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One of John Maynard Keynes’s best-known quotes is also the most misused. His “in the long run we are all dead” quip has been interpreted as a call to focus policy efforts on correcting short-term swings in economic activity. This is perhaps manifested in James Carville’s slogan for Bill Clinton’s 1992 campaign: “It’s the economy, stupid.” That voter prosperity today outweighs future economic considerations is indeed a flaw of liberal democracies everywhere.
Keynes goes on to say: “Economists set themselves too easy, too useless a task if, in tempestuous seasons, they can only tell us that when the storm is long past the ocean is flat again.” Rather than encouraging short-termism, Keynes was critiquing economic models that complacently assume a return to some long-run point of balance.
The notion that Keynesian economics equated largely to near-term demand management was in part a convenience. Structural reforms are far harder than interest rate or tax tweaks. As they involve boosting the productive, or “supply side”, capacity of an economy — including its labour, capital, technology and ideas — they often enact a cost on today’s voters, for long-term gain. Those gains can be decades away, such as the benefits of investing in skills, education and research and development. They also rely on political commitment.
Take planning reform. It is essential to spur the development of railways, homes and electricity pylons, but it irks homeowners. Outdated tax systems stifle growth and contribute to inequality, but changes involve upsetting one group to benefit another. Ageing populations pile pressure on the state, yet nationwide protests greeted Emmanuel Macron’s efforts to raise France’s retirement age. Surveys also show citizens want action to tackle climate change, but many do not want to pay for it.
Advanced economies have already opened to trade, reformed banking sectors and privatised finance, the groundwork for growth since the 1970s. Future supply-side measures may be more complex or involve more disruption for voters: redesigning existing legislation, allocating resources more efficiently and building things. Although it is dubbed “modern supply-side” economics, the US Inflation Reduction Act faces its own supply limitations in skills, workers and permitting.
The result is over-reliance on demand management and unrealistic expectations of the power of monetary policy and budgets to guide the economy. The implications are threefold. First, economies have not kept pace with long-term shifts such as climate change, ageing societies and technology. Second, countries have become less resilient to shocks. Britain is an inflationary outlier in part due to labour shortages, exacerbated by limitations in its skills and health system. Finally, these factors have stifled productivity growth. As this underpins sustained wage growth and tax revenues, it feeds us-vs-them politics, making reform harder.
The upshot is an erosion in underlying growth. The IMF recently forecast medium-term global growth to be at its weakest since 1990. A report published last week by Fitch Ratings shows that gross domestic product growth in major developed economies has slowed over the past decade compared with long-run historical averages — which suggests that growth potential is waning.
So how can reform happen? Russell Jones looks at Britain’s economic history in The Tyranny of Nostalgia. First, a consensus for change has been easier to muster in the aftermath of disruption. Margaret Thatcher’s free-market reforms came after the economic pains of the 1970s. Under Tony Blair, reforms were made early in the electoral cycle, such as the Bank of England’s independence in 1997. The economic backdrop mattered, too. Blair inherited solid growth and public finances, enabling him to focus on fixing public services.
But democracies cannot wait until the political and economic conditions align. With globalisation — a driver of growth — slowing, reforms take on greater importance. Supply-side policymaking must become an open-ended process to support economic agility and productivity.
Institutions need to be geared for the long term. Structural growth requires regular monitoring. The private sector needs incentives to invest for the future. Creative policy design helps, cushioning the short-term cost of reform. Ultimately, the public conversation must mature to an acceptance of trade-offs, without which long-term economic progress for everyone stutters.
It is time to update our understanding of Keynesianism. Yes, economies are prone to a boom-and-bust cycle, but they are also not guaranteed to return to the same long-term path to prosperity. It’s the supply side, stupid.