“We might as well require a man to wear still the coat which fitted him when a boy as civilized society to remain ever under the regimen of their barbarous ancestors”, inscribed inside the Jefferson Memorial
Though it is hard for anyone to take their eyes off of Europe these days, I came across blog posts from Kevin Hassett of AEI and John Taylor of Stanford that really jumped out at me, for the same reason. Both of them were pining hard for a return to Reagan’s world. They argue austerity and supply-side policies across the developed world would, if given enough time, right the ship by freeing up resources for the private sector…okay, I see I’ve lost you. You’ve heard this debate so many times before that your eyes reflexively gloss over. But my argument is different. It’s simple.
It’s about how individuals behave. Rather than assume their policies always work, it would have been much cleaner if Hassett and Taylor started with the question: under which circumstances would supply-side policies be most effective? Then you could see whether those conditions actually obtained in the current environment.
Basically, supply-side policies work best when there is pent-up private sector demand. By lowering the cost of investment, you can unleash a self-reinforcing cycle. The bigger the pent-up demand, the bigger the payoff to an improvement in expectations. Without that pent-up demand, resources freed from supply-side measures and austerity get saved, not spent, and no self-reinforcing cycle is triggered.
The world of 1980 had tons of pent-up demand and gale-force tailwinds. Inflation and interest rates were coming down from high levels, household leverage was very, very low, financial innovation non-existent, consumption had been deferred, and demography was coiled as the baby boomers were just coming on line. On the government side, unions were powerful, price and wage controls were a reality, and tax rates were high. This was the ideal set up for supply side reforms.
Fast-forward to post-2008. Whatever the opposite of pent-up demand is, that’s what we have. Inflation and interest rates are already low, household leverage is a major burden, consumption was pulled forward during the boom, and demography is no longer our friend. Plus, we have globalization acting like a supply shock to our labor pool, holding down wages. In short, the tailwinds are now headwinds. On the government side, unions are far less powerful today, there are no price and wage controls, and tax rates are low. It seems next to impossible to make the case that supply-side policies can have anywhere near the effect today that they had in the 80s.
Yet, so many still do. Much of our body politic is stuck—along with the bulk of the baby boomers—in the 1980s, still trying to relive those old battles in the rear-view mirror. The US has changed. The world has changed. The problems have changed. The emerging world is rapidly plugging into the grid, hungrier and willing to work for less. We need to be pragmatic. Adjust and compete. Look around the globe without preconceived notions and see what we can learn from others. Being stuck in the same old big government/small government debate keeps us from doing this. Sometimes supply-side policies are right and sometimes they’re not. Sometimes Keynesian polices are right, sometimes they’re not. Until we approach policies as tools in a toolkit and not as divine scriptures, we are going to be stuck in an ideological logjam, wasting precious time. Time to get off the ideological paradigm.