As the election results became clear in 2016, financial markets rose amid a surge of economic optimism. That surge continued for two years as Donald Trump and Republicans pursued a pro-growth agenda of tax reform, deregulation and encouraging domestic energy production. But with Democrats now controlling the House and Mr. Trump already campaigning for re-election, Washington is again taking an anti-growth turn. Don’t be surprised if slower growth follows.
That’s the disappointing big picture if you step back from the daily fray and look at the direction of U.S. economic policy. Mr. Trump’s first two years were focused relentlessly on ending the economic malaise of the Obama years. Nearly every policy was seen through a growth prism.
But as he focuses on re-election, Mr. Trump is returning to the issues that marked the worst moments of his 2016 campaign. He is restrictionist on immigration, increasingly protectionist on trade, and more interventionist in regulating business. He favors price controls on drugs, a mandate for paid family leave, and his regulators are revving up what looks like it could become the largest federal antitrust campaign since the 1970s.
Meanwhile, House and Senate Democrats are advancing their own election agenda that includes higher taxes and new regulation on finance and industry. The only pro-growth measure that could pass would be Mr. Trump’s renegotiated NAFTA deal, but that is in greater jeopardy after last week’s tariffs on Mexico. Gridlock will probably prevail through 2020, but investors will have to start discounting the chance that Democrats could implement much of their agenda in 2021.
All of this is already hurting growth, and especially business investment. The Institute for Supply Management’s manufacturing index fell to 52.1% in May, its lowest since 2016. Surveys of CFOs show that investment plans for 2019 have slowed sharply amid the new policy uncertainty. A majority of business-earnings calls mention trade as a major concern.
The residual good news is that the policy reforms of 2017 built considerable pro-growth momentum that led to 3.1% growth in 2018. The labor market is still buoyant, and wages are rising. Yet these are often lagging indicators, and consumer confidence typically declines if markets and growth fall.
Falling bond yields are signaling a growth slowdown and the yield curve is inverted in what nearly always predicts a recession if it continues for three months. The Atlanta Federal Reserve’s “GDP Now” estimate for second-quarter growth is down to 1.3%, and even some long-time bulls are warning that we may be looking at a return to the slow growth of the Obama years.
Mr. Trump seems to believe the Federal Reserve can make everything great again by cutting interest rates, and he may get the rate cuts he wants this year. We opposed the Fed’s rate increase in December, and that advice looks vindicated by declining inflation. But the Fed can’t offset bad trade policy by itself.
U.S. tariffs have a negative impact on growth around the world, which in turn hurts U.S. exports. That's part of the explanation for the recent decline in U.S. manufacturing, as slower growth abroad means declining demand for American goods. We aren't predicting recession, though you can't rule that out if Mr. Trump follows through on his worst trade threats against China, Mexico and Europe.
A conceit of nearly all politicians is that they can get away with bad economic policies without paying too high a price. Barack Obama believed that his regulatory assaults on business had more benefits than costs. His economic advisers told him that higher tax rates don't matter. They should have learned otherwise after eight years of 2% growth and slow wage gains that laid the path for Mr. Trump in 2016.
Now Mr. Trump and his Republican fellow-travelers think they can impose tariffs willy-nilly with little damage. They say the doomsayers were wrong about the impact of the initial round of China tariffs, and in any case the tariffs are popular with the public. They say Mr. Trump needs wedge issues against Democrats in 2020, and he can run as a trade hawk on China against Joe Biden.
But Mr. Trump campaigned in 2016 on reviving the economy, and the surge of growth has helped to offset his personal unpopularity. Bad policies operate at the margin and their effect is cumulative. The initial tariffs were dwarfed by the growth effects of tax reform and deregulation, but the damage from tariffs will rise if they increase in severity and are imposed impulsively. Sooner or later bad policies always exact a high economic and political cost.