How To Put The Genie Of Inflation Back Into The Bottle

The American economy is facing inflationary pressures not because of too much government spending but because, for almost two decades, there has not been enough.

Roman Bratschi for Noema Magazine
Credits

Yakov Feygin is the associate director of the Future of Capitalism program at the Berggruen Institute and an associate editor at Noema Magazine.

As President Joe Biden’s administration and its progressive allies push to pass an ambitious social spending bill, moderate Democrats are worried. They point to rising prices and postulate that we are facing an era of high inflation. Wouldn’t more spending after an already large pandemic stimulus make matters worse?

Those voices should consider what John Maynard Keynes said in a 1933 letter to President Franklin D. Roosevelt during the worst year of the Great Depression. First, he argued, the president should boost consumer spending and convince businesses to get back to what they do best: making and selling things. Then, once things were up and running again, he could pursue economic reform to fix the systemic problems preventing the economy from meeting its potential. Then, as now, many conflated the ideas of “economic recovery” and “economic reform.” The purpose of economic recovery is to spend to prevent a crisis from spiraling. The purpose of reform is to spend so that we do not have these problems in the first place.

The U.S. economy is facing inflationary pressures not because of too much government spending but because, for almost two decades, there has not been enough. Our country simply does not have the kind of productive capacity that can create high, widespread growth without some inflation. We need to spend on building up that capacity so the economy can run at peak performance in normal times — and so it can be more resilient through future crises.

So far, the U.S. government has followed Keynes’ advice. With the CARES Act and American Rescue Plan, government spending softened the pandemic’s impact. Through expanded unemployment insurance, direct payments to households and other stimulus spending, the economy not only avoided a repeat of the Great Depression, but poverty rates in America fell for the first time in decades.

“The purpose of economic recovery is to spend to prevent a crisis from spiraling. The purpose of reform is to spend so that we do not have these problems in the first place.”

Some fear that these programs have been too successful. By spending to absorb the shock of the virus, they believe, the government has contributed to rising rates of inflation that will become uncontrollable. They point to labor shortages and the spiking cost of products like cars to justify putting the brakes on further spending.

The truth, however, is more complicated. States that cut pandemic-related unemployment benefits early have seen no improvement in the availability of workers. One reason is that parents, for the most part mothers, have dropped out of the workforce as child care has become more expensive and difficult to find. Jobs in the construction and manufacturing industries have been understaffed because of retirements and a failure to hire enough new skilled workers in the decades since the 2008 recession.

To make matters worse, supply chains continue to be strained. Pandemic-related changes to spending and the continuing impact of the virus have created bottlenecks in the production of practically every commodity. One has only to look at the backup of cargo ships outside the Port of Los Angeles to get an idea of the problem’s scale. Supply chains that once supplied car factories with semiconductors, for example, became stressed due to the rapid shifts in consumption patterns during the pandemic. Demand for durable goods with semiconductors in them, especially those that enabled us to work from home, soared while factories had to take health precautions and cut back on production. All of this has put upward pressure on prices. It also means delays, frustration and, often, actual scarcity of goods.

The housing market offers a stark lesson in how all of these factors combine to produce major problems. After the 2009 crisis, it took decades for American households to begin entering the housing market at rates that could sustain a healthy housing construction industry. Developers lost skilled workers to retirements and labor market churn, and because they expected a depressed market for new housing, they didn’t train enough new workers. Then the pandemic triggered a rush to buy real estate as households shifted their consumption from services to assets, and supply crunches disrupted the delivery of construction material. Developers scarred by the post-2009 environment could not believe this new surge in demand. Housing prices went up.

These pain points have been created by the lack of spending over the past decades. The American economy suffered a historically slow recovery from the 2008 financial crisis due to low government spending. President Barack Obama’s stimulus is now widely understood to have been too small and its effects offset by austerity in states and by the 2011 budget cuts. Low demand meant that new investment in private firms remained low. New infrastructure was not built in sufficient quantities. The vaunted processes of automation stalled because labor was so cheap and readily available, there was no point in replacing workers.

“We need an economy that is strong enough to be able to adapt to rapid changes in worker and consumer behavior brought on by climate disasters.”

By the time the pandemic arrived, America’s economy was woefully unprepared for another disaster — and this will hardly be the last crisis we face. With climate change, anyone under the age of 40 will be facing a future full of floods, fires and storms. We need an economy that is strong enough to be able to adapt to rapid changes in worker and consumer behavior brought on by disasters. We need to pursue an economy-wide project of long-term resilience and stabilization.

Now that the pandemic has exposed this vulnerability, we have a choice. We could accept our fate, cut spending and raise interest rates, thereby hurting household purchasing power and putting people out of work. The economy will reenter a slow, long-term decline, and even though prices will remain stable in the short run, this will still leave us prone to disruption in the next crisis.

Or, we could turn to another option: We could invest in America so that we have enough capacity to serve a healthy economy. We could build a supply side that is robust enough to respond to a surging demand side and, in so doing, put the genie of inflation back into the bottle.

First, we must pursue an active industrial policy that shores up the manufacturing of key goods like semiconductors, while also making sure that these activities aren’t concentrated in a single firm and that there is reserve capacity in case of an emergency. Instead of offshoring all production of low-end semi-conductors to factories in Taiwan, for example, we should use the spending power of the government to issue long-term capital to vital but low-margin sectors. We can also work on predicting supply crunches ahead of time and prevent them with a running reserve of strategic materials. The necessity of government coordination for supply chains is already dawning on some of the shipping industry’s leading CEOs.

“We must improve child and elder care to prevent the labor force from shrinking.”

Second, we need to maintain and expand the electrical grid to lower the price of clean energy and build redundancies into the power supply. The cost of renewable energy is rapidly falling. America’s geographic diversity allows us to use wind and solar energy generated in low-demand parts of the country to serve regions that aren’t getting much wind and sun. A solar panel in Texas can power a train in Chicago, and wind from the California coast can heat a home in Texas when the sun isn’t shining there. But the grid is not up to the challenge of incorporating these new forms of generation, which require long-range, rapid transmission across the country. Building a high-voltage super grid would move us to a decarbonized economy and reduce energy costs to businesses and homes, thereby putting downward pressure on prices.

Finally, social services and health care are vital for building a resilient supply side that can withstand inflationary pressures. We must also improve child and elder care to prevent the labor force from shrinking. As America ages, many of us — particularly women — will be forced to choose between work and taking care of our children or parents. Government investment in care will prevent a shrinking labor force, allowing more workers to hold full-time jobs. And allowing Medicare to negotiate with pharmaceutical companies could greatly reduce drug costs, which have been among the biggest contributors to overall price growth for the past three decades.

History shows us that spending in line with social priorities can help the economy in the wake of a world-shaping cataclysm. Economic historian Andrew Bossie found that in the years following World War II, there was a short, sharp rise in inflation — and part of the cure for this inflation was spending to employ and educate returning veterans. This created a buffer of demand that stabilized and stimulated the development of civilian-oriented industries.

Contrast that with the demobilization from World War I. Fearing inflation, the Federal Reserve raised interest rates, leading to a short recession. Though relatively benign, this recession broke worker bargaining power and anchored wages downward. In the Roaring ‘20s, low wage growth led households to overextend themselves on credit, fueling a borrowing boom whose bust resulted in the Great Depression.

We need to learn from this today — after all, the pandemic delivered such a shock to the U.S. economy that coming back from it will be like demobilizing from war. Fortunately, there is some recognition of these issues. The Biden administration’s Build Back Better plan clearly emphasizes the importance of developing social services for a more robust work force. The reconciliation bill and proposed legislation, like the Industrial Finance Corporation Act and the National Investment Authority, all point to a slow return to the state as an active investor in America’s infrastructure and manufacturing capacity. We have begun to recover. Now it is time to reform.