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Understanding the economic impact of US midterm elections

by Ira Kalish
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    07 November 2018

    Understanding the economic impact of US midterm elections Democratic control of the House makes big new legislation unlikely, but there could be continued movement on trade

    07 November 2018
    • Ira Kalish United States
    • Ira Kalish United States
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    The midterm election will bring back a divided US government, which means little if any major legislation, and investors may be fine with that. The biggest fights to come—and the biggest question marks—will likely concern trade.

    The late Tip O’Neill, speaker of the US House of Representatives in the 1970s and ’80s, liked to say that all politics is local.1 Yet both President Trump and Democrats tried to nationalize Tuesday’s midterm elections, making the results to some extent a referendum on Trump himself.2 Interestingly, however, Trump did not emphasize the strong state of the US economy, much to the chagrin of congressional Republican leaders. Rather, he focused on issues—particularly immigration—that were expected to motivate his political base.3 Exit polls notwithstanding, it is too early to definitively say what motivated voters,4 but in the end, the result was a mixed bag for both parties—although Democrats gained on balance. Most significantly, Democrats took control of the House of Representatives for the first time in eight years, albeit by a modest margin. Republicans retained control of the Senate, where they boosted their small majority. Democrats picked up a number of key governorships, especially in the Midwest and Northeast, though they failed, by a narrow margin, to pick up key races in the South.

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    How can we assess this? On the one hand, the first midterm election of a president’s term usually results in losses for the president’s party.5 This indeed happened. On the other hand, a president’s party often does well in midterms when the economy is strong. This explains, at least in part, the fact that the “blue wave” for which many Democrats had high hopes did not materialize. As such, this midterm was very different from the Obama administration’s first midterm election in 2010, in which it suffered big losses. On the other hand, many key races were very close, including many in which Republicans held onto seats that were seriously challenged. For example, Republicans held onto the governorship in Florida and a Senate seat in Texas, but by unusually small margins. This suggests that, in a different economic environment, Democrats might become quite competitive in previously inhospitable states such as Texas, Georgia, and Florida. Demographic changes have led many Democrats to look forward to the day when these states can be turned.6

    What will all of this mean for policies? Democratic control of one house of Congress means that the White House cannot expect to easily achieve major legislation over the next two years. The Republicans would like to make last year’s tax cuts permanent; this is now unlikely to happen. As for spending, there will probably be no significant shift in the trajectory of spending, although it is possible that the two parties will agree to sustain high levels of spending that are currently set to decline in two years. On the regulatory front—at least, regulation that involves Congress as opposed to simply coming out of the White House—not much is likely to happen. As for immigration, the new Congress will not agree to fund (or to continue funding) the much-discussed wall with Mexico.7 Indeed, it is hard to imagine that the administration will agree with the Democrats on anything to do with immigration. On the other hand, the administration could find common ground with the new Democratic majority in the House on such issues as infrastructure investment, paid family leave, drug prices, and raising the federal minimum wage.8 Yet even on these, finding support in the Republican-led Senate would be difficult.

    The economic issue that has seen the most significant government actions in 2018 is trade, in large part because the president generally has the authority to act without congressional approval.9 That will remain true, and it is likely that the United States will continue to take harsh action against China, something that appears to be popular with voters across the political spectrum.

    The one area of trade policy in which the new Congress will make a difference involves US trade with Mexico and Canada. The Trump administration has negotiated the US Mexico Canada Agreement (USMCA) as a replacement for NAFTA, and it must be approved by both houses of Congress before becoming law. Passage is not guaranteed: While many Democrats agree with the administration’s protectionist bent, and many likely agree with the labor market rules of the new USMCA, it is possible that they will be averse to the agreement nonetheless, reluctant to hand the president a victory. They have learned what Republicans learned during the Clinton years: that is, Bill Clinton reached a number of key agreements with the Republican Congress, but Clinton got most of the credit.10 Thus, during the Obama years, the Republican majority in Congress chose not to reach deals with the president, even on issues, such as trade, on which they actually shared common ground; their goal was to avoid giving Obama the appearance of success.11 Democrats, after two years of pummeling by President Trump, may decide to deny him the appearance of success on the trade deal. If that happens, the original NAFTA will remain in place, unless the administration follows through with its earlier threat to exit NAFTA early in 2019.12 On the other hand, Democrats might be willing to support the USMCA in exchange for something. Moreover, some Midwestern Democrats might be reluctant to reject the agreement on the fear that the alternative (no agreement) could be worse for their districts or states.13 Either way, businesses are likely to face a heightened degree of uncertainty about North American trade for at least the next few months.

    Beyond economic policy, the composition of the new Congress means that the House will be in a position to implement serious investigations of the administration. This will entail subpoenas of key documents and public hearings in which administration officials will be compelled to testify under oath. At the least, such investigations have the potential to seriously distract lawmakers. That was the case in 1973–74 during the Watergate scandal, when the legislative process ground to a near halt.14

    Another important impact of the midterms is that, with the governorships of at least seven states—and control of a number of statehouses—switching to the Democrats, the party will have the opportunity to redraw more legislative districts following the 2020 census. Efforts to redo Republican-drawn district lines—Democrats ended up with a 6.9-point margin in House voting but only a narrow margin in the chamber15—could improve Democratic prospects in House elections during the next decade.

    Investors greeted the election results without any sharp movements in asset prices. US equities rose while bond yields declined, and the value of the dollar fell modestly. Evidently the outcome of the midterms was not significantly different from what investors expected. Nor does it promise a significant shift in policy.

    Author

    Dr. Ira Kalish is Deloitte's chief global economist and is based in Los Angeles.

    Acknowledgements

    Cover image by: Wayne Brezinka 

    Endnotes
      1. Paul Kane, “All politics is local? In the era of Trump, not anymore,” Washington Post, February 25, 2017. View in article

      2. Stuart Rothenberg, “Breaking the midterm mode: Parties make it about Trump,” Roll Call, October 15, 2018. View in article

      3. Grace Segers, “Trump focuses on immigration issues ahead of midterm elections,” CBS News, October 30, 2018. View in article

      4. Gary Langer et al., “Key exit poll takeaways: Voters negative on Trump, most interested in health care, immigration,” ABC News, November 7, 2018. View in article

      5. Marcus H. Johnson, “Why does the president’s party lose seats in the midterm elections?”, Medium, April 9, 2018. View in article

      6. Daniel Strauss, “Is this the year Georgia turns blue?”, Politico, January 22, 2018. View in article

      7. Tal Axelrod, “Pelosi: I don’t see any Dems voting for wall funding,” The Hill, October 16, 2018. View in article

      8. Matthew Dessem, “Nancy Pelosi responds to Republicans’ racist fearmongering with paean to ‘the bipartisan marketplace of ideas,” Slate, November 7, 2018. View in article

      9. Neil Irwin, “The Trump trade strategy is coming into focus. That doesn’t necessarily mean it will work,” New York Times, October 6, 2018. View in article

      10. PBS, interview with Newt Gingrich, spring 2001. View in article

      11. Andy Barr, “The GOP’s no-compromise pledge,” Politico, October 28, 2010. View in article

      12. Bob Bryan, “A top Republican senator just made it clear that Trump’s new trade deal with Mexico and Canada could still fall apart,” Business Insider, October 2, 2018. View in article

      13. Keith Johnson, “The trade war inside the Democratic Party,” Foreign Policy, November 5, 2018. View in article

      14. US House of Representatives, “93rd Congress (1973–1975),” accessed November 7, 2018. View in article

      15. New York Times, “Live forecast: Who will win the House?,” accessed November 7, 2018. View in article

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    United States (U.S.) , Public Sector , Economics , Americas Economics , Americas

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    Ira Kalish

    Ira Kalish

    Chief Global Economist, Deloitte Touche Tohmatsu

    Dr. Kalish is the Chief Global Economist of Deloitte Touche Tohmatsu Ltd. He is a specialist in global economic issues as well as the effects of economic, demographic, and social trends on the global business environment. He advises Deloitte clients as well as Deloitte’s leadership on economic issues and their impact on business strategy. In addition, he has given numerous presentations to corporations and trade organizations on topics related to the global economy. He is widely traveled and has given presentations in 47 countries on six continents. He has been quoted by the Wall Street Journal, The Economist, and The Financial Times. Dr. Kalish holds a bachelor’s degree in economics from Vassar College and a PhD in international economics from Johns Hopkins University.

    • ikalish@deloitte.com
    • +1 310 420 0392

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