DESMOND LACHMAN: US will have its day of economic reckoning

With polls showing Donald Trump and Kamala Harris locked in a tight race, it is impossible to know who will win November’s presidential election. However, what is not difficult to know is that if the elected candidate sticks to his or her electoral promises, the US economy could be in for some rough sledding over the next four years.

This has to be of serious concern to the rest of the world economy. With the US still having the world’s largest economy, it remains the case that when the US sneezes the rest of the world catches pneumonia.

Whoever becomes the next US president will inherit an economy with highly compromised public finances. According to the non-partisan Congressional Budget Office, the country is running a budget deficit of 7% of GDP, and doing so at a time when unemployment is close to a post-war low.

That is precisely when the budget should at least be in balance to create the fiscal space to deal with any future economic slowdown. According to the Congressional Budget Office, the prospective maintenance of large deficits puts the public-debt-to-GDP ratio well on its way to exceed 100% by 2027. That would be higher than the level reached at the end of World War 2.

A striking feature of the election campaign is that neither of the candidates is putting forward a plan to return the country’s public finances to a sustainable path. On the contrary, they both appear to be making campaign promises that if implemented would aggravate an already troublesome public finance situation.

As might be expected from a Democratic candidate, Harris risks worsening the budget position through public spending increases. Among other things, she is promising ramped-up public spending on housing, healthcare, child and family welfare, infrastructure investment and the environment. It is far from clear how she proposes to fund her spending initiatives in general and the granting of Medicare for all in particular.

As might be expected from a Republican candidate, Trump would add to the deficit by making unfunded tax cuts. Among his proposals are ending taxes on social security benefits, at an estimated cost of $1.8-trillion over a 10-year period, and making permanent the 2017 corporate and individual tax cuts, at an estimated cost of $2.5-trillion. In addition, he is proposing further corporate tax rate cuts and the exemption of tips from taxes.

As Kenneth Rogoff and Carmen Reinhart chronicled in their magisterial book This Time is Different: Eight Centuries of Financial Folly, unsustainable public finances generally end in economic tears. It is difficult to see why, absent a fundamental change in policy direction, the same will not happen to the US either in terms of a dollar crisis or a burst in inflation.

Beyond the budget, another source of concern, regardless of who wins the election, is US’s likely continued retreat from free trade. Both candidates are promoting some version of an “America first” trade policy and a particularly tough line on Chinese trade.

Under a Trump administration it is difficult to see how we will avoid an international trade war. He is proposing a 60% tariff on all Chinese imports and a 10% across-the-board tariff on imports from all other countries. That is bound to invite retaliation from US trade partners that could lead us down the road to the economically destructive road to the beggar-thy-neighbour policies of the 1930s.

There are other means by which each candidate in their own way could cause further damage. Harris could do so by over-regulating the economy. That would sap investor confidence in general and in the oil industry in particular. Trump could do so by carrying through on his threat to deport millions of immigrants. That could add to inflation and slow economic growth. Over the past few years, by keeping wages contained the influx of immigrants has promoted economic growth and allowed the US Federal Reserve to bring down inflation without having to throw the economy into a recession.

All of this suggests that in the years immediately ahead SA could be facing a challenging international economic environment. The US’s compromised public finances and its adoption of a protectionist policy stance likely mean slower world economic growth and a reduction of global risk appetite. If that is indeed the case, SA cannot afford to lose time to get its own public finances in order.

• Lachman, a former deputy director in the IMF’s policy development & review department and chief emerging-market economic strategist at Salomon Smith Barney, is a senior fellow of the American Enterprise Institute.