Trump's economic policies face hurdles: Deficit dilemmas and immigration impact

• Thanks to the dollar's role in the global financial system, the USA can go into debt more easily than others. But even there, politicians will eventually have to deal with the growing public debt.
• For now, no one knows how to address it. Some of Donald Trump's ideas could exacerbate this problem, Wojciech Kopczuk said in an interview.
• The economist believes that for most people, it doesn't matter that the future president is advised by the richest man in the world. – Clearly, voters are interested in their own incomes, he says.
• He points out that around 2033 in the USA, the accumulated surplus in the pension system will end, and the current stream of contributions will no longer be sufficient to cover expenses.
• If there is no legislative response, pensions will have to automatically fall by 20% to maintain the legally required balance of this system – our respondent points out.

Are you surprised by the rise in popularity of the Republicans? I'm not even talking about Donald Trump's victory in the presidential election because the polls indicated such a possibility, but rather about the change in social moods. The labour market in the USA is in good shape, unemployment is near historical lows. It might seem this would favour support for the ruling Democrats. But that didn't happen.

Wojciech Kopczuk, Professor of Economics at Columbia University in New York: The US economy is in decent shape, but this does not translate into consumer sentiment or optimism. It's probably a consequence of high inflation. Today, it seems that inflation has been contained, but in recent years it was the highest in several decades. This influenced the income distribution in the economy. The real incomes of the lowest-paid Americans have increased because the unemployment rate is low. But in the middle of the income distribution, in the broadly understood middle class, these effects were smaller. These people mostly voted for Trump.

Poorer Americans, whose real incomes have increased despite inflation, voted for the Democrats?

In this group, voter turnout is generally low. In the discussion about which social groups voted how, it's often overlooked that only certain shifts in preferences occurred, not a radical change. For example, in this year's elections, more Latinos and African Americans supported the Republican candidate than four years ago, but still, most of them voted for the Democratic candidate. But these changes in preferences matter when the difference in support for candidates is 2 percentage points.

How large is the group of people who have been impoverished by inflation?

I don't know, but it doesn't matter that much. It also matters how they perceive it. People often think that when prices rise sharply, it's the government's fault, and when wages rise equally sharply, it's their own achievement.

In previous election campaigns, the issue of income inequality was significant. It became prominent with the 2014 book by Thomas Piketty, "Capital in the Twenty-First Century." His thesis was that inequalities are entrenched because the more affluent people are in power, the more government policies favour the rich. What has happened to income inequality since then?

Income inequality remains high, although the COVID-19 pandemic temporarily reduced it. Piketty's narrative was exaggerated, but there is an awareness of this issue in American public life. There is still ongoing discussion about how to reduce inequalities, e.g., by increasing taxes on the wealthiest individuals. However, in recent years, this topic has not been as prominently featured in broader public debate as before, although Democrats would like to maintain those emotions.

I'm asking about inequality because Donald Trump's election program seemed very favourable to wealthy Americans. It included a proposal to cut taxes for companies and the wealthiest households. Trump is advised by the richest man in the world, Elon Musk. Doesn't this bother middle-class voters?

This is a topic of importance to a certain segment of society, discussed, for example, in the pages of "The New York Times". But for the majority of people, including those in smaller towns, it doesn't matter. The Republicans' favourable policies for the wealthy were not a burden for them either in polls or in elections. Clearly, voters care about their own incomes.

And voters believed that Trump's policies, even if they benefit big companies and the wealthiest Americans the most, would ultimately "be the rising tide to lift all boats"?

You could say that. Tax cuts are generally seen as good for the economy. And if people don't see the negative consequences of these changes for themselves, they support them.

It's paradoxical that high inflation, which burdened the Democrats, influenced the election results, but the winning candidate's program will be pro-inflationary. How much might Trump's proposed tariff hikes and immigration restrictions increase inflation in the USA?

This will probably slightly increase inflation, but the effect doesn't have to be strong. I wouldn't expect anything comparable to inflation from a few years ago. The relative prices of imported and domestic goods will certainly change. Some economists argue that inflation won't increase at all because rises in the prices of imported goods will be offset by falling prices of some other goods. This could be the case if the increase in tariffs is not accompanied by an increase in the money supply, i.e., if monetary and fiscal policies are not expansive. In my view, this is a simplification, and there will be some increase in inflation, but it won't be large.

What about the announced immigration restrictions? Could this not accelerate the growth of wages and, consequently, prices?

This may happen, especially in sectors where the most illegal immigrants work, such as agriculture and construction. But in my opinion, Trump will not be able to reduce immigration as much as he promises.

As long as the US economy is doing well, many people will want to come here. This migration pressure will always exist, and the USA cannot easily close itself off from immigration. This is currently the main source of growth in the number of active workers. The USA has the same problem as Europe, though less severe: low birth rates. Without immigration, there will be problems with maintaining the social security system. This would be a huge burden on public finances. You could say that the alternative to immigration is a crisis.

Donald Trump declares that his policy will reduce the deficit in the public finance sector and halt the accumulation of public debt.

He also promises tax cuts, which will have the opposite effect. Overall, I don't see Trump having a plan that could actually reduce the enormous deficit today. But the Democrats weren't much different from him in this regard. Concerns about the condition of public finances would exist regardless of who would have won the election. The main difference is that Donald Trump will emphasize tax cuts, while Kamala Harris would have emphasized increasing spending.

The rapid rise in US debt has been discussed at least since 2011, when the S&P agency stripped it of its top credit rating. That was over a decade ago, and public debt is growing unabated, without any noticeable negative effects. Is there a limit to such expansive fiscal policies?

No one knows. At one time, some economists claimed there was a hard limit that the United States could not exceed. But it was surpassed long ago. The USA is not a typical country in this regard. The dollar serves as the main reserve currency, ensuring Washington a high demand for Treasury bonds. For now, no crisis is on the horizon. But that could change quickly. With today's geopolitical tensions, it's easy to imagine a scenario where Asian countries stop buying US debt.

You mentioned possible problems with maintaining the social security system. When can they be expected?

They will become very apparent around 2033. At that time, the accumulated surplus in the pension system will end, and the current stream of contributions will no longer be sufficient to cover expenses. If there is no legislative reaction, pensions will have to automatically fall by 20% in order to maintain the legally required balance of this system. Of course, there will always be the option of subsidizing this system from the budget, raising contributions, or increasing the retirement age, but each of these solutions is a political minefield, and the necessity to do something will be unavoidable.

And won't Trump's confrontational policy, increasing geopolitical tensions, undermine the dollar's position, making it difficult to finance the budget deficit?

I don't think so. For now, there isn't much of an alternative to the dollar. The USA is still seen as a safe place to invest money. That hasn't changed either during the 2008-2009 financial crisis or during the pandemic.

An important point in Trump's program is lowering taxes for businesses. Is this something that could stimulate the US economy? Are firms in the USA overtaxed?

I don't expect business taxes to be significantly reduced compared to today. Already in 2017, during Donald Trump's first term, there was a major reform that reduced taxes for the wealthiest and for businesses. However, it was a temporary solution, and important elements are set to expire next year. I believe Donald Trump will want to extend that tax cut. It is not predetermined that this will fully succeed. Tax changes are enacted by Congress. If they don't have 60% support in the Senate, they must be balanced, meaning they cannot result in a drop in budget revenues. And Republicans don't have such a majority in the Senate.

Won't tariff hikes balance the tax cuts?

I don't think the revenue from these higher tariffs will be significant. First of all, it's hard for me to imagine that Trump would be able to raise them as he promises, i.e., to 60% on goods from China and 20% on products from other countries. The latter seems particularly unlikely to me.

That would mean a radical increase in tariffs on goods from Canada or Mexico, where American automotive companies and many others produce a lot - not just final products but also components that cross the border multiple times in the supply chain. Therefore, I think the tariff increases will be selective.

An additional complication is that unless Congress enacts tariff increases, they cannot be considered as a source of financing tax cuts for procedural reasons, which are practically significant in Congress.

Another of Trump's campaign promises is deregulation. Elon Musk is supposed to help the president-elect with this. Is the American economy overregulated? Is this something that is hampering its growth?

Deregulation is unfortunately a very vague slogan. Republicans will certainly differ from Democrats on antitrust and environmental policies. It's hard to say what impact this will have on the economy. Loosening environmental regulations, which somewhat restrain the mining and construction industries, may be beneficial in the short term, but is likely to be the opposite in the long term. The area where there is potential for deregulation is regulations regarding land use and infrastructure investments. In the USA, it is difficult to build a new road, railroad, or bridge. National, state, and local regulations overlap. As a result, such investments are often paralyzed by lawsuits. There is also room to relax regulations regarding the construction of houses. But it is not obvious that Republicans will deal with these regulations, which are actually harmful.

Europe is certainly overregulated. This is one of the conclusions from the famous report by Mario Draghi, which diagnosed the causes of the declining competitiveness of the Old Continent. What, in your opinion, is the reason for the US economy performing much better than the euro area economy in recent years?

There is no doubt that the USA is a more dynamic economy than Europe today. This is partly due to a more flexible labour market. During the COVID-19 pandemic, there were significant structural changes in economies. In the USA, where it is easier to hire and fire people, the flow of workers from inefficient firms to more productive ones happens quickly, while in Europe, it is slower. This, in my opinion, is the main explanation for the divergent trajectories of these economies.

There are other important, but in my view less significant, factors as well. In the United States, the fiscal stimulus during the pandemic was larger than in Europe, which allowed for a quicker rebound in economic activity (but also contributed to high inflation). The energy crisis related to the war in Ukraine proved to be a burden for Europe. In the USA, it wasn't as acutely felt.

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Wojciech Kopczuk is a Professor of Economics at Columbia University in New York. He has been working at this prestigious institution since 2003. Simultaneously, he is a researcher at the American National Bureau of Economic Research (NBER) and the European Centre for Economic Policy Research (CEPR).