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Big Government Is the Answer to America's Supply Problems

Big Government Is the Answer to America's Supply Problems

Thursday, 17 June, 2021 - 04:30

In the wake of the pandemic, Americans are rediscovering the importance of the economy’s supply side. But this won’t be a rerun of the 1980 — we’re learning that there’s a lot more to bolstering supply than tax cuts and deregulation.

Economists, as most people know, tend to think of the world in terms of supply and demand. The Great Recession taught us to remember the importance of aggregate demand — quantitative easing and financial bailouts helped cushion the blow, and more fiscal stimulus back then would have set us on the road to recovery even sooner. But the Covid-19 pandemic is very different. Supply chain disruptions and a labor shortage are reminding us that not all economic problems are due to a lack of demand. Inflation is persisting at high levels, even as the job recovery has been sluggish.

That situation is reminding some people of the stagflation of the 1970s. We’re certainly not in 70s territory yet — the inflation will probably resolve over the next few months, and job growth will pick up if the pandemic doesn’t have a resurgence. But even a temporary and minor stagflation should focus minds on supply-based solutions; in stagflation, demand-based solutions like easy monetary policy and government borrowing don’t solve the problem.

On top of that, Covid reminded us of the importance of supply at the microeconomic level. The failure of the US to make enough masks and ventilators early in the pandemic taught us that even supply chains that are efficient in normal times can become fragile in a crisis.

Thus, America is being reminded of the importance of the supply side. But unlike in the 70s and 80s, it’s now clear that the chosen remedies of that bygone age, tax cuts and deregulation, won’t be sufficient to produce either macroeconomic stability or microeconomic resilience. Tax cuts have notably failed to boost growth in recent decades. And deregulation is a simple term for a highly complex thing; many regulations are actually useful for the economy, while many others are benign.

Instead of the old Ronald Reagan formula, supply-side economics should take on a different character in the post-Covid era: government needs to take more active steps to ensure that production can expand.

One obvious area is labor supply. Immigration, which once sustained US population growth, has been falling for years:

This is particularly important in the context of skilled immigration. Immigration helped produce an abundance of skilled labor — graduate students, H-1B workers, and green card holders — that kept US technology industries dominant even as manufacturing shifted to Asia. Fortunately, President Joe Biden is trying to slash through the red tape thrown up by his predecessor to reduce skilled immigration. But if we’re going to ensure a steady inflow of the talent we need to stay ahead of overseas competitors like China, the US should establish a more permanent solution. Adding a Canada-style points system to our current immigration regime and increasing the number of employer-sponsored green cards, should do the trick.

It’s also becoming clear that robust supply chains need government support. Left to their own devices, companies will tend to wring every last bit of efficiency out of their production chains, offshoring and outsourcing each piece to wherever the price is cheapest. Even if they recognize the threat of fragility, competitive and shareholder pressure force them to chase short-term dollars. Correcting this requires the coordinating force of government, which is why Biden is looking at ways to ensure robust supply chains in crucial areas like computer chips, batteries, rare earths and pharmaceuticals — things that would be crucial in case of war or another pandemic.

In fact, supply chain robustness is an area where raising the corporate tax might be good supply-side policy. The US has long used tax incentives to encourage corporate activities like research and investment. Raising the baseline tax rate, as Biden has proposed, and then offering a reduction for companies that reshore critical supply chains might be the most effective incentive here.

A third area where government is absolutely crucial is infrastructure. Left to its own devices, the free market will not produce enough scientific research, roads or education. Furthermore, the shift to green energy won’t move fast enough on its own; it needs a government boost. Infrastructure does increase demand in the economy, but at its core it’s supply-side policy.

This is what supply-side policy is shaping up to look like in the Biden Era — in fact, it wouldn’t be far-fetched to say that one pillar of Biden’s economic approach is using an activist government to expand supply. But as long as the US is thinking along these lines, it’s time to brainstorm other ways in which government could increase the incentives for the private sector to expand production. Perhaps it would be a good idea to tweak the financial system so that it’s better at helping capital-intensive companies scale up quickly — after all, capital is one of the key factors of production, and supply-based policy should ideally make it easy to come by.

All in all, it's a good thing if America's post-pandemic economy helps the nation move beyond the days when we thought all we needed to do was cut taxes and deregulate, and supply would take care of itself.


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