War, economy, and the people
US President Donald Trump has put the world on edge. The recent spate of events - the bombing of Syria, sending the US carrier strike group towards Korean peninsula, dropping 'mother of all bombs' on ISIS in Afghanistan - indicate his love for war.
In fact, recent US budgetary documents suggest that for fiscal 2018, the Trump administration has allocated the most towards defence and the least towards protection of the environment. Compared to 2017, defence and homeland security have seen an increase in budgetary allocation by 10 per cent and 7 per cent, respectively. Environmental protection agency saw budgetary allocation declined by 31 per cent. The US has allocated $654 billion towards defence, the highest in the world. This is much greater in comparison to India's $53.5 billion and China's $152 billion.
With so much money geared towards defence spending, it is evident that Mr Trump needs a way to utilise this defence spending. Post Second World War, the success story of the US economy is partly explained by its ability to sell weapons. Till date, the US remains as the largest exporter of conventional weapons.
There are, however, two other ways to strengthen the economy - increase labour productivity, and innovation. However, none of these is likely to happen. Data suggest that there are four headwinds: demographics, education, debt, and inequality, that is hitting the US economy. Trump chose protectionist strategies taking into account these factors.
Consider demography. The high growth of the US economy during the seventies and eighties was because of a younger working-age population, and women were entering the labour force. But now, with the retirements of baby boomers and smaller number of working-age population, labour force participation has fallen. This means lower US real income but more government spending on account of welfare activities. The elderly population need protection concerning greater social security, specifically lower medical costs, something that Trump promised.
About education, the costs of US College education are higher, and there are many dropouts. College completion rate in the US is around 15 percentage point lower than its neighbour Canada. Increased costs of education have been reasons for many young Americans to quit education in between, with a negative impact on productivity.
A fall in labour productivity has led firms to hire fewer people. Recent data suggest hourly wage rates of contractual factory workers has decreased. The promise about imposing 35 per cent tax on American businesses outsourcing jobs or building factories outside the US, signalled that Trump cares about unemployed American. By targeting China, Trump was able to woo voters from the Rust Belt states such as Michigan, Wisconsin, and Iowa, who believed that their jobs are lost because of cheaper Chinese imports and Mexican labours, and not because of a fall in labour productivity.
In reality, this fall in labour productivity and jobs loss are fuelled by a paradigm shift in technology. Technological innovations are no longer inclusive. The innovations that happened during last 150 years were inclusive. For instance, in travel, the economy graduated from horse driven buggy to Boeing.
In computing power, the present day mobile phone handsets have more computing power than the computer that launched a rocket to the moon. All this was instrumental in improving productivity, and real income growth in the US, in a way that no one has ever imagined before. But no longer.
In this age of data algorithm, 3D printer, and tech start-ups, wealth is getting cornered in the hands of the select few. The US regulators have already approved smart pills which send highly accurate diagnostic information from inside patient's body to doctors via Bluetooth. Very soon, the computing power of mobile handset will equal that of a human brain. A significant societal dislocation is waiting to happen as machine and robots take up jobs once worked by people. In this lower interest and highly automated manufacturing regime, firms and start-ups owners, are likely to corner a larger share of wealth, but not low-skilled labours.
The USA has already been transformed into a gig economy where the labour market is increasingly characterised by the prevalence of short-term contracts or freelance work as opposed to permanent jobs. This will hasten income inequality. The US labourers are without jobs and becoming poorer not because their jobs are taken away by the foreign cheaper labours but because of advancement in technology.
Trump cannot increase US growth, particularly, with a lower labour productivity. In fact, growth in government spending with lower tax collection from corporations means a higher fiscal deficit. Tax collections are falling because of technological nature of business with companies like Google, Facebook, Netflix, etc., paying lower tax in comparison to manufacturing firms. Federal government debt as a share of GDP is growing very rapidly: from $ 5 trillion in 2001 to around $ 20 trillion at present.
Debt in private sector is also increasing. The promise of a lower tax regime, and hence potential future profits have led many fund managers to start buying US junk bonds, taking the US stock market to an all-time high. In the longer run, without inclusive innovation, rising fiscal deficit cannot be sustained. In fact, higher fiscal deficit without a concomitant increase in productivity will lead to an increase in interest rate. This may set back investment and future employment generation.
What about trade? The biggest categories of US exports are aircraft, automobiles, and pharmaceutical - predominantly high-skilled manufacturing items. To an extent, it was possible because of US open arms policy, welcoming global talents. Clamping down on skilled labour immigration may dent productivity. It will also hurt skilled labour force participation.
Trade and economic power matter. Russia is a waning superpower, but China is not. Things would have gone for a toss if the spying allegation was raised against China. It is quite unlikely that the US economic protectionist policies are going to lift the US economy. Trump may have to engage militarily to regain America's lost pride. The free trade policy was able to prevent war for decades but may be no more. We have already started seeing that to happen.