Budget 2024 must tackle supply constraints

TORONTO—The biggest economic problem we have in Canada is that we are trying to fight inflation and restore economic growth through rearview mirror policies. The consequence is likely to be a new era of stagnation. The real inflation challenge is that we live in a supply-constrained world with rising prices as consumers compete for limited availability of wanted goods and services. To compensate for the price increases, workers demand higher pay, setting a course for a wage-price spiral. The traditional monetary policy response is to raise interest rates leading to higher unemployment and less business investment. But this doesn’t bring on needed new productive capacity or supply. This challenge is well set out in a new book, Permacrisis, by former U.K. prime minister Gordon Brown, Allianz chief economic adviser Mohamed Aly El-Erian, and Nobel economics prize winner Michael Spence. The biggest challenge, they argue, is to put the world on a path for productivity gains and sustainable economic growth that will generate the wealth we need for a sustainable future. Using excessively tight monetary policy will not solve the supply problem—in fact, it could worsen it, since high interest rates will discourage needed investment. For starters, they argue, central bankers should revise the inflation target “from an unrealistic two per cent to what is likely to be a more appropriate three per cent for years to come.” We are moving from the easy money era of the past to a supply-constrained "new normal" era, and policies need to adjust, otherwise we may be stuck in a slow-growth, more difficult and dangerous zero-sum world. As the three authors put it, “this new era requires a different mindset, one focused on finding inclusive ways to enhance productivity growth.” The alternative is “a lengthy period of stagnation.” For Canada, productivity growth must be the top priority of Budget 2024. In the forthcoming economic and fiscal outlook, Finance Minister Chrystia Freeland should not only make clear this is the number one priority, she should also provide serious analysis on the barriers to supply-enhancing productivity growth in Canada, and explain how the government plans to boost much-needed intangible and tangible investments to boost innovation-led productivity. Our post-pandemic world, then, is one of supply-constrained growth, not demand-constrained growth. As we came out of the pandemic, with a high level of pent-up household savings generated in large part by the government's income support policies, “the demand was there for TVs, cars and houses, but the inventory was not. And with that shift has come inflationary pressures not seen in decades,” the three authors contend. But, as they argue, “declining global productivity, the growing ranks of the elderly, a shrinking labour pool, rising in-country inequality, the changing nature of globalization through onshoring and reshoring, and increasing global shocks—all of these things represent significant changes and substantial headwinds to growth.” Because our supply-constrained world is likely to be with us for some time, policies have to transition to this different world. There are many explanations for a future world of supply constraints. One is the growth of the global middle class, which is increasing the demand for a wide range of consumer goods. There will be several hundred million new consumers, and they will want many of the things we have. There is a looming shortage of low-paid unskilled workers reducing the pool of low-cost productive labour. As a recent Wall Street Journal article reported from Bangladesh, “the workers who make your clothes want higher pay,” so “the era of ultracheap productive labour, and ultracheap clothes, on which many companies rely is increasingly under strain.” The world is running out of low-cost labour. Populations in many parts of the world are also aging so that in many countries, including Canada, older people continue to consume, but are no longer producers. A recent headline in The Financial Times declared that “Germany admits to desperate shortage of workers.” Climate change and its related shocks to food and water supply, migration, health and its threat of drought and floods represent another supply shock, and one likely to worsen. High levels of public debt are another constraint in a world that is unlikely to see a return to the low interest rates of recent years. Existing debt levels with higher interest rates means governments have less flexibility to support investment-led growth. Geopolitical issues, including the higher costs from friend-shoring as existing and efficient economic dependencies are broken, as well as the costs of supply disruptions from the war in Ukraine, also impact supply. So does the partial deglobalization underway, with a more fragmented world divided into competing blocs. Higher levels of corporate concentration are also a factor. From geopolitical tensions to rising debt levels and aging, the combined effect of these trends is a reduction in the capacity of the supply side to respond to increases in aggregate demand. Supply cannot keep up, so this slack is taken up by price increases that are driving inflation. New approaches are needed. “Without question, the secular factors constraining the supply side are not going away anytime soon,” warn Brown, El-Erian, and Spence. “The short-to-medium-run prospects for the global economy include decking growth. Fiscal capacity, that is the capacity of governments to borrow or even in some cases to sustain existing levels of debt, will contract—a trend that is far from ideal when there are large public sector investments required to engineer the energy transition needed to restore sustainable growth patterns and deal with climate change.” Fortunately, there are also pro-growth headwinds—with science and technology offering significant potential for a surge in productivity, for example. But to capitalize on the pro-growth headwinds we must have a new mindset that puts a much higher priority in pursuing supply-side solutions in a supply-constrained world. Will Budget 2024 respond? The Hill Times David Crane can be reached at crane@interlog.com

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Budget 2024 must tackle supply constraints

We must have a new mindset that puts a much higher priority in pursuing supply-side solutions in a supply-constrained world.

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