Confidence is Everything

If I was running or was in any way responsible for a large economy, the first thing I would worry about is how secure people and institutions felt about their lives and their money.

Capital expenditures are a very important part of a large economy like this one. These expenditures are essentially multi-year investments that institutions and people make in order to earn money or somehow improve their lives. That washing machine you just bought for your new house? Two large investments, both made for multi-year periods.

You will not make these investments if you think your life may be upended tomorrow but some kind of an economic or other storm – such as deportation.

Similarly a business will not make such an investment (like a $500 million new plant), if there is a chance that they will suddenly not be able to sell product from that plant to all their markets.

When you contemplate a 20% border adjustment loudly, as the government, you are sending a signal to everyone contemplating such an investment. DON’T BOTHER - unless your consumer is entirely domestic. When you impose a 20% tax on your side of the border, you know the other side of the border will retaliate with a 20% tax on their side of the border. And suddenly, you have poorer consumers on both sides.

Aside from poorer consumers, you will have poorer producers on both sides of the border, who will start going bust in droves because now they cannot sell product where they were selling product a year ago. Suddenly, they are laying off their employees and then you have economic chaos in every direction.

The system will eventually re-converge in a few years, with domestic producers picking up the slack at higher price points. But even they will be affected by the confidence problem. If I invest now, will this tax be eliminated in 2 years and then I go bust?

Meanwhile, back on the farm you have a bunch of immigrants wondering if they should apply that coat of paint and replace that dying washing machine, or maybe even buy a new house. Suddenly, they are panicked consumers hoarding cash and not even going to the movie theater. If I get deported, how much cash will I need?

The problem is much bigger when you realize that it’s not just the undocumented immigrants who are wondering if they should hang around. Meanwhile, as they dribble out the United States loses skills it desperately needs – across the economic and skill spectrum.

Let’s not forget tourists who decide not to bother showing up because they just might not be welcome here. Who wants to buy expensive tickets and book non-refundable rooms and then be turned away at the border? Let’s go to Paris instead.

Creating uncertainty reduces consumer and business confidence. The University of Michigan has a survey that attempts to measure this confidence. It’s far from perfect but is a reasonably good leading indicator of where things are headed. It’s not exactly rising – and not without good reason.

When you affect confidence, you affect capital expenditures, operating expenditures and hiring and suddenly you have lower growth – even (and especially) if you never impose those border taxes. This is no way to accelerate growth in an economy. You can douse short term fuel on the fire – like a tax cut. That will only cause a few big flames that will lead to a lot of smoldering in just a few seconds.