May 03, 2019
(This piece was first posted on my Patreon page.) The Trumpers were celebrating over the 3.2 percent GDP reported for the first quarter last week. They claimed it proved the success of their tax cuts.
But fans of arithmetic saw things differently. First of all, the jump in GDP was largely a fluke, with a big jump in inventory accumulations and a fall in imports accounting for almost half of the growth. Pulling these out, GDP growth was under 2.0 percent.
This isn’t just cherry picking. It is virtually certain that inventories accumulation will slow next quarter, this usually happens after a month of rapid accumulation. The logic is straightforward, if companies added a lot to their inventory in the first quarter, then they probably want to add less in the second quarter.
It’s a similar story with imports. Our imports typically rise quarter to quarter, unless the economy is in a recession. The shrinkage in the first quarter is likely a fluke, which means unless imports are revised up in subsequent reports (the GDP data will be revised twice before the second quarter data are released), we are likely to see a larger than usual jump in imports in the second quarter.
In that story, both inventories and imports are likely to be a drag on growth. This means that if we have an underlying growth rate of 2.0 percent, a slower rate of inventory accumulation, coupled with more rapid growth in imports, could mean that second quarter GDP will be close to 1.0 percent.
But apart from the pace of overall GDP growth, the big news in the first quarter data was the 2.7 percent rate of investment growth in the quarter. This is huge, because the sales pitch for the Trump tax cut was that it was going to lead to an investment boom.
Rather than seeing the single digit investment growth that is typical for the economy, we were supposed to see investment growth in the range of 30 percent annually. This would lead to a huge increase in the capital stock and therefore higher productivity and higher wages.
The 2.7 percent investment growth for the quarter doesn’t quite fit the boom story. And this number is not an outlier. While investment growth was acceptable last year, at 6.9 percent, that is hardly exceptional. It also grew 6.9 percent in 2014, and in 2011 and 2012 it grew 8.7 percent and 9.5 percent, respectively. There is basically zero evidence of a boom in the data.
Nor is there any evidence going forward. Non-defense capital goods orders, the largest single category of investment, are up just 2.8 percent from year ago levels, excluding aircraft. (If we include the volatile aircraft category, orders are down 1.2 percent from 2018.)
At this point, we can pretty much send the tax cut induced investment story to the dust bin of history. But the tax cut did provide a boost to demand through increased consumption. This led to more rapid growth and a lower unemployment rate.
The basic story is that all those billions that we gave to corporations with a lower tax rate ended up in shareholders’ pockets through dividends and share buybacks. They turned around and spent this money, leading to a higher level of consumption.
While this gain won’t be repeated (unless we cut taxes even more in 2019), we did get a one-time boost to growth in 2018. The added growth pushed the unemployment rate down by roughly 0.3 percent and increased the employment rate for prime age workers (ages 25 to 54) by around 0.6 percentage points. This translates into additional employment for more than 1 million workers compared to a scenario in which we did not have the tax cut.
In a context where the economy is already at a relatively low level of unemployment, the further increase in demand is an especially big deal. Employers have to hire people they might ordinarily avoid. This means African Americans, Hispanics, people with less education, and people with criminal records. The lower unemployment rate gives an opportunity to people who would not otherwise have a chance of getting a job.
It also leads to upward pressure on wages, and we have seen a modest acceleration of wage growth to around 3.3 percent from around 2.6 percent pre-tax cut. Since inflation remains around 2.0 percent, this means real wages are growing, even for those at the bottom, by around 1.0 percent a year. That’s still not great, but better than what we had been seeing.
And, as noted above inflation is not rising. This means that we may still have some more room to expand demand and push the unemployment rate still lower. But the people who argued that the tax cut would overheat the economy, leading to high interest rates and/or accelerating inflation, were clearly wrong. The economy could easily support the boost to demand from the tax cut.
This fact is also important because it sets a benchmark for the economy going forward. If the hawks at the Fed had carried the day, they would have jacked up interest rates in 2014, and the unemployment rate never would have fallen below 5.0 percent. In that world, the conventional wisdom in the profession would be that 5.0 percent was the non-accelerating inflation rate of unemployment (NAIRU). They would argue that we would see spiraling inflation if the unemployment rate fell below this level.
While we (myself and other progressive economists) would challenge this contention, they would have authority on their side. And in economics, authority trumps evidence.
But actually having an unemployment rate under 4.0 percent, and zero acceleration of inflation, does make it harder for the inflation hawks to argue that this is not possible, just as the 4.0 percent unemployment rate in 2000 (also without a noticeable uptick in inflation), made it difficult for mainstream economists to continue to argue in that decade that the unemployment rate could not fall below 6.0 percent without spiraling inflation.
So these are some very positive outcomes from the Trump tax cut. This still doesn’t mean the tax cut was a good idea. We have an endless number of neglected needs in our society, starting with addressing global warming, but including inadequate support for child care, health care, education, housing and others. In this context, giving a tax cut of $150 billion a year, that was tilted to the rich, was a really bad use of public money.
But all the deficit hawks who screamed about its impact on the deficit and debt were off the mark. It was actually a good thing to run a larger deficit, the economy needed an additional boost to demand, the Trump tax cut was just a really bad way to provide it.
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