More On: Economics
Theoretically, the US might avoid inflation and avoid a recession by achieving massive productivity improvements. However, do not count on it.
When a panel of White House economists released their diagnosis of the US economy's position in July, they drew a historical connection with the immediate years following World War II. According to their account, comparable supply shortfalls and pent-up demand were responsible for all the inflation. Once resolved, a golden age of high growth and low inflation comparable to the 1950s awaited. Unfortunately, with Russia's invasion of Ukraine, a decade more akin to the 1970s seems more likely than ever before.
As is the case now, much of the damage was self-inflicted.
In short order, Congress overspent, putting unnecessary wars and expansive welfare programs on the national credit card; the Fed mismanaged the money supply, keeping interest rates too low for an extended period; and shocks to global food and energy markets, largely in response to US foreign policy, combined to produce the most miserable economic decade since the 1930s in the United States.
Back then, it was Vietnam, LBJ's Great Society initiatives, the Kennedy and Nixon tax cuts, the Fed maintaining artificially low interest rates for an extended period of time, droughts, poor harvests, and the US siding with Israel in the Yom Kippur War. In our own era, it has been Afghanistan, Iraq, and the war on terror, the expansion of Medicare and Medicaid, the Bush and Trump tax cuts, the Fed maintaining excessively low interest rates for an extended period of time, and the US intervention on Ukraine's side against Russia.
Stagflation was a period of subdued growth and elevated inflation. Characterized by higher-than-average unemployment, it violated postwar Keynesian dogma, which believed that one could have either higher inflation or higher unemployment in exchange for lower inflation when the economy was at full employment. As is the case today, the Fed obfuscated while Congress and the president enacted counterproductive interventionist policies that exacerbated economic disruption. Today, even price restrictions, which practically all economists agree were a horrible concept and a failure both then and now, are openly discussed.
Accepting that the Fed is significantly behind the curve in attempting to contain inflation—that the current timetable of interest rate hikes and quantitative tightening will be insufficient—the deficit has expanded year after year, and the debt now stands at a likely unpayable $30 trillion. Indeed, servicing debt in a higher–interest rate environment will prove prohibitively expensive. Along with rising economic conflict, the global economy is contracting, which will result in higher prices for consumers globally.
Recognizing these realities leaves optimists with only one hope: we will grow our way out.
Although intimidating, it is not as impossible as it appears.
Several factors prevented us from growing out of it in the 1970s—that is, avoiding inflation by growing the real economy faster than inflation.
To begin, the one-time productivity gains associated with enormous industrialization and economic rationalization during World War II—as well as the building of road networks, motorways, dams, and bridges—were exhausted.
On a global scale, a rebuilt Japan and Germany were diminishing the US businesses' comparative edge. As trade and investment restrictions were reduced, enterprises attempting to thrive in a more expensive and competitive environment increasingly moved operations offshore.
Domestically, this resulted in a significant expansion in the service sector's share of the US economy. Numerous factors collaborated to exacerbate the pre-existing difficulties in this case. It was not recognized at the time, but efficiency gains, which drive growth and wages, are considerably more difficult to achieve in the service industry. The classic example provided is that of a string quartet—each piece requires a specific number of people and a specific length of time to perform. Simultaneously, a rush of low-skill labor entered the market as baby boomers and their mothers returned to work, frequently after extended vacations. This resulted in a decrease in the price of labor, inhibiting capital investment at a time when total factor productivity was approaching a plateau.
Labor markets provide the best opportunity for us to grow out of inflation and avoid stagnation. For while labor markets in the 1970s were relatively loose and were likely to become even looser as the workforce became increasingly globalized, labor markets today are already quite tight and are likely to become even tighter as the large baby boom generation continues to retire and the major economies increasingly turn inward. Sanctions will hasten the process of reshoring employment, strengthening protective barriers, and subsidizing the establishment of local supply chains that is already underway. When combined with the high cost of labor, which encourages efficiency gains through higher investment in capital and the next generation of fundamental technologies such as AI, it is conceivable for the US to avoid inflation and avoid a recession—but don't bank on it.
It is significant that the White House economists manage to avoid mentioning persistent budget deficits or erroneous monetary policy in their report. Perhaps telling, but unsurprising. As was the case in the 1970s, the president, Congress, and the Federal Reserve have all mismanaged the economy. Thus, while there are undoubtedly other contributing elements, these are the most within the nominal control of democratic republican individuals, the role of the state should not be overlooked.
Naturally, they will be.