In economics, as in life, sometimes the obvious answer is wrong.
In fact, American economist Richard Thaler won the Nobel this week for a career spent making that very point.
Unfortunately, as U.S. President Donald Trump plays to his base on two major issues, taxes and trade, there is some very good evidence that what seems obvious to him will hurt not help.
Rather than making America great, killing the North American Free Trade Agreement and cutting taxes for the rich could do the opposite.
“If we can’t make a deal, it’ll be terminated and that will be fine,” Trump said of the trade negotiations this week.
Hyperbole never hurts
The charitable view might be that Trump is playing his self-appointed role as dealmaker-in-chief, as outlined in his book, The Art of the Deal, in which he wrote “a little hyperbole never hurts.”
As anyone who has negotiated for a car knows, making it clear you really want the vehicle is a losing strategy.
Maybe Trump’s intransigent position is some sort of hyperbolic dealmaking ploy that requires pretending to be willing to forego the deal altogether. If so, the only good negotiating response from Canadian and Mexican leaders is to do the same thing — a game of chicken where the final result could be bad for everyone.
Certainly U.S. business leaders are worried.
As Prime Minister Justin Trudeau pointed out Wednesday, U.S. companies have a very large and lucrative Canadian market.
“The U.S. sells more to Canada than it does to China, Japan and the U.K. — combined,” he told a congressional committee.
A less charitable view of Trump’s off-the-cuff remarks about killing the deal is that he really believes free trade is bad. On that point, it’s almost absurd to list the economists who disagree, since it is very nearly all of them.
On the issue of tax cuts for businesses and the rich, another of Trump’s election promises, there are a lot more economic voices willing to say it is a good thing.
The Laffer curve, famously sketched on a napkin by supply-side economist Arthur Laffer back in the 1970s, seems to show that cutting taxes actually stimulates the economy while increasing tax revenues.
Regrettably, when it was tried during the Reagan administration that didn’t happen. The rich got richer and the deficit soared.
Certainly the economists at the International Monetary Fund have come down firmly on the side that says higher taxes — not lower taxes — are what most developed world economies, including the U.S., need just now.
In a new report called Tackling Inequality, the IMF says taxes in rich countries have become less progressive. In other words, in a system where the rich are supposed to be paying a greater share of their income in taxes than the poor, the rich are paying a smaller share than they used to.
“Our empirical results suggest that it is possible to increase the degree of tax progressivity while preserving growth, at least for levels of progressivity that are not excessive,” Victor Gaspar of the IMF said this week in an introduction to the inequality report.
Mick Mulvaney, Trump’s head of the Office of Management and Budget, was outraged by what he saw as an IMF attempt to sabotage the tax cuts.
Spock or Homer?
Earlier this week, behavioural economist Richard Thaler earned a Nobel for looking beyond the obvious in economics.
He found people often behave in ways that economic theory has declared irrational.
For instance, he showed people don’t save for retirement when economists say they will. He showed that people value things (like a coffee mug) more after they own it, even for a few minutes. He showed that people who would never buy an expensive bottle of wine would drink that same bottle from their own cellar, even if they could sell it for the full value.
Thaler said rather than acting like the ultra-rational Mr. Spock from Star Trek, humans are more likely to make economic decisions like Homer Simpson.
One question is whether Donald Trump is more like the Vulcan or more like Bart Simpson’s dad.
It might seem obvious, for example, that having ten times as many nuclear warheads, as Trump reportedly requested, would make a country more formidable. But after you have enough nukes to wipe out civilization, extra missiles are gravy.
It may seem that making stuff at home with your own workers would make your country richer. But real-life experiments, including during the Great Depression, showed that protectionism just made everyone poorer.
It could be concluded that letting companies and rich people keep their money instead of paying taxes would invigorate the economy. Or it could turn out that rich people would just sit on their cash piles and, as happened during the Reagan era, the overwhelming U.S. national debt would just get bigger leading to higher interest rates and a new economic crash.
“The idea that one would produce additional revenue by lowering tax rates is something that, being a conceptual possibility, is rarely documented empirically,” Gaspar told the Financial Times.
In polite IMF-speak that is the equivalent of calling real-world hogwash on the theoretical advantages of Trump’s intended cuts.
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