United States

2017 economic outlook and the prospect for reform

RSM's Economist provides bank executives insights at WIB Conference


U.S. economic growth: Signals flashing green

With the first 100 days of the Trump administration now past, we can take a look at the prospect for reform and the performance trends in the economy. Bank executives are watching these closely as they gauge opportunities for business investment, borrowing and consumer confidence. Growth for the U.S. economy for 2017 is near 1.9 percent. More encouraging news comes from employment growth, which remains quite strong with gains near 200,000 per month. The unemployment rate should decline to 4.5 percent by end of 2017. RSM’s middle market business index has jumped to a cyclical high of 129.8, with expectations on gross revenues, net earnings, hiring and compensation posting fresh highs. Demand for consumption and services remains solid. The housing recovery is best described as mild, with 1.25 million starts on an annualized basis. The manufacturing sector continues a modest rebound, with key risks being the auto sector and the impact of U.S. dollar appreciation on exports. The probability of a recession is low, around 5 percent.

Prospects for change in Washington

On the fiscal side, expect multiyear increases in defense spending and infrastructure projects, with the congressional bills for infrastructure paired with repatriation of profits held outside the U.S. With prospects for entitlement reform modest, at best, annual operating deficits should be much larger. Tax reform looks more likely, with tax brackets simplifying down to 12, 25 and 33 percent and corporate tax reform also proposed. Other ideas being considered are the elimination of the corporate tax regime and implementation of a value added tax (VAT); if a VAT tax doesn’t happen, then the corporate tax rate could be reduced to 15 to 20 percent.

Financial institutions with international operations should be tracking proposals for a border arrangement tax system, which could be necessary to increase revenues. The border tax is a destination-based cash flow tax with border adjustments. That is, it taxes cash flows rather than income. It reduces tax avoidance and creates incentives to source raw materials used at earlier stages of production domestically and to produce inside the United States. Such an approach gives preference to:

  • Exports over imports
  • Equity over debt
  • Fixed business investment
  • Immediate depreciation

The impact on manufacturers could vary based on how the dollar appreciates against other currencies. Thus, if dollar appreciation is less than that necessary to offset the additional costs that firms pay for imports, companies with thin profit margins will face significant dislocation. Domestic retail, footwear and apparel would face a disproportionate burden of adjustment should currency markets not adjust to reflect policy changes. The automotive and aerospace ecosystems are also at risk, given their dependence on cross-border assembly and component sourcing.

A closer look at the rocky U.S.-Mexico trade relationship

The possibility of a border adjustment tax is just one factor causing friction in the U.S.-Mexico trade relationship. Banks with exposure to Mexico, on their own or via clients with operations there, should stay alert to shifting economic and regulatory forces. That relationship is critical to both countries, with $1.3 trillion in NAFTA cross-border trade. Mexico is the primary trade partner for 30 out of the 50 states, and over the past seven years U.S. exports to Mexico have increased more than any destination. Over the past decade, Mexican direct investment in the United States has risen by 200 percent. Anything that disrupts NAFTA supply chains would be significant. The sources of disruption could involve a border tax arrangement, stepped up trade rule enforcement and selective targeting of global firms for domestic political purposes.

Industries most connected to U.S.-Mexico trade―accounting for 68.5 percent of U.S. goods imported to Mexico―are motor vehicles, computers, machinery and appliances. The same categories account for 48.1 percent of U.S. goods exported to Mexico. The impact on efficient manufacturing is considerable, as the integrated NAFTA auto production system generates savings of $4,300 per auto purchased in the United States. As the cross-border (in both directions) trade in specific industries shows, many goods cross borders multiple times as they are manufactured in steps. The value of imports and exports becomes difficult to track. One telling statistic: 40 percent of content imported from Mexico was originally made in the United States. Given the size, proximity and spaghetti-like supply chains of U.S.-Mexico trade, the notion of trade balances fades as executives, regulators, and other stakeholders focus on joint production, supply and value chains.

We expect the relationship will face further evolution as the Trump administration moves this fall to renegotiate NAFTA, with a June 2018 completion date, at the latest. The renegotiation would follow the template used for the Trans-Pacific Partnership. Revisions would focus on rules of origin (especially for the automotive sector), reductions in nontariff barriers and choke points that block movement of goods across the border, and the creation of a North American energy distribution infrastructure with cross-border oil and gas pipelines.