Last July when a team of White House economists issued their analysis of the predicament the US economy was mired in, the historical parallel they landed on was the immediate years following the Second World War. In their telling, it was similar supply shortages and pent-up demand that was causing all the inflation. Once resolved, a golden age of 1950s good growth and low inflation awaited. Alas, with the Russian invasion of Ukraine, a decade more analogous to the 1970s is likelier than ever before us.
Then as now, much of the damage has been self-imposed.
In short order: Congress spent profligately, putting unnecessary wars and expansive welfare schemes on the national credit card; the Fed mismanaged the money supply, keeping interest rates too low for too long; and shocks to global food and energy markets, in large part as a response to US foreign policy, combined to produce the most miserable economic decade experienced in the United States since the 1930s.
Back then, it was Vietnam, LBJ’s Great Society programs, the Kennedy and Nixon tax cuts, the Fed keeping interest rates too low for too long, droughts, bad harvests, and the US taking Israel’s side in the Yom Kippur War. In our own times, it has been Afghanistan, Iraq, and the war on terror, the expansion of Medicare and Medicaid, the Bush and Trump tax cuts, the Fed keeping interest rates too low for too long, and the US intervention on the side of Ukraine against Russia.
Stagflation was a period of low growth and high inflation. Characterized by higher-than-usual unemployment, it defied the postwar Keynesian orthodoxy, which held that one could have either higher inflation, when the economy was in full employment, or higher unemployment in exchange for lower inflation. Then as now, the Fed obfuscated while Congress and the president enacted unhelpful interventionist policies that further disrupted the economy. Today even price controls, which virtually all economists then and now agree were a bad idea and a failure, are openly mulled over.
Admitting that the Fed is way behind the curve in trying to control inflation—that the present schedule of interest rate hikes and quantitative tightening will be insufficient, that Congress will not rein in its spending—the deficit has grown year on year, and the debt now stands at a probably unpayable $30 trillion. Indeed, servicing the debt in a higher–interest rate environment will prove taxing enough. On top of escalating economic warfare, the global economy is retrenching, and this will lead to higher prices for consumers across the board.
Recognizing these things leaves optimists with only one hope: we grow our way out of it.
Though daunting, it isn’t as impossible as it may seem.
In the 1970s, several things prevented our growing out of it—that is, escaping inflation by growing the real economy at a rate faster than inflation.
First, the one-off productivity increases that came about from the mass industrialization and rationalization of the economy during the Second World War, as well as the expansion of road networks, highways, dams, bridges, et cetera—were spent.
On the international level, a rebuilt Japan and Germany were increasingly eroding the comparative advantage of US businesses. As barriers to trade and investment were lowered, firms seeking to survive the higher-cost and more competitive environment increasingly took operations offshore.
Domestically, this translated into a rapid increase in the percentage of the US economy that came from services. Here, several things interacted to compound the existing problems. It wasn’t properly recognized at the time, but efficiency gains, which drive growth and wages, are much harder to come by in the service sector. The famous example given is a string quartet—it takes a set number of people and a set amount of time to play a piece. At the same time, a flood of low-skill labor was also entering the market, as the baby boomers and the mothers of the baby boomers returned to the workforce, often after long absences. This lowered the price of labor, discouraging capital investment at a time when total factor productivity was beginning to flatline.
It is in the labor markets that we find our best chance of growing out of inflation and avoiding stagnation. For while labor markets in the 1970s were loose and made looser by the increasing globalization of the workforce, today labor markets are already quite tight and likely to only get tighter as the many baby boomers continue to retire and the major economies turn increasingly inward. Sanctions will accelerate the already ongoing processes of reshoring jobs, raising protective barriers, and subsidizing the creation of domestic supply chains. Together with the high cost of labor encouraging efficiency gains through increased investment in capital, in the next generation of basic technologies like AI, it is possible that the US could escape inflation and stave off a recession—but don’t count on it.
It is telling that in their report the White House’s economists manage never to mention continual fiscal deficits or mistaken monetary policy. Telling, perhaps, but not surprising. As in the 1970s, the president, Congress, and the Fed have mismanaged the economy. So while there are obviously other contributing factors, these being the most within the nominal control of the citizens of a democratic republic, the part played by the state should not be forgotten.
Of course, they no doubt will be.
