The Wrong-Headed Tilt of US Economic Policy

Here are some interesting bits from an article by Mark Thoma in The Fiscal Times:

In the wake of the Great Recession, why has employment been so slow to recover? One answer is that an important but widely unrecognized change in fiscal policy has taken place.

Due largely to the influence of supply-side Republicans and many Democrats who embrace growth policies, policies that were originally intended to stimulate innovation in the private sector were applied to the government sector and infrastructure spending. This change in policy that puts growth at the forefront has shifted resources and attention away from traditional policies that could have reduced joblessness at a more rapid rate.

To understand the change in policy, it’s useful to divide fiscal approaches into two broad categories: supply-side policies designed to enhance the economy’s long-run growth prospects and demand-side policies designed to stabilize short-run business cycle fluctuations.

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In past recessions, fiscal policy operated differently. The main goal was to increase aggregate demand through additional government purchases of goods and services, tax cuts, or even through government- created jobs that provided people with the income they need to go out and purchase goods and services themselves. Infrastructure spending was part of the mix, but the main goal was to stimulate demand and boost the economy; the impact on long-run economic growth was not the important consideration.

For this reason, in the past we were much more likely to consider “make-work” as a stabilization tool. Make-work is generally summarized as “paying half the unemployed to dig holes, then paying the other half fill them in again.” But that is a bit unfair since the goal is always to spend money where it does the most good, for example, to clean up a city park that has fallen into disrepair even if that doesn’t directly have an impact on long-run growth.

But as noted above, in the most recent recession, due largely to the influence of Republicans devoted to supply-side economics and to many Democrats who embrace growth policies, supply-side policies that were originally intended as a means of stimulating innovative activity in the private sector were extended to the government sector and infrastructure spending. Republicans would not have approved any other type of policy to combat the recession, particularly policies of the “make-work” variety. Growth had to be at the forefront, and Democrats accepted this approach to stabilization policy. The result was that, contrary to past policy where growth and stabilization policy were independent, present policy addressed both supply-side and demand side concerns simultaneously.

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In the past, we did not pay enough attention to whether the policies used to fight a recession would also help with long-run economic growth. But in the present the pendulum has swung too far in the other direction – long-run growth should not be the only consideration when selecting stabilization policies.

In the future, we must do a better job of attacking the unemployment problem when recessions hit the economy even if it means implementing policies that do not directly have an impact on long-run economic growth. Those who promote supply-side policies above all else might be surprised at how much growth will be helped nonetheless by policies that avoid the long-term problems associated with high and persistent unemployment.

What I like about this article is that it recognizes that political "solutions" go in and out of favour, that the mood shifts like a pendulum, and that the last 40 years has let the pendulum swing too far toward "supply side" economics while giving "demand side" economics the short shrift.