The looming battles over US economic policy thinking

A very happy new year to Free Lunch readers and welcome to my colleague Tej Parikh, who has joined the team to write a regular Sunday edition of Free Lunch (or as one reader I met immediately quipped when hearing the news: Free Brunch). Tej hit the ground running with an excellent myth-buster about European stock markets — make sure to read it if you haven’t already. Send us your reactions, comments and ideas for things to cover — we both receive emails sent to freelunch@ft.com. It’s going to be an exciting year in economics. Read on for my overview of the looming battles of ideas in US economic policy thinking.

The latest issue of Foreign Affairs features an essay by political scientist Michael Beckley, whose title quite dramatically captures the state of US politics: “The Strange Triumph of a Broken America”. Beckley’s focus is largely on the paradoxical tension between America’s continued global dominance and its internal divisions, but I would like to focus on the economic nature of the domestic discord. In Beckley’s succinct phrase, the US has “impoverished rural areas and empowered them politically”:

. . . from 2000 to 2019, 94 percent of new U.S. jobs were created in urban areas . . . Because rural Americans must drive longer distances to reach even limited options for food and health care and are thus more exposed to high fuel prices and local monopolies, costs for such goods and services rose . . . faster in rural areas than in urban ones from 2020 to 2022

Donald Trump’s success in winning over a multi-ethnic, lower-paid electorate to his coalition

could pave the way for Republicans to pursue policies aimed at helping working-class communities and bridging the urban-rural divide, such as expanding high-speed Internet in rural areas to enable remote work, building roads and clinics to boost commerce and health-care access, offering tax incentives to attract businesses, and establishing job-training centers tailored to local industries. But the urban-rural divide itself remains a powerful obstacle to reform, because it fuels political polarization and gridlock. This fault line is likely to define American society for years to come, threatening national cohesion in a dangerous world.

Indeed — and the rural-urban divide is just one part of a broader chasm between the successful and left-behind parts of America. What is more, this faultline splits defeated Democrats and victorious Republicans alike into starkly divided and curiously analogous camps over what lessons can be learnt from the election results concerning how to think about economics. As Donald Trump returns to power, both parties are fighting over whether and how the government should orient its economic policy towards the most broken parts of the US economy.

On the Democrat side, the struggle between Bidenomics populists and many traditional establishment Democrats has been visible for the past four years and has continued through post-election recriminations on fiscal policy, inflation, antitrust and tariffs. On the Republican side, we see it in the fights between Big Tech executives and Maga standard bearers that have flared up since Trump’s win, most prominently on immigration and the H1-B (skilled worker) visa programme. In both cases, we can, without too much exaggeration, talk of a populist wing and an oligarchic one.

I have recently discussed this with Oren Cass, an FT contributing editor, who also thinks there is a battle taking place over what will become the received wisdom on economics within the parties (Cass is himself an important voice within that battle on the conservative side). As he put it to me: “I think it’s important to recognise a lot of the specific fights — on industrial policy, on H-1Bs, very soon on tax — as pitched battles in the broader ideological conflict. That’s certainly how the participants see it and what drives the level of aggression with which they’re prosecuted.”

So let’s start the year, and this new era of US politics, with a rundown of the policy questions over which this struggle for the new economic paradigm is going to be fought.

Fiscal policy. The Biden administration’s choice to throw fiscal resources at the economy during the pandemic was inspired by his team’s sense that the Obama administration had undermined the recovery from the global financial crisis by spending too little. Without putting it quite in those terms, much of Team Bidenomics saw advantages in running the economy hot. Much of the rest of the Democratic establishment (including several people who had been in charge of that Obama-era policy response) were extremely critical of this choice, back in 2021.

Free Lunch readers know well that I don’t buy the central claim of that criticism — that it caused the later jump in inflation — for several reasons: the fiscal impulse wore off quickly (see the Brookings fiscal impact measure in the chart below); US aggregate demand did not exceed its pre-existing trend in real terms, and only after the inflationary burst in nominal terms; the rest of the world had similar inflation without a big fiscal splurge; Vladimir Putin’s energy price weaponisation affected energy prices everywhere; and the most careful technical studies by the best economists find that little of the inflation can be attributed to demand pressure.

But there are other conventional reasons to worry about big deficit spending, above all public finance sustainability. The US has rarely if ever run such big public deficits in a strong peacetime economy.

Much the same divide exists among Republicans. They all want lower tax cuts of course. Some version of Trump’s 2017 tax package will probably be extended, and some, including probably Trump himself, will be happy to just see the ensuing deficit juice economic growth. Take another look at the chart above: the US economy is humming along nicely with a slightly negative fiscal impulse, so a deficit-funded tax cut could easily trigger a boom. Other Republicans will worry (or claim to) about the deficit. Elon Musk has promised that his ostensible quest for increased government efficiency should cut spending by the trillions, after all.

Tariffs and trade. Well, we know that Trump loves tariffs and fake national security blocks on trade. But so did Biden (see: electric vehicle tariffs and Nippon Steel)! Yet in both parties, there is a large coalition of economists, business executives and Wall Street types not wanting to give up the gains from globalisation. On the Republican side, this is shaping up to be a conflict over whether tariffs are intended to be permanent — to trade less and shift economic activity back onshore for good — or a bargaining chip to boost market access for US exports and hence increase trade.

Industrial policy. Linked to this is the question of whether to use government policy to favour particular sectors, especially in manufacturing and energy. The Chips Act and Inflation Reduction Act were centrepieces of Bidenomics, and not to the liking of many more centrist Democrat-supporting economists. But they worked if the goal was to boost manufacturing investment and factory construction. They were designed to appeal to Republicans too, and have caused a lot more investment and spending to happen in the red and rural districts that voted for Trump than in naturally Democratic ones. IRA tax credits are now also payable to things beyond the technologies supposedly too green or “woke” for some Republicans’ comfort, such as nuclear or fusion energy. As for the Chips Act, Cass wrote in the FT just a few weeks ago about the reasons why Trump may find it better to use it rather than to scrap it.

The care economy. Outgoing Treasury secretary Janet Yellen and vice-president Kamala Harris have argued consistently for family-friendly government policies on the supply-side economic grounds that growth and productivity would be boosted by allowing more women to work and improving the educational prospects of children. One might think that this is one cause that most Democrats would rally behind and most Republicans resist. But Harris’s soon-to-be successor JD Vance has been vocal in favour of child tax credits, which were also singled out as a favoured policy in the platform adopted at the Republican convention in the summer. So some version of the care economy has powerful supporters in the Republican party.

Antitrust and regulation. Led by Musk, the tech billionaire wing of the Republican party rails against any restriction that government puts on what businesses can do. But Vance has praised Lina Khan, the Federal Trade Commission chair who has advanced a much more aggressive approach to antitrust policy than Washington was long used to under either party, and said he agreed with her on Big Tech. Her imminent replacement does not suggest that economic populism is guiding personnel decisions at the moment, but don’t expect the suspicions of big business among some Maga Republicans to just go away. And remember, Khan was disliked by the donor class in the Democratic party too — another parallelism between the two sides of politics.

There are, no doubt, more policy areas where these front lines are drawn down the middle of both parties. Where do you see the most likely skirmishes erupting? And which side — the populist or the oligarchic — do you think is most likely to prevail, on either side of the political aisle? Let us know via freelunch@ft.com.

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