An obsessive focus on the demand side of the economy has dominated the years following the 2009 global recession. Most economists embraced the Secular Stagnation hypothesis, which argued that structural forces had caused a permanent shortfall in demand. We agonized over “r-star”, the equilibrium real rate of interest, worrying it had become permanently lower, making it harder for central banks to stimulate…domestic demand. We lived in constant fear that automation would halve demand for labor.
Policymaker focused all efforts on stimulating demand: central banks cut interest rates to zero and bought massive quantities of a growing range of financial assets; governments increased public spending and deployed a widening range of subsidies.
Perhaps because of the years I spent working in industry and technology, I thought focusing so much on demand and so little on supply was deeply misguided.
Now we’ve been shocked to discover that the supply side matters; that in fact all our problems come from the supply side: insufficient labor supply, disruptions in global supply chains, shortages in energy supply. Companies can’t find enough workers, electronic chips and components; they can’t get containers through clogged ports or find enough truck drivers to get their products on shelves; consumers face goods shortages and rising prices at the gas pump and in the stores. These disruptions have been precipitated by last year’s decision to shut down entire economies – a decision perhaps facilitated by this tendency to underestimate the supply side. But their causes run deeper, in over a decade of unbalanced policy mix.
The US administration’s flippant dismissal of these problems (White House Chief of Staff Klain and press secretary Psaki brushed them off as “champagne problems”) has been criticized as elitist and out of touch. For me it shows how little thought policymakers have been giving to the supply side of the economy – they never believed it could be an issue, and even now some of them can’t take it seriously.
Many policymakers are still in denial. They insist that supply side disruptions are just temporary hiccups that will quickly sort themselves out – central bankers at the Fed and ECB sound confident that higher inflation will be transitory. They remain fixated on stimulating demand, because that’s all they have done and worried about for the last dozen years.
Yet our best hopes for a better future come from supply-side developments: companies’ efforts to restructure supply chains and make them more efficient and resilient to shocks; the accelerated adoption of digital-industrial technologies to boost productivity; advances in automation to compensate for workers shortages. These trends promise to raise potential growth, income levels and living standards.
We also need the supply side more than ever to remedy the problems created by our maniacal focus on stimulating demand: (1) we have created a massive overhang of public debt – once interest rates rise in line with inflation, we’ll need stronger economic growth to keep this debt sustainable and avoid dangerous financial instability; (2) loose monetary policy has helped propel stock markets to higher and higher valuations – unless these get validated by stronger growth and profitability, we risk a major correction once monetary policy pulls back to a more normal stance.
It’s time for policymakers to shift focus and rhetoric. The US administration’s infrastructure plan is a step in the right direction. It’s far from perfect, but at least it recognizes we need better infrastructure to boost supply – better transportation, communication, energy and digital infrastructure.
We need better education and training to upgrade human capital. Education should be better aligned to the skills needed in the economy; it should be more demanding and competitive; it should reinforce the message that everyone has a responsibility to become a contributing member of our economies.
Technologists and innovators are focusing on human-machine collaboration; they realize that humans and robots have different, complementary abilities, and that for the foreseeable future the most successful companies will be the ones that optimize the combination of technology and human capital. This sets the stage for more and better jobs, but only if the education system keeps pace, if we teach young people the right skills instead of throwing them off track with dystopian prospects of mass automation and universal basic income.
Finally: incentives. It’s taken us over a decade to rediscover the importance of the supply side; let’s not take another decade to realize that incentives matter. Taxes, regulations and social subsidies play an important role; but they can undermine incentives to work, invest and innovate. Policymakers should think a lot harder through the impact these measures have on incentives, through the tradeoffs and the unintended consequences.
The good news is that while most economists and policymakers ignored the supply side, innovators and industry leaders did not; but now it’s time for all of us to pull in the same direction. This requires a rapid shift in policies.