event, anxiety about Canada being the target of a trade war has waned somewhat now that President Trump has settled into office, as the business community succumbs to the probability that some NAFTA adjustments are likely.

More pressing – and concerning – at this point is the potential for a border adjustment tax and/or the effects of standalone U.S. corporate tax reform. At the moment, it seems unlikely that the border adjustment tax will become law due to its overall complexity as well as its potentially negative impacts on politically influential U.S. businesses, many of whom are fiercely lobbying against its adoption. However, reform of the corporate tax structure is, in our view, a more likely outcome given that the statutory U.S. corporate tax rate of 39.1 per cent is the highest in the G20, according to the Congressional Budget Office. A lowering of the U.S. corporate tax rate could materially impact the relative competiveness of Canadian versus American made goods since Canadian-made goods would lose some of their competitive advantage due to a lower U.S. tax regime. Canadian policymakers may be forced to respond in some way to avoid losing ground. While this is indeed a potential challenge, it may be less of a risk relative to the prospect for widespread trade protectionism and trade wars which would hurt Canada as a small open economy dependent on exports.

Currency Manipulators?

The Trump administration has also leveled charges of currency manipulation at China, Japan, and Germany. All have countered the allegations, with China having the strongest case as it has spent nearly $1 trillion over the last 18 months to support the yuan. Meanwhile, Japan says that it’s acting within the G20 agreement to avoid competitive devaluation by conducting monetary policy for domestic purposes in order to stave off deflation and German Chancellor Angela Merkel asserts that monetary policy is the purview of the ECB and Germany will not question its independence. The new U.S. administration’s rhetoric is only increasing the likelihood of beggar-thy-neighbor currency wars, or worse, an all-out trade war, with the U.S. against the world.

Given the slow-growing, highly indebted state of the global economy, it’s not inconceivable that trade battles could tip the world back into recession, or perhaps worse. Under such a scenario, risky assets would likely run into turbulence at a time when central banks have few weapons left in their arsenals. Though it may be unfashionable to say so, it’s important to note that tariffs are not always associated with bad outcomes. Indeed, for the first 150 years of its existence, the United States was actively protectionist, yet all the while advancing toward superpower status.

More recently, the Asian tigers have followed a similar path. However, with global tariff rates so very low, changing direction dramatically could prove tumultuous. So, while taking steps toward a more level playing field in trade policy and re-examining the goals of immigration policy are not unreasonable aims, one hopes the new administration considers the potential adverse consequences of pushing too far too fast. Moving precipitously on tariffs risks slowing, or even reversing, the persistent flow of labour and capital into the United States that has consistently made the U.S among the most vibrant and flexible economies in the developed world.

Erik Weisman is a fixed income portfolio manager with MFS.

Erik Weisman’s comments, opinions and analyses are for informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analyses are rendered as of the date given and may change without notice due to market conditions and other factors. This material is not intended as a complete analysis of every material fact regarding any market, industry, investment or strategy. Issued in Canada by MFS Investment Management Canada Limited. No securities commission or similar regulatory authority in Canada has reviewed this communication.

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