By Marco Annunziata, Co-Founder, Annunziata + Desai Advisors, and Visiting Professor, Singapore Management University
We’ve kicked off the new year with a strong dose of enthusiasm and uncertainty, mixed in equal measure—both linked to the new administration in Washington D.C. President Donald Trump has promised a sharp break from the policies of the past four years, with major changes to key areas of American economic policy.
Some of the proposed measures raise hopes of a further acceleration in the already robust growth rate in the United States. Others, conversely, provoke fears of negative impacts on US and global economic activity, as well as inflation. The uncertainty arises not just from the possible gap between election promises and actual policies but also from inherent inconsistencies in the announced package of objectives and measures.
How should we view the likely policies of the new US administration and their impacts on the global economic outlook?
I would argue that tariffs and immigration policies, while important, are likely to play second fiddle to the new government’s stance on regulation and fiscal policy. The overall policy platform, on paper, looks positive for innovation and growth, but with some question marks and meaningful risks, especially on the fiscal-deficit and government-debt front.
Tariffs
Let’s start with tariffs. A tariff is a tax that is ultimately borne by domestic consumers and is an implicit subsidy for domestic producers. Concerns that new tariffs will put inflation back on a higher path and derail growth, however, are overdone. Tariffs cause a one-off increase in some relative prices, not a continuing rise in the overall price level. Across-the-board tariffs of about 10 percent might temporarily raise inflation by a few tenths of a percent but not push it back into the 5-10 percent range of 2021-23. We should also remember that the US is essentially a large closed economy: Exports account for just 11 percent of gross domestic product (GDP) and imports for about 14 percent. The adverse fallout of tariffs on US growth and inflation, therefore, would be limited. This holds even for the recently announced 25% tariffs on Canada and Mexico, which together account for just under one third of US imports. By comparison, both imports and exports account for around 50 percent of the euro area’s GDP.
Equally overdone, however, are President Trump’s hopes that tariffs will raise substantial revenue at the expense of foreign producers. Revenue from customs duties averaged 0.8 percent of GDP during 2010-18; it rose to an average of 1.4 percent of GDP during 2019-23 after Trump launched his first round of trade wars. This increase is not insignificant, but it’s a long way from financing a fiscal deficit now running at 6-7 percent of GDP. Moreover, even higher tariffs would divert consumption towards non-affected products, muting further revenue gains.
Tariffs would impose higher costs on consumers, reduce competitive pressures on some US producers, and fuel efforts to lobby for exemptions and find ways to circumvent the new taxes—an overall negative hit to the efficiency that the Trump government claims to prioritize. Some tariffs might arguably be justified on national-security grounds; overall, they are a bad policy that will most likely impose little damage on the US but could hurt some of its trading partners more.
Immigration
Immigration is another important economic issue, but not for the reasons dominating the headlines. Immigration has made an important contribution to the post-pandemic recovery. Foreign-born workers accounted for one-third of the rise in employment over the past four years. Mass deportations over a short period could create sudden labor shortages in sectors such as construction, hospitality and agriculture, putting upward pressure on wages. If implemented more gradually, however, even substantial deportations would be less disruptive. To put things in context: During Trump’s first term, about 1.2 million illegal immigrants were deported; President Barack Obama deported about 1.6 million during his first term and approximately 1.5 million during his second (see source). Since then, the labor force has expanded from under 160 million in early 2017 to nearly 169 million today, and the last four years have seen record levels of illegal immigration.
A tightening of immigration, including some substantial deportations, therefore, seems unlikely to derail growth, given also that labor demand has already cooled off somewhat. Much will depend on how the policy is implemented, but immigration restrictions seem unlikely to scupper gains in economic growth and disinflation.
Much more important is the issue of immigration reform. The ability to attract talent from all over the world and across the skills spectrum has always been a major comparative advantage for the United States. Congress should design a new immigration system that ensures this pipeline of talent can be maintained—at manageable levels and through lawful channels.
Deregulation
The new administration’s approach to regulation could turn out to be by far the most consequential. During his first term, President Trump drove an important effort towards leaner regulation, including the requirement that two existing rules be eliminated for every new one introduced. This time around, deregulation stands again among his top priorities, including the creation of the new Department of Government Efficiency (DOGE).
The emphasis on deregulation—together with the promise of lower taxation—goes a long way towards explaining the enthusiastic reception that the new administration has received from the business community. The optimism index for small businesses compiled by the NFIB (National Federation of Independent Business) soared after the November election, much as it did in 2016. And US business leaders on Davos panels (the World Economic Forum’s annual meeting in Davos, Switzerland) sounded quite bullish on the prospects of the US economy under the new leadership.
This enthusiasm is easy to understand. Today, more than ever, strong economic growth requires a dynamic and innovative private sector. Technological innovation moves much faster in a flexible economy with light-touch regulation. And the fast pace of innovation, in turn, requires companies to be nimble and adaptable—again, something more easily achieved in an economy with fewer bureaucratic restrictions and lighter tax burdens.
In the five quarters leading to the third quarter (Q3) of 2024, US productivity growth accelerated to an average rate of 2.5 percent on an annual basis, compared to a 1.5-percent average over the past 10 years. Productivity numbers are highly volatile, so it’s too early to call a structural shift, but we might be seeing a decade or more of innovation finally starting to lift the economy’s overall growth potential. With innovation still powering ahead, including advances in artificial intelligence (AI), there are good reasons to hope the acceleration might be sustained.
Translating innovation into faster growth throughout the economy requires hard work, as companies must rethink their operations, retool their processes and reskill their workforces. It requires investments in new technologies and equipment. Again, all this is more easily achieved in a flexible economy with a lighter tax burden.
The previous four years, to the contrary, saw a massive increase in the regulatory burden, with a cost that University of Chicago Professor Casey Mulligan estimated at $47,000 per US household. This has gone hand in hand with the strongly interventionist approach of many US government agencies, which often contributed to creating uncertainty and obstacles for businesses. Against this background, the visible relief of many business leaders should perhaps not come as a surprise.
Fiscal policy
A lower tax burden (compared to what appeared likely under a Kamala Harris presidency) should support both the competitiveness of US companies and the purchasing power of US households. Overall, the balance of lighter regulation and lower taxation against higher tariffs and immigration restrictions would seem to lean decisively towards stronger growth, albeit with inflation likely to prove sticky around current levels.
The problem with lower taxes, however, is that they would add pressure to an already very substantial budget deficit. This looks like the Achilles’ heel of the new administration’s policy framework. As we saw above, higher tariffs on imports can make only a limited contribution to shrinking the budget gap. The new DOGE could achieve important savings by reversing at least in part the expansions in both social benefits and government employment of the post-COVID period, but even that would not be enough to bring the deficit down from the current 6-7 percent of GDP to a more sustainable 3 percent.
Budget flexibility looks quite limited. Non-defense discretionary expenditures amount to less than $1 trillion, or around 3.5 percent of GDP. Interest expenditures now impose a much heavier burden and are projected at a similar level of 3.5 percent of GDP for the next several years, compared to an average of 1.5 percent during 2012-21. The bulk of the federal government’s expenditures consists of entitlements—that is, outlays on Social Security and healthcare—and reducing them would require an improbable political effort.
What should we expect for the US and global economies?
On balance, the net impact of the new policies on US growth is likely to be positive, with deregulation and lower taxes having the dominant impacts, both directly and through the already visible boost to confidence—all of which should prove beneficial for investment, employment and consumption.
This situation, however, will make further progress on disinflation even more difficult because of the combined impact of stronger underlying growth, loose fiscal policy and one-off price increases driven by tariffs. The Federal Reserve (the Fed), as a consequence, seems likely to take a more cautious stance on monetary policy: Rates will probably remain on hold for the first half of the year, and if activity and job numbers remain robust and inflation sticky, the rate-cutting cycle might already be over. During the Fed’s end-January policy meeting, Chair Jerome Powell gave a clear indication that if current economic conditions persist, monetary policy will likely stay on hold for some time.
Adding to this picture is the likelihood of persistent sizable fiscal deficits with commensurate issuance needs; yields on benchmark US Treasury bonds also seem destined to remain elevated, possibly heading towards 5 percent and above on the 10-year maturity, depending on macro and fiscal developments. Loose fiscal policy and an already sizable debt stock pose ongoing risks. High debts and high interest rates make for an awkward combination that, at some point, will need to be resolved, most likely through a combination of higher economic growth and fiscal consolidation. But that’s unlikely to happen in the near term. For now, this remains one of the inherent contradictions in the new administration’s policy framework: President Trump has repeatedly expressed a desire for lower interest rates, but imminent fiscal policy looks set to push them in the opposite direction.
Similarly, though President Trump seems to hope for a weaker US dollar, both robust US growth and tariffs point instead to greater dollar strength—which, in turn, would temper the impacts on domestic prices.
Uncertainty is still significant at the time of writing, and many devils might emerge in the details of the executions of different policies. The big picture, however, is that the US is shifting away from a trend of greater government intervention in the economy and towards policies that reassert the primary role of a dynamic and innovative private sector. This should prove a net positive for both the US and the global economy.