spence152_Yu Fangping CostfotoFuture Publishing via Getty Images_supply inflation

Economics

The Supply-Side Fight Against Inflation

Jul 1, 2022 Michael Spence

Central banks’ only real option for tackling inflation is to reduce demand – an approach that implies a significant drag on global growth. But even as interest rates rise, a recession can be avoided if policymakers recognize the large role that supply-side measures must play in restoring price stability.

MILAN – Central banks’ efforts to contain high and rising inflation are fueling growth headwinds and threatening to tip the global economy into recession. But the proximate cause of today’s inflationary pressures is a large, broad-based, and persistent imbalance between supply and demand. Higher interest rates will dampen demand, but supply-side measures must also play a large role in inflation-taming strategies.

Over the past year or so, the rollback of pandemic-containment policies has spurred a simultaneous surge in demand and contraction in supply. While this was to be expected, supply has proved surprisingly inelastic. In labor markets, for example, shortages have become the norm, leading to canceled flights, disrupted supply chains, restaurant closures, and challenges to health-care delivery.

These shortages appear to be at least partly the result of a pandemic-driven shift in preferences. Many types of workers are seeking greater flexibility – including hybrid or work-from-home options – or otherwise improved working conditions. Health-care workers, in particular, report feeling burned out by their jobs.

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Michael Spence

Writing for PS since 2008
163 Commentaries

Michael Spence, a Nobel laureate in economics, is Professor of Economics Emeritus and a former dean of the Graduate School of Business at Stanford University. He is Senior Fellow at the Hoover Institution, Senior Adviser to General Atlantic, and Chairman of the firm’s Global Growth Institute. He serves on the Academic Committee at Luohan Academy, and chairs the Advisory Board of the Asia Global Institute. He was Chairman of the independent Commission on Growth and Development, an international body that from 2006-10 analyzed opportunities for global economic growth, and is the author of The Next Convergence: The Future of Economic Growth in a Multispeed World (Macmillan Publishers, 2012).

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Avraam Dectis Jul 26, 2022

Great article Dr. Spence!

I do think there are policy solutions for some of the things you have mentioned.

First, the aging issue. We can engineer more births by mitigating the most onerous obstacle to a robust fertility rate, which is the cost of children. This can be done with parent accounts where the parents are credited with a lump sum at the birth of the child and which they can then withdraw a portion of the their lump sum each month to pay expenses. The unified balance can be placed in the stock market, thus providing a retirement account as well.

Parent accounts are discussed further here:

https://trillionstrillions.medium.com/a-free-way-to-increase-the-economic-well-being-of-most-citizens-and-also-reverse-the-decline-in-cd7043006842

Second, the supply and inflation issues.

Instead of looking at those as attributes of minor tactical mistakes, they should be considered as effects of systemic deficiencies.

There are two systemic deficiencies. The income tax, which inadequately constrains inflation. The lack of a mechanism to balance capital flows is the second failure.

A consumption tax, which taxes the more you consume, is inherently better at constraining inflation.

Capital Transfer Securities, solve capital flow imbalances by supporting balanced international capital flows and also supporting domestic industries.

Superiority of consumption taxes and the Theorem of Proper Taxation are described here:

https://trillionstrillions.medium.com/income-tax-is-stupid-and-should-be-abolished-a52a1ef291de

Capital Transfer Securities are described here:

https://trillionstrillions.medium.com/promoting-growth-how-to-support-domestic-industries-and-control-capital-flows-with-capital-22c3c74cb552

Systemic solutions are generally called for when tactical solutions keep failing.
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Avraam Dectis Jul 26, 2022

Started good, but lost me at nationalization, price controls and mandatory unions…….
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Per Kurowski Jul 6, 2022

Current risk weighted bank capital requirements reward banks more when financing “safe” government debt & residential mortgages (carbs-demand-the present) than when financing “risky” businesses (proteins-supply-the future)
That inflates inflation and weakens the economy.
https://subprimeregulations.blogspot.com/2021/11/to-help-moor-inflationary-expectations.html
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Leo Arouet Jul 5, 2022

I agree with whole, but Biden won't back in policies of Trump owing his contest with China.
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Thaomas H Jul 3, 2022

All these things will be good for increasing growth (supply) and I'd add another Spence does not mention -- much higher level of immigration especially of highly skilled people. It is hard to see how any of them, however, could possible have much effect on above-target inflation which the Fed (and presumably other central banks) are fighting on a month to month basis.
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Bill Blazo Jul 2, 2022

This column was basically a laundry list of complaints followed by three measly paragraphs about actual solutions. According to the author, these three things will help us in the supply-side fight against inflation:

1) More AI technology

2) Higher wages for workers

3) Streamlined regulatory regimes

The third point was extremely vague; there was virtually no substance behind it, so it's difficult to know exactly what the author would change. The other two points are good, for the most part, but they certainly won't help alleviate inflationary pressure anytime soon. Want to know what actually will?

INDUSTRIAL STRATEGY

State-led industrial planning and development is what America needs to rediscover. This includes the following things:

1) Massive new investments in critical sectors to economic stability and national security, from semiconductors to green energy.

2) The partial or full nationalization of major economic sectors to ensure price and employment stability, such as defense, health-care, oil and gas, energy, meat and dairy, etc.

3) Targeted and negotiated price controls on certain industries to ensure price stability.

4) Mandatory unionization for all large corporations.

And I could go on for a while, but you get the point. More direct government influence over the economy, so the state has real power to specifically control prices and supply and demand cycles. The last thing we need is a few more corrupt capitalists making idiotic decisions like deindustrializing the country so they can hire cheap Asian labor. Nor do we need central banks being the only institutions fighting against inflation. Inflation is a manageable problem that the entire state apparatus should address. Let’s get it done.
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Madurai Padmanabhan Jul 1, 2022

“improving the balance between supply and demand” cannot be a pure rational play based on rules drawn up by a few in the past.

As the Singapore PM remarked, albeit in a different context “Wisdom cannot be the monopoly of some”; building real relationships based on shared knowledge, deeper listening and a more genuine belief in equity of the planet’s bounty is a primary need.

Of course the current distractions and costs due to new military realignments is certainly likely to allocate resources inappropriately.

Misplaced Emotion caused by war may tilt the balance and “ we will all go down together”. Rules and technology must have a human face, (where AI could perhaps facilitate painting the skin color judiciously)
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