Investment set to fall as business is baffled by Trump

Economic growth is closely linked to investment. In the short term, there is a demand-side effect: higher investment, by increasing aggregate demand, creates a multiplier effect. GDP rises and unemployment falls. Over the longer term, higher net investment causes a supply-side effect: industrial capacity and potential output rise. This will be from both the greater quantity of capital and, if new investment incorporates superior technology, from a greater productivity of capital.

One of the biggest determinants of investment is certainty about the future: certainty allows businesses to plan investment. Uncertainty, by contrast, is likely to dampen investment. Investment is for future output and if the future is unknown, why undertake costly investment? After all, the cost of investment is generally recouped over several months or year, not immediately. Uncertainty thus increases the risks of investment.

There is currently great uncertainty in the USA and its trading partners. The frequent changes in policy by President Trump are causing a fall in confidence and consequently a fall in investment. The past few weeks have seen large cuts in US government expenditure as his administration seeks to dismantle the current structure of government. The businesses supplying federal agencies thus face great uncertainty about future contracts. Laid-off workers will be forced to cut their spending, which will have knock-on effect on business, who will cut employment and investment as the multiplier and accelerator work through.

There are also worries that the economic chaos caused by President Trump’s frequent policy changes will cause inflation to rise. Higher inflation will prompt the Federal Reserve to raise interest rates. This, in turn, will increase the cost of borrowing for investment.

Tariff uncertainty

Perhaps the biggest uncertainty for business concerns the imposition of tariffs. Many US businesses rely on imports of raw materials, components, equipment, etc. Imposing tariffs on imports raises business costs. But this will vary from firm to firm, depending on the proportion of their inputs that are imported. And even when the inputs are from other US companies, those companies may rely on imports and thus be forced to raise prices to their customers. And if, in retaliation, other countries impose tariffs on US goods, this will affect US exporters and discourage them from investing.

For many multinational companies, whether based in the USA or elsewhere, supply chains involve many countries. New tariffs will force them to rethink which suppliers to use and where to locate production. The resulting uncertainty can cause them to delay or cancel investments.

Uncertainty has also been caused by the frequent changes in the planned level of tariffs. With the Trump administration using tariffs as a threat to get trading partners to change policy, the threatened tariff rates have varied depending on how trading partners have responded. There has also been uncertainty on just how the tariff policy will be implemented, making it more difficult for businesses to estimate the effect on them.

Then there are serious issues for the longer term. Other countries will be less willing to sign trade deals with the USA if they will not be honoured. Countries may increasingly look to diverting trade from the USA to other countries.

Video

• Trump An ‘Uncertainty Tax’ Says Vanguard Chief Economist

Bloomberg Podcasts on YouTube, Joe Davis (6/3/25)

Articles

• Trump’s erratic trade policies are baffling businesses, threatening investment and economic growth

Associated Press, Paul Wiseman, Anne D’innocenzio and Mae Anderson (6/3/25)

• The world is beginning to tire of Trump’s whiplash leadership

CNN, Stephen Collinson (6/3/25)

• US stocks slide and Nasdaq enters correction as chaos over Trump’s tariffs intensifies

CNN, John Towfighi (6/3/25)

• Trump’s Tariffs And Trade: Uncertainty, Chaos Or Brilliance?

Forbes, Mike Patton (6/3/25)

• How Trump’s second term might affect the market and your finances

The Conversation, Art Durnev (4/3/25)

• US corporate bond investors cautiously navigate trade war uncertainty

Reuters, Matt Tracy (6/3/25)

• This week in Trumponomics: Playing chicken with markets

Yahoo Finance, Rick Newman (8/3/25)

• Measuring fear: What the VIX reveals about market uncertainty

The FRED Blog, Aakash Kalyani (13/2/25)

Data

• US Economic Policy Uncertainty Index

Economic Policy Uncertainty

• World Uncertainty Index (WUI): Global

World Uncertainty Index

• CBOE Volatility Index: VIX

FRED Economic Data (St Louis Fed)

Questions