Bruno’s Newsletter #5

When Janet Yellen delivered her first programmatic speech at a virtual Davos meeting in January 2022, the economic impact from the rapid deployment of vaccines was starting to be felt. Rereading the speech, it is evident that she drew important lessons from the experience. The robust support to families, businesses, and state and local governments provided by the American Rescue Plan had played a part in the economic recovery, but there was nothing new about the approach. As Yellen puts it, “In this respect, the Biden strategy was similar to the Keynesian approach championed, for example, by the Obama Administration in the aftermath of the Global Financial Crisis and embodied in earlier stimulus packages enacted to combat previous downturns.” Vaccines, however, were not a Keynesian approach. Neither were they the product of traditional supply side approaches, since the government essentially removed the bulk of traditional industry risks related to vaccine development. Revealingly, Yellen noted in her speech that “my economists at Treasury today are monitoring vaccination and health statistics in parallel to the latest economic indicators.” A new world, indeed.

The way Yellen sees the distinctive trait of “modern supply side economics” has to do with the level of intervention. Both Keynesian and traditional supply side approaches assume a state of economic readiness. The pandemic, however, showed that an economy also needs background conditions operating at a deeper level.

Old supply side economics attempts to promote growth through aggressive deregulation paired with tax cuts to promote private capital investment, increasing its rate of return. This for Yellen is not sufficient and may even have detrimental effects. At one point she argues that a country’s growth potential depends, among other factors, on the stability of its political system. If extensive tax cuts increase inequality to the point where social and political fractures become irreparable, then old supply side economics may turn out to be counterproductive. It undermines its own conditions of possibility.

Like public health, political stability is rarely seen as the goal of economic policy. One might even say that a Treasury Secretary should not get involved in such issues. That Yellen strongly disagrees points towards the definitional core of modern supply side economics as she sees it.

To use a famous Kantian distinction, traditional approaches to economic policy are regulative. Modern supply side is constitutive. Economic activity is generally understood as an engine of production, but it presupposes a number of framework conditions, transcendental conditions, that it is not able or even empowered to produce. I have argued that the pandemic was a revolutionary moment for economics and what the revolutionary moment ultimately represents is the discovery of those framework conditions. There can be no economy if people cannot meet each other for fear of contracting a dangerous virus. But at this point it becomes necessary to turn economic policy back towards the basic structure, which we normally take for granted. The climate crisis is another example. Can tax cuts boost growth if an economy is simultaneously forced to deal with extreme climate events? Yellen is suggesting that dealing with the climate crisis might be a central goal for a modern approach to economic policymaking. How can we modify the framework conditions of a market economy so that, once they are assured, we can step back and allow it to operate freely from that point? Note that these constitutive policies cannot by definition interfere with the market process since they are prior to it. To repeat, they have as their object that which we tend to take for granted when discussing economic life. “Modern supply side economics seeks to spur economic growth by both boosting labor supply and raising productivity, while reducing inequality and environmental damage.” As Hyman Minsky once put it:

Yellen sees the flagship initiatives of the current administration as pursuing an agenda of modern supply side economics: the infrastructure bill is aimed at expanding the workforce and increasing productivity, while clean energy manufacturing responds to the climate crisis. Potential output in the United States is constrained by a declining labor force, Yellen notes. And with few exceptions, productivity growth has been sluggish for many decades. “We have underinvested in public infrastructure, and in education and training for children and all those who have not sought a four year college degree.” Slow productivity growth has contributed to slow growth in wages and compensation, with especially slow historical gains for workers at the bottom of the wage distribution. Passed within days of each other last August, the Inflation Reduction Act and the Chips and Science Act offered more than $400bn in tax credits, loans and subsidies designed to promote the development of a domestic cleantech and semiconductor supply chain. Some of the incentives took the form of tax credits tied to production volumes: $3 for every kilogram of green hydrogen, for example, or $35 for every kilowatt-hour of battery capacity. Tax credits for consumers who buy electric cars can be claimed only if the cars in question are made in North America. (The Economist offers a good survey). A year later the Financial Times was able to identify at least $224bn in cleantech and semiconductor manufacturing projects, promising to create 100,000 jobs. The largest commitments came from semiconductor groups such as Intel and Taiwan Semiconductor Manufacturing Company. New supply chains may develop: on January 31 General Motors announced a $650m investment in a new lithium mine in Nevada.

The most interesting argument, however, is one Yellen did not make in the original 2022 speech. She briefly elaborated on it during a fireside chat at Yale in April this year (video here). This time, the modern supply side agenda is no longer simply about promoting “growth that is inclusive and green.” It also responds to an increasingly conflictual geopolitical environment by promoting economic resilience. Access to vital technology and resources is another framework condition of economic growth and this is where the expansion of American semiconductor manufacturing comes in. What her discussion tends to ignore is that constitutive policies in this are are in reality no less the target of geopolitical rivalry. Framework conditions can be shaped in different ways and in accordance with rival plans. In fact, as I argued in my Belt and Road book from 2018, China has adopted a very similar approach to the one now defended by Yellen: industrial policy aimed not at specific outcomes but rather at the framework conditions of global economic integration. Whether constitutive rather than regulative industrial policy should still be called industrial policy is best left for another time. I am partial to economic design or, more simply, model design.