This article originally appeared in the Financial Times on 26 January 2017.
It is difficult to understand why Donald Trump’s campaign promise to “Make America Great Again” resounded so much with so many. True, the threat of terrorism, rising inequality and job-killing digitalization have been breeding anxiety for some time. However, on most metrics the U.S. economy has been doing just fine and certainly better than Europe.
While the median U.S. household’s real income still stands below the late-1990s peak, it has risen solidly over the past four years and will soon make new highs. Americans still live in the biggest homes, drive the largest cars and eat the thickest steaks. U.S. living standards, measured by per capita GDP, are some of the highest in the world (aside from a few special cases such as Luxembourg, Norway and Switzerland) and stand 50% above those of Europe and Japan. American technology, films and music shape people’s days and nights around the globe. The U.S. financial industry is on a sounder and more profitable footing, its housing and service sectors are the most vibrant, and its top universities are unrivalled. Carnage it is not.
If any major economy in the world needs to be made great again, it is Europe’s. Following a decent economic performance between the euro’s creation and the global financial crisis, Europe has been stumbling through a lost decade. Economic growth in the European Union has stagnated on balance since 2008 and the unemployment rate remains twice as high as in the U.S. As a consequence of the euro crisis, the banking sector is balkanized and financial markets are fragmented. The move toward “ever deeper union” has stalled; separatism and a new nationalism are on the rise. Brexit appears to be a taste of things to come rather than an isolated, idiosyncratic event.
Somewhat ironically, however, Donald Trump’s promise to put America first might actually help make Europe great again.
First, while the new U.S. administration aims to discourage imports into the U.S. and boost domestic production, European exporters should still be able to increase their market share in the U.S. for some time. One reason is that the dollar has strengthened and the euro has weakened since the U.S. presidential election, increasing the competitiveness of European exports. If the Federal Reserve follows through with the three policy rate hikes envisaged by the FOMC’s own projections and the European Central Bank keeps expanding its balance sheet and taxing banks for their excess reserves, the dollar could strengthen even further.
Moreover, higher consumer and business confidence, as well as higher stock prices, could boost U.S. demand for both domestically and foreign produced goods. Switching demand away from foreign to domestic goods could work eventually, but in the near term, there simply isn’t enough quality and capacity in U.S. manufacturing to fill the gap. Most of the “Make America Great Again” hats that Trump supporters were sporting at the inauguration were manufactured in China or Vietnam, and it will take a while, and a major relative price change, before we see the more affluent Americans favor Chevrolet, Lincoln, Chrysler and Jeep over BMW, Mercedes, Lexus and Range Rover.
Second, the prospect of a more protectionist U.S. administration, together with existing local pressures from populist movements, will likely provoke policy responses in Europe aimed at stimulating domestic demand and potential growth. The external threat to Germany’s export-led growth model is now palpable and this will help German Chancellor Angela Merkel to overcome the opposition in her party to a more expansionary fiscal policy. In addition, while the austerity rhetoric toward Greece is unlikely to change significantly, we may see more leniency toward growth-oriented fiscal policies elsewhere in the euro area.
Third, a more isolationist U.S. foreign and defense policy could catalyze a new joint European defense initiative. Committing to a common defense budget, financed by joint issuance, to counter actual or perceived external threats is a much easier sell than other forms of fiscal union.
Taken together, relative to the optimism on the U.S. and the pessimism on Europe that is priced into markets at this stage, Europe looks set to have the bigger potential to surprise on the upside.
All said, Donald Trump may well succeed in making an already great America even greater. But the chances are that in four or eight years’ time, more Europeans than Americans will have reasons to say, “Thank you, Mr. President!”