By Trevor Cox
Trump won’t achieve 4% GDP growth, but the stock market will continue to rally. Using the macroeconomic Solow growth model 4% growth via Trump’s methods is impossible in a developed country. The model has three exogenous variables: capital, labor, and knowledge, which lead to the endogenous variable total production. This model was first formulated in the 1950s and shows how third world cities can explode into first world cities within a generation through investment and the sharing of knowledge. Then the former third world cities level off and look like first world cites. If the reasonable assumptions are made to hold knowledge and labor constant, the function becomes an increasing concave function with capital on the x-axis and production on the y-axis. The function’s concavity shows that no matter how much investment is made in a country’s capital its production/GDP will level off at some steady state. Although Trump’s idea on how to reach 4% growth is ambiguous, he seems to hold the idea that America can invest its way to such a point. This is impossible.
America would be the richest and most advanced nation in the world if it were to achieve 4% growth. For this to occur, a paradigm shift would have had to occur in the global economy. Such a shift could only occur through knowledge leaps. Such knowledge leaps greatly increase productivity and therefore GDP. Some historic examples of knowledge leaps include trains, oil refineries, and the internet. These inventions occurred in a random, unpredictable manner, and were brought about by driven entrepreneurs who had a great deal of luck. Neither top-down nor bottom-up investment can create such world changing entrepreneurs. However, some politicians would like you to think that it was their specific meddling that caused such leaps. The only necessary inputs to these paradigm shifts are a working justice system and private property rights. These derive from a country’s culture and a respected republic, which allow innovation to thrive. America is fortunate enough to have a hard-working culture and greatly respected justice system. Meanwhile a country like Iran is riddled with corruption and has an authoritarian form of government. World changing inventions are seldom created in such environments.
If Trump hopes to achieve his moonshot goal of 4% growth, he can only continue to promote private property and respectable institutions with the hope of a great invention being created. Even though he is quite the builder, building a new interstate highway system with a golden T emblazoned on each entrance sign will not grow America’s overheating economy. As his business acumen should tell him, Trump’s government should not waste money on convoluted schemes to increase GDP via capital investment. He should allow GDP increases to occur naturally in the private sector, and relieve the burden that the government imposes on the private sector.
This leads to my next point on why the stock market will continue to climb in two words: tax-reform. Although a jump in GDP growth rate to 4% is random and unpredictable, tax-reform isn’t. Treasury Secretary Steven Mnuchin has talked about how he hopes to institute tax reform that will decrease the burden that corporations face for being located in America. According to the tax foundation the US has the third highest corporate tax rate in the world. If Congress were to pass a bill to decrease this burdensome tax and reform the tax code to make it simple and clear, corporate earnings across the board would increase, and current stock price is the best indicator of what investors believe projected future earnings to be. Hence the market will continue to soar across all sectors until tax-reform is passed or until Republicans lose congressional control.
The soaring of stock prices has nothing to do with changes in GDP growth. Investors are ignoring our generally slow growing economy and are instead looking to an increase in expected future earnings of corporations to decide stock prices. China is growing faster than the US because they are economically less developed than the US. Recent trends show that the Chinese economy is experience a slowdown, which is matched by the across the board leveling off of the developed economy – around 2% growth. Furthermore, one must look at the differences in GDP per capita between the US and China to get a fuller sense of how disparate the two countries are — China’s being a meager $6,807.43 compared to America’s robust $53,041.98. The two are not even near each other, and the comparison of these two economy’s as seemingly equal is dangerous. Even if China’s gross GDP overtakes the US’s, this won’t make a difference because the US’s population is only about one quarter of China’s. America does not need to catch up to China. China needs to catch up to America.