Varieties of Industrial Policy

I was on a virtual panel last week on industrial policy as derisking, in response to an important new paper by Daniela Gabor. For me, the conversation helped clarify why people who have broadly similar politics and analysis can have very different feelings about the Inflation Reduction Act and similar measures elsewhere. 

There are substantive disagreements, to be sure. But I think the more fundamental issue is that while we, inevitably, discuss the relationship between the state, the organization of production and private businesses in terms of alternative ideal types, the actual policy alternatives are often somewhere in the fuzzy middle ground. When we deal with a case that resembles one of our ideal types in some ways, but another in other ways, our evaluation of it isn’t going to depend so much on our assessment of each of these features, but on which of them we consider most salient.

I think this is part of what’s going on with current discussions of price controls. There has been a lot of heated debate following Zach Carter’s New Yorker profile of Isabella Weber on whether the energy price regulation adopted by Germany can be described as a form of price controls. Much of this criticism is clearly in bad faith. But the broad space between orthodox inflation-control policy, on the one hand, and comprehensive World War II style price ceilings, on the other, means that there is room for legitimate disagreement about how we describe policies somewhere in the middle. If you think that the defining feature of price regulation is that government is deciding how much people should pay for particular commodities, you will probably include the German policy. If you’re focused on other dimensions of it, you might not.

I am not going to say more about this topic now, though I hope to return to it in the future. But I think there is something parallel going on in the derisking debate.

People who talk about industrial policy mean some deliberate government action to shift the sectoral composition of output — to pick winners and losers, whether at the industry or firm level. But of course, there are lots of ways to do this. (Indeed, as people sometimes point out, governments are always doing this in some way — what distinguishes “industrial policy” is that it is visible effort to pick different winners.) Given the range of ways governments can conduct industrial policy, and their different implications for larger political-economy questions, it makes sense to try to distinguish different models. Daniela Gabor’s paper was a very helpful contribution to this.

The problem, again, is that models are ideal types — they identify discrete poles in a continuous landscape. We need abstractions like this — there’s no other way to talk about all the possible variation on the multiple dimensions on which we can describe real-world situations. If the classification is a good one, it will pick out ways in which variation on one dimension is linked to variation on another. But in the real world things never match up exactly; which pole a particular point is closer to will depend on which dimension we are looking at.

In our current discussions of industrial policy, four dimensions seem most important — four questions we might ask about how a government is seeking to direct investment to new areas. Here I’ll sketch them out quickly; I’ll explore them in a bit more detail below.

First is ownership — what kind of property rights are exercised over production? This is not a simple binary. We can draw a slope from for-profit private enterprises, to non-profits, to publicly-owned enterprises, to direct public provision.

Second is the form of control the government exercises over investment (assuming it is not being carried out directly by the public sector). Here the alternatives are hard rules or incentives, the latter of which can be positive (carrots) or negative (sticks).

The third question is whether the target of the intervention is investment in the sense of creation of new means of production, or investment in the sense of financing. 

The last question is how detailed or fine-grained the intervention is — how narrowly specified are the activities that we are trying to shift investment into and out of?

“Derisking” in its original sense had specific meaning, found in the upper right of the table. The idea was that in lower-income countries, the binding constraint on investment was financing. Because of limited fiscal capacity (and state capacity more generally), the public sector should not try to fill this gap directly, but rather to make projects more attractive to private finance. Offering guarantees to foreign investors would make efficient use of scarce public resources, while trusting profit motive to guide capital to socially useful projects.

In terms of my four dimensions, this combines private ownership and positive incentives with broad financial target.

The opposite case is what Daniela calls the big green state. There we have public ownership and control of production, with the state making specific decisions about production on social rather than monetary criteria. 

For the four of us on the panel, and for most people on the left, the second of these is clearly preferable to the first. In general, movement from the upper right toward the lower left is going to look like progress.

But there are lots of cases that are off the diagonal. In general, variation on each of these dimensions is independent of variation on the others. We can imagine real world cases that fall almost anywhere within the grid.

Say we want more wind and solar power and less dirty power.

We could have government build and operate new power plants and transmission lines, while buying out and shutting down old ones.

We could have a public fund or bank that would lend to green producers, along with rules that would penalize banks for holding assets linked to dirty ones.

We could have regulations that would require private producers to reduce carbon emissions, either setting broad portfolio standards or mandating the adoption of specific technologies.

Or we could have tax credits or similar incentives to encourage voluntary reductions, which again could be framed in a broad, rules-based way or incorporate specific decisions about technologies, geography, timelines, etc.

As we evaluate concrete initiatives, the hard question may not be where we place them in this grid nor on where we would like to be, but how much weight we give to each dimension. 

The neoliberal consensus was in favor of private ownership and broad, rules-based incentives, for climate policy as in other areas. A carbon price is the canonical example. For those of us on the panel, again, the consensus is  that the lower left corner is first best. But at the risk of flattening out complex views, I think the difference between let’s say Daniela on one side and Skanda Amarnath (or me) on the other is the which dimensions we prioritize. Broadly speaking, she cares more about movement in horizontal axis, as I’ve drawn the table, with a particular emphasis on staying off of the right side. While we care more about vertical axis, with a particular preference for the bottom row. 

Some people might say it doesn’t matter how you manage investment, as long as you get the clean power. But here I am completely on (what I understand to be) Daniela’s side. We can’t look at policy in isolation, but have to see it as part of a broader political economy, as part of the relationship between private capital and the state. How we achieve our goals here matters for more than the immediate outcome, it shifts the terrain on which next battle will be fought. 

But even if we agree that the test for industrial policy is whether it moves us toward a broader socialization of production, it’s not always easy to evaluate particular instances.

Let’s compare two hypothetical cases. In one, government imposes strict standards for carbon emissions, so many tons per megawatt. How producers get there is up to them, but if they don’t, there will be stiff fines for the companies and criminal penalties for their executives. In the second case, we have a set of generous tax credits. Participation is voluntary, but if the companies want the credits they have to adopt particular technologies on a specified schedule, source inputs in a specified way, etc. 

Which case is moving us more in the direction of the big green state? The second one shifts more expertise and decision making into the public sector, it expands the domain of the political not just to carbon emissions in general but to the organization of production. But unlike the first, it does not challenge the assumption that private profitability is the first requirement of any change in the organization of production. It respects capital-owners’ veto, while the first does not. 

(Neoliberals, it goes without saying, would hate both — the first damages the business climate and discourages investment, while the second distorts market more.) 

Or what about if we have a strict rule limiting the share of “dirty” assets in the portfolios of financial institutions? This is the path Europe seems to have been on, pre IRA. In our discussion, Daniela suggested that this might have been better, since it had more of an element of discipline — it involved sticks rather than just subsidy carrots. To Skanda or me, it looks weak compared with the US approach, both because it focuses on financing rather than real investment, and because it is based on a broad classification of assets rather than trying to identify key areas to push investment towards. (It was this debate that crystallized the idea in this post for me.)

Or again, suppose we have a sovereign wealth fund that takes equity stakes in green energy producers, as Labour seems to be proposing in the UK. How close is this to direct public provision of power?

In the table, under public ownership, I’ve distinguished public provision from public enterprise. The distinction I have in mind is between a service that is provided by government, by public employees, paid for out of the general budget, on the one hand; and entities that are owned by the government but are set up formally as independent enterprises, more or less self-financing, with their own governance, on the other. Nationalizing an industry, in the sense of taking ownership of the existing businesses, is not the same as providing something as a public service. To some people, the question of who owns a project is decisive. To others, a business where the government is the majority stakeholder, but which operates for profit, is not necessarily more public in a substantive sense than a business  that isprivately owned but tightly regulated.

Moving to the right, government can change the decisions of private businesses by drawing sharp lines with regulation — “you must”; “you must not” — or in a smoother way with taxes and subsidies. A preference for the latter is an important part of the neoliberal program, effectively shifting the trading -off of different social goals to the private sector; there’s a good discussion of this in Beth Popp Berman’s Thinking Like an Economist. On the other side, hard rules are easier to enforce and better for democratic accountability — everybody knows what the minimum wage is. Of course there is a gray area in between: a regulation with weak penalties can function like a tax, while a sufficiently punitive tax is effectively a regulation.

Finally, incentives can be positive or negative, subsidies or taxes. This is another point where Daniela perhaps puts more stress than I might. Carrots and sticks, after all, are ways of getting the mule to move; either way, it’s the farmer deciding which way it goes. That said, the distinction certainly matters if fiscal capacity is limited; and of course it matters to business, who will always want the carrot.

On the vertical axis, the big distinction is whether what is being targeted is investment in the sense of the creation of new means of production, or investment in the sense of financing. Let’s step back a bit and think about why this matters.

There’s a model of business decision-making that you learn in school, which is perhaps implicitly held by people with more radical politics. Investment normally has to be financed; it involves the creation of real asset and a liability, which is held somewhere in financial system. You build a $10 million wind turbine, you issue a $10 million bond. Which real investment is worth doing, then, will depend on the terms on which business can issue liabilities. The higher the interest rate on the bond, the higher must be the income from the project it finances, to make it worth issuing.

Business, in this story, will invest in anything whose expected return exceeds their cost of capital; that cost of capital in turn is set in financial markets. From this point of view, a subsidy or incentive to holders of financial assets is equivalent to one to the underlying activity. Telling the power producer “I’ll give you 10 percent of the cost of the turbine you built” and telling the bank “I’ll give you 10 percent of the value of the bond you bought” are substantively the same thing. 

As I said, this is the orthodox view. But it also implicitly underlies an analysis that talks about private capital without distinguishing between “capital” as a quantity of money in financial form, and “capital” as the concrete means of production of some private enterprise. If you don’t think that the question “what factory should I build” is essentially the same as the question “which factory’s debt should I hold?”, then it doesn’t make sense to use the same word for both.

Alternatively, we might argue that the relevant hurdle rate for private investment is well above borrowing costs and not very sensitive to them. Investment projects must pass several independent criteria and financing is often not the binding constraint. The required return is not set in financial markets; it is well above the prevailing interest rate and largely insensitive to it. If you look at survey evidence of corporate investment decisions, financing conditions seem to have very little to do with it.  If this is true, a subsidy to an activity is very different from a subsidy to financial claims against that activity. (A long-standing theme of this blog is the pervasive illusion by which a claim on an income from something is equated with the thing itself.)

Daniela defines derisking as, among other things, “the production of inevitability”, which I think is exactly right as a description of the (genuine and important) trend toward endlessly broadening the range of claims that can be held in financial portfolios. But I am not convinced it is a good description of efforts to encourage functioning businesses to expand in certain directions. Even though we use the word “invest” for both.

Conversely, when financing is a constraint, as it often is for smaller businesses and households, it takes the form of being unable to access credit at all, or a hard limit on the quantity of financing available (due to limited collateral, etc.), rather than the price of it. One lesson of the Great Recession is that credit conditions matter much more for small businesses than for large ones. So to the extent that we want to work through financing, we need to be targeting our interventions at the sites where credit constraints actually bind. (The lower part of the top row, in terms of my table.) A general preference for green assets, as in Europe, will not achieve much; a program to lend specifically for, say, home retrofits might. 

This leads to the final dimension, what I am calling fine-grained versus broad or rules-based interventions. (Perhaps one could come up with better labels.) While for some people the critical question is ownership, for others — including me — the critical question is market coordination versus public coordination. It is whether we, as the government, are consciously choosing to shift production in specific ways, or whether we are setting out broad priorities and letting prices and the profit motive determine what specific form they will take. This — and this may be the central point of this post — cuts across the other criteria. Privately-owned firms can have their investment choices substantively shaped by the public. Publicly-owned firms can respond to the market. 

Or again, yes, one way of distinguishing incentives is whether they are positive or negative. But another is how precise they are — in how much detail they specify the behavior that is to be punished or rewarded. A fine-grained incentive effectively moves discretion about specific choices and tradeoffs to the entity offering the incentive. A broad incentive leaves it to the receiver. An incentive conditioned on X shifts more discretion to the public sector than an incentive conditioned on any of X, Y or Z, regardless of whether the incentive is a positive or negative. 

Let me end with a few concrete examples.

In her paper, Daniela draws a sharp distinction between the IRA and CHIPS Act, with the former as a clear example of derisking and the latter a more positive model. The basis for this is that CHIPS includes penalties and explicit mandates, while the IRA is overwhelmingly about subsidies.1. This is reflected in the table by CHIPS’ position to the left of the IRA. (Both are areas rather than points, given the range of provisions they include.) From another point of view, this is a less salient distinction; what matters is that they are both fairly fine-grained measures to redirect the investment decisions of private businesses. If you focus on the vertical axis they don’t look that different.

Similarly, Daniela points to things like the ECB’s climate action plan, which creates climate disclosure requirements for bank bond holdings and limits the use of carbon-linked bonds as collateral, as a possible alternative to the subsidy approach. It is true that these measures impose limits and penalties on the private sector, as opposed to the bottomless mimosas of the IRA. But the effectiveness of these measures would require a strong direct link from banks’ desired bond holdings, to the real investment decisions of productive businesses. I am very skeptical of such a link; I doubt measures like this will have any effect on real investment decisions at all. To me, that seems more salient.

The key point here is that Daniela and I agree 100% both that private profit should not be the condition of addressing public needs, and that the public sector does need to redirect investment toward particular ends. Where we differ, I think, is on which of those considerations is more relevant in this particular case.

If the EPA succeeds in imposing its tough new standards for greenhouse gas emissions from power plants, that will be an example of a rules-based rather than incentive-based policy. This is not exactly industrial policy — it leaves broad discretion to producers about how to meet the standards. But it is still more targeted than a carbon tax or permit, since it limits emissions at each individual plant rather than allowing producers to trade off lower emissions one place for higher emissions somewhere else.

Finally, consider the UK Labour Party’s proposal for a climate-focused National Wealth Fund, or similar proposals for green banks elsewhere. The team at Common Wealth has a very good discussion of how this could be a tool for actively redirecting credit as part of a broader green industrial policy. But other supporters of the idea stress ownership stakes as an end in itself. This is similar to the language one hears from advocates of social wealth funds: The goal is to replace private shareholders with the government, without necessarily changing anything about the companies that the shares are a claim on. 2 From this point of view, there’s a critical difference between whether the fund or bank has an equity stake in the businesses it supports or only makes loans.

To me, that doesn’t matter. The important question is does it acts as an investment fund, buying the liabilities (bonds or shares or whatever) of established business for which there’s already a market? Or does it function as more of a bank, lending directly to smaller businesses and households that otherwise might not have access to credit? This would require a form of fine-grained targeting, as opposed to buying a broad set of assets that fit some general criteria.3 Climate advocate showing to shape the NWF need to think carefully about whether it’s more important for it to get ownership stakes or for it to target its lending to credit-constrained businesses.

My goal in all this is not to say that I am right and others are wrong (though obviously I have a point of view). My goal is to try to clarify where the disagreements are. The better we understand the contours of the landscape, the easier it will be to find a route toward where we want to go. 

At Jacobin: Yes, We Should Support Industrial Policy and the Green New Deal

(This piece was published by Jacobin on April 6, 2023, in response to the Dylan Riley post linked in the first paragraph. The version below adds a few unimportant footnotes and one somewhat important paragraph that I forgot to write before submitting it — the one about halfway through that mentions Oskar Lange.)

A few days ago, Dylan Riley wrote a post on New Left Review’s Sidecar blog that provoked a furious response on twitter. 1 Since I largely agree with the criticism made by Alex Williams, Nathan Tankus, Doug Henwood and others, perhaps I shouldn’t add to the chorus. But I want to try to clarify the larger stakes in this debate.

Riley’s piece starts from the suggestion that the failure of Silicon Valley Bank reflects a larger crisis of overcapacity and lack of investment opportunities. SVB, he writes,

had parked a huge quantity of its deposits in low-yield – but supposedly safe – government-backed securities and low-interest bonds. … the bank was overwhelmed by the massive growth in deposits from its tech clients – and neither it nor they could find anything worthwhile to invest in. …the SVB collapse is a beautiful, almost paradigmatic, demonstration of the fundamental structural problem of contemporary capitalism: a hyper-competitive system, clogged with excess capacity and savings, with no obvious outlets to soak them up.

This is an elegant framing but it runs into a problem immediately, involving the ambivalent meaning of ‘invest.” The depositors in SVB were not venture capitalists, but the firms that they had stakes in. The reason SVB had such big deposits was not because finance was unable to find profitable outlets even in the tech world, but precisely because it had done so. (Whether these businesses are doing anything socially useful is of course a different question.) The fact that SVB’s assets consisted of Treasury bonds rather than loans to its depositors reflects the shift in business financing, especially in tech, away from banks toward specialized venture capital funds — an interesting development, certainly, but one that doesn’t tell us anything about the overall population of businesses looking for financing.

Lurking behind Riley’s formulation here seems to be a crude version of commodity money theory, in which money is either out in the world being useful, or being left idle in the bank. But money in the real world is always in the form of bank deposits — that’s what money is — regardless of how actively it is circulating.

To be fair, Silicon Valley Bank is just the hook here. The real argument of the post — the one that provoked such a reaction — is that the ongoing crisis of overcapacity means that Green New Deal-type programs of public investment in decarbonization are a self-defeating dead end.   “Imagine,” writes Riley,

that Bidenomics in its most ambitious form were successful. What exactly would this mean? Above all it would lead to the onshoring of industrial capacity in both chip manufacturing and green tech. But that process would unfold in a global context in which all the other capitalist powers were vigorously attempting to do more or less the same thing. The consequence of this simultaneous industrialization drive would be a massive exacerbation of the problems of overcapacity on a world scale, putting sharp pressure on the returns of the same private capital that was ‘crowded-in’ by ‘market-making’ industrialization policies.

There are a number of distinct arguments in, or at least in the vicinity of, Riley’s post. We can of course debate the specific content of the IRA — where does it fall on Daniela Gabor’s spectrum from “de-risking” to the “big green state”? There’s a larger political question about the extent to which activists and intellectuals on the left should attach themselves to programs carried out by the established political actors through the state, as opposed to popular movements outside of it. And then there is the specific question of overcapacity — is it reasonable to think that any boost to investment via public spending will just diminish opportunities for profitable accumulation elsewhere?

I’m not unsympathetic to the first two of these arguments, even if I don’t agree with them in this particular case.

In my opinion, the IRA model passes two key tests: The public money goes to productive enterprises, not to holders of financial assets; and there is affirmative direction of spending toward specific activities. To me there is an important difference between “for each new solar panel you install with union labor, you will get x dollars of subsidies” and “if you hold a bond that fits these broad criteria, the interest is taxed at a lower rate” — even though, at a sufficiently high level of abstraction, both involve subsidizing private capital. But there’s a lot of room for debate here about how to describe specific measures and where to draw the line; a different read of its provisions might plausibly put the IRA on the other side of it.

Similarly, it’s important to remember that winning some specific legislation does not mean that you control the state — there’s a real danger in imagining ourselves “in the room where it happens” when in reality we are very far from it. When Riley writes that “no socialist should advocate an ‘industrial policy’ of any sort, nor have any truck with self-defeating New Deals,” I, obviously, do not agree. But if you wrote a parallel sentence about the humanitarian activities of the US military in various parts of the globe, I would agree wholeheartedly.  Over the years I’ve had many disagreements with people with broadly similar political commitments, who thought this particular intervention could was worth supporting. As far as I am concerned, when the instruments of the state are marines and cruise missiles, the only possible engagement from the left is protest and obstruction.

War is different from industrial policy. But one can imagine an argument along these lines that would be worth taking seriously. If you wanted to write a stronger critique of the Green New Deal from the left, you might stress the tight links between industrial policy and nationalism, and the frightening anti-China rhetoric that’s a ubiquitous part of the case for public investment.

Here, though, I want to talk about the specifically economic argument, about overproduction.

Riley’s post draws on a long-standing argument among writers for the New Left Review, that the fundamental challenge for contemporary capitalism is overproduction or excess capacity. In this story, the end of the postwar Golden Age was due to the end of US dominance in world trade. Starting in the 1970s, stable oligopolies in manufacturing gave way to to cutthroat competition as producers from an increasing number of countries competed for a limited market. Because manufacturing is so dependent on long-lived, specialized capital goods, producers are unwilling to exit even in the face of falling prices, giving rise to chronic depressed profits and excess capacity, and a turn to financial predation — what Robert Brenner calls neofeudalism — as an alternative outlet for investment. Even when profits recover, there’s little incentive to accumulate new means of production, given that there’s already capacity to produce more than markets can absorb. 

The most influential version of this story is probably Brenner’s book-length New Left Review article from 1998. 2 It is clearly compelling on some level – a lot of people seem to believe something like it. It draws on a long tradition of theories of overproduction and destructive competition, going back at least to the underconsumption theories of Hobson, Lenin and Luxemburg on the one side and, on the other, the first generation of the US economics profession, shaped by the pathological effects of competition between railways. Richard Ely, founder of the American Economics Association, described the problem clearly: “whenever the principle of increasing returns works with any high degree of intensity, competition can never regulate private business satisfactorily.”  His contemporary Arthur Hadley described destructive competition in capital-intensive industries in very much the same terms as Brenner: at prices 

far below the point where it pays to do your own business, it pays to steal business from another man. The influx of new capital will cease; but the fight will go on, either until the old investment and machinery are worn out, or until a pool of some sort is arranged.

(The quotes are from Michael Perelman’s excellent The End of Economics.)

There’s an important truth to the idea that, in a world of long-lived specialized capital goods and constant or falling marginal costs, there is no tendency for market prices to reflect costs of production. Too much competition, and firms will sell at prices that don’t recoup their fixed costs, and drive each other to bankruptcy. Too little competition, and firms will recover their full costs and then some, while limiting socially useful output. No market process ensures that competition ends up at the goldilocks level in the middle.

But while this problem is real, there’s something very strange about the way Riley deploys it as an argument against the Green New Deal. Rather than a story about competition, he — following Brenner — talks as if there was a fixed amount of demand out there that producers must compete for. In a world of overproduction, he says, any public investment will just create more excess capacity, driving down profits and accumulation somewhere else.

In a funny way, this is the mirror image of the Treasury View of the 1930s — which said that any increase in public employment would just mean an equal fall in private employment — or of its modern day successors like Jason Furman and Lawrence Summers. The Furman-Summers line is that the world has only a certain amount of productive capacity; any public spending above that level that will just result in inflation, or else crowding out of private investment. The Brenner-Riley line is that the world has only a certain amount of demand, both in general and for carbon-reducing technology specifically. Try to produce any more than that, and you’ll just have excess capacity and falling profits. Both sides agree that the economy is like a bathtub — try to overfill it and the excess will just run over the sides. The difference is that for first side demand is the water and productive capacity is the tub, while for the other the water is capacity and the tub is demand.

Riley invokes Oskar Lange’s 1930s discussions of electoral socialism in support of his contention that “half-measures are self-contradictory absurdities” — which very much includes any “blather about New Deals.” But the situation facing socialist governments in the 1930s was quite different. Their problem was that any serious discussion of nationalization would terrify capital and discourage investment, sending the economy into a deeper slump and dooming socialists’ prospects for extending their initial electoral gains. This meant that nationalization had to be carried out all at once or not at all — which in practice, of course, meant the latter. (There is a good discussion of this in Przeworski’s Paper Stones.) Keynesian fiscal policy was precisely what offered the way out of this trap, by allowing an expansion of the public sector on terms consistent with continued private accumulation. Riley here is rejecting exactly the solution to the problem Lange identified.

But there’s a deeper problem with the Riley-Brenner vision. In Jim Crotty’s review of Brenner’s long article, he argues that, in response to what Brenner saw as an excessive focus on labor-capital conflict in accounts of the end of the postwar boom, he created an equally one-sided story focused exclusively on inter-capitalist competition. I think this gets to the crux of the matter.

Let’s take a step back.

The development of a capitalist economy is a complex process, which can go wrong at many points. Production on an increased scale requires the expansion of the physical and organizational means of production, with whatever technical and material requirements that entails. Additional labor must be enlisted and supervised. New raw materials must be acquired, and the production process itself has to be carried out on an increased scale. The resulting products have to be sold at a price that covers the cost of production — in other words, there must be sufficient demand. The resulting surplus has to be channeled back to investment. All of this has to take place without excessive changes in relative prices, and in particular without politically destabilizing changes in wages or the distribution of income. The reinvestment stage normally happens via the financial system; the ongoing payment commitments this generates have to be consistently met. And it all must take place without generating unsustainable cross-border payment flows or commitments. 

All of these steps have to happen in sync, across a wide range of sectors and enterprises. A business expanding production has to be confident that the market for its products is also growing, as well as the supply of the inputs it uses, the financing it depends on, and the labor it exploits. An interruption in any of these will halt the whole process. When growth is steady and incremental, this can be mostly taken for granted, but not in the case of more rapid or qualitative change, as in industrialization.

This problem was clearly recognized by earlier development economists. It’s the idea behind the “two gap” and “three gap” models of Hollis Chenery and his collaborators, the “big push” of Rosenstein-Rodan, or Gerschenkron’s famous essay on late industrialization.3  Everything has to move forward together. Industrialization requires not only factories, but ports, railroads, water, electricity, schools. All of these depend on the others. You need savings (or at least credit), and you need demand, and you need labor, and you need foreign exchange.4 

At the same time, an essential feature of the capitalist mode of production is that the various steps each involve different decision makers, acting with an eye only to their own monetary returns. From the point of view of each decision maker, the choices of all the others look like fixed, objective constraints. From the point of view of a particular producer, the question of whether there is sufficient demand to justify additional output is an objective fact. For the producers collectively, it is their decisions that determine the level of demand just as much as — in fact simultaneously with — the level of current output.  But for them individually, it’s a given, an external constraint. 

The problem comes when in thinking about the system as a whole we treat something like destructive competition not as what it is – a coordination problem – but from the partial perspective of the individual producer. From this perspective, it appears as objectively given, as if there were only so much demand to go around. The mainstream, of course, makes the exact same error when they treat the productive capacity of the system as prior to and independent of the actual level of activity. (This is the point of Arjun Jayadev’s and my recent paper on supply constraints.) The fact that when one part of the system moves ahead faster it encounters friction from parts that are lagging imposes genuine limits on the pace of expansion — both supply and demand constraints are real – but we should not treat them as absolute or externally given. 

The faster and farther reaching are the changes in production, the harder it is for a decentralized market system to maintain coherence, and the more necessary conscious, more or less centralized coordination becomes. This was one of the main lessons of the economic mobilization for World War II, and a critical consideration for decarbonization. Planning is ubiquitous in real-world capitalism, and more rapid transformations in activity require planning at a higher level.  

At the same time, we shouldn’t underestimate the capacity of our system of anarchic production for profit to eventually break through the barriers it encounters — something Marx understood better than anyone. That is why it’s become the world-encompassing system it is. Sustained demand will itself call forth the new labor and improved production techniques required to meet it.  Conversely, while Say’s law may not hold in the short run, or as a matter of logic, it is very much the case that improvements in production create new markets, and expand demand qualitatively as well as quantitatively.

Overproduction and excess capacity are not new phenomena. They have been a recurring feature of the great crises that capitalist economies have experienced for the past two hundred years. Here is Jules Michelet’s beautiful contemporary description of the 1842 commercial crisis in France:

The cotton mills were at the last gasp, choking to death. The warehouses were stuffed, and there were no sales. The terrified manufacturer dared neither work nor stop working with those devouring machines. Yet usury is not laid off, so he worked half-time, and the glut grew worse. Prices fell, but in vain; they went on falling until cotton cloth stood at six sous.

We should never forget about the misery and chaos of crises like this. But we should also not forget how this story ends. It is not “and then eventually enough mills were shut down and things went back to how they were before.”

Here’s how the Michelet passage continues:

Then something completely unexpected happened. The words six sous aroused the people. Millions of purchasers — poor people who had never bought anything — began to stir. Then we saw what an immense and powerful consumer the people is when engaged. The warehouses were emptied in a moment. The machines began to work furiously again, and chimneys began to smoke. That was a revolution in France, little noted but a great revolution nonetheless. It was a revolution in cleanliness and the embellishments of the homes of the poor; underwear, bedding, table linen, and window curtains were now being used by whole classes who had not used them since the beginning of the world.

An openness to the possibility of this sort of transformational change is what’s fundamentally missing from both the Summers-Furman and Brenner-Riley views. This is not a system in homeostasis, that if disturbed returns to its old position. It is a system lurching from one unstable equilibrium to another. And this is very relevant, I think, to decarbonization. 

Not so very long ago, it was conventional wisdom that photovoltaic energy was never going to be more than a niche power source — useful when you can’t connect to the grid, but way too expensive to to ever be used at utility scale. And now look — solar accounted for nearly half of new electricity generation installed last year. There’s an almost endless scope for further growth in renewable energy, as more of the economy is electrified. The fact that Silicon Valley Bank was holding a bunch of Treasury bonds does not mean that the field of productive investment has been exhausted.

The tremendous growth of renewable energy over the past generation wouldn’t have happened without public subsidies and regulation. At the same time, most of the actual production has been carried out by employees of private, profit-seeking businesses. Riley is absolutely right that no one should be counting on private investment in education or in care work. Explaining why those activities depend critically on the autonomy and intrinsic motivation of the workers carrying them out, and are therefore inherently unsuited to for-profit businesses, is something we need to keep doing. The same goes for many public functions that have been turned over to contractors. But there are many other areas where it is still possible to harness the profit motive to meet human needs. 

(I am not, to be clear, saying anything about the virtues of markets or the profit motive in the abstract. I would like to progressively eliminate them from human life. I am simply stating the fact that my house was put up by a private builder, for profit, and yet the roof does keep out the rain.) 

There is plenty of scope to criticize the specific content of the IRA and other climate legislation, and the strategic choices of the groups that support them. (Altho a bit of humility is called for with the latter.) But we need to categorically reject the idea that there is some hard constraint such that any program to increase private spending on decarbonization will be canceled out by a reduction in spending somewhere else. 

The bottom line, both for the politics and the economics, is that we need to resist thinking in terms of a change in one area while everything else stays the same. Ceteris paribus may be a useful analytic tool, but it’s fundamentally inapplicable to historical processes where one change creates the pressure, and the possibility, for another. 

Yes, given the existing productive technology, given existing markets, one country’s support for renewable energy might compete with another’s. But these things are not given. Economies of scale exist at the level of the industry as well as the firm; technological progress in one place quickly spills over to others. As, say, hydrogen becomes practical for large-scale energy storage, it will be come practical to produce green energy in areas where it isn’t today. This is as far as you can get from the Brenner paradigm of a zero-sum competition for shares of a fixed market.

The real problem for the Green New Deal and broader industrial policy program is not scarcity, whether of material or of markets. It is twofold. First, it requires a capacity for public planning that is currently lacking, in the US and elsewhere. Industrial policy means building up and legitimating the state’s direct role in a wider range of activity— a challenge when the biggest existing form of direct public provision, the public schools, are under ferocious attack from the right. Second, to the extent that a rush of public and private spending leads to a sustained boom, that will create profound challenges for a system that is used to managing distributional conflicts through unemployment. We’ve gotten a sense of what the political reaction to full employment might look like from recent inflation discourse, with its fears of “labor scarcity.” It’s reasonable, for now, to respond that it’s silly to worry about a wage-price spiral when labor is so weak. But what happens when labor is stronger?

These are real challenges. But we shouldn’t see them as arguments against this program, only as markers for where the next conflicts are likely to be. That’s always how it is. “Gradualism cannot work,” declares Riley, but all politics is incremental. Socialism is only a direction of travel. Even if the “commanding heights of the economy” could “be seized at once” — Riley’s rather ambitious alternative to the Green New Deal — that would only be a step toward the next struggle.

A program to mobilize the existing bourgeois state to push private spending in the direction of meeting human needs, and the need for a habitable planet in particular, faces many obstacles — that is true. Whatever successes the left has had under the Biden administration have been limited and compromised. Some of the most important, like the expansion of unemployment and family benefits, have already been rolled back — that is also true. But the same could be said for all the socialist programs of the past. We have to just keep going, with one eye on the long run direction of travel and the other on the contingencies of the present. The one thing we can say for certain about the future is that it hasn’t happened yet. If we keep going, we will see things that haven’t been seen since the beginning of the world.

New Paper: Rethinking Supply Constraints

I have a new paper on how we conceptualize the supply side of the economy, coauthored with Arjun Jayadev. I presented a version of this at the Political Economy research Institute in December 2022. You can watch video of my presentation here — I come on, after some technical difficulties, around 47:00. (The other presentations from the conference are also very worth watching.) The paper will be published in the upcoming issue of the Review of Keynesian Economics. (The linked version is our draft; when the published version comes out I’ll post that.)

Our fundamental argument is that while macroeconomic supply constraints are normally conceptualized in terms of a level (or level-path) of potential output, in many contexts it would be better to think in terms of a constraint on the rate of change — a speed limit rather than a ceiling.

While this is a general argument, it’s motivate by the experiences of the pandemic and the post-financial crisis recovery of the preceding decade. We think the speed-limit conception of supply constraints makes sense of a number of macroeconomic developments that are hard to make sense of in the conventional view.

First, deviations in output are persistent. We saw this clearly in the wake of the Great Recession, but it seems to be a more general phenomenon. There’s a long-standing empirical finding that there’s no general tendency of output to return to its previous trend. One way we could explain this is the real business cycle way — short-term as well as long-term variation in output growth are driven by changes in the economy’s productive capacity. But of course, there is lots of evidence that business cycles are driven by demand. Alternatively, we could argue that potential grows steadily but actual output may remain far below it indefinitely. I was making arguments like this a few years ago. The problem is that direct evidence on the output gap (unemployment, growth in wages and prices, businesses’ reported capacity utilization rates, etc.) suggest that the output gap did close over the course of the 2010s. So we’re left with the idea that potential output adjusts to actual output — hysteresis. But if we take this idea seriously, it rules out the conventional idea of a level of potential output. In a world where hysteresis is important, a zero output gap is consistent with lots of different level-paths of output; supply constraints only bind the speed of the transitions between them.

Second, there’s no well-defined level of full employment. (Here we have to ding Keynes a bit.) Employment grows steadily over business cycles — there’s no sign of convergence to some long-term trend. Estimates of the NAIRU or natural unemployment rate follow actual unemployment more or less one for one. And if we try to make a bottom-up estimate of full employment — what fraction of the population could plausibly be engaged in paid work — we end up with a value much higher than actual employment even at cyclical peaks.

Third, we observe inflation and other signs of supply constraints in response to changes in the composition of output and employment, and not just in the level. This has been very clear during the pandemic, but there’s good reason to think it’s true in general.

Fourth, increasing returns are pervasive in real economies. This is a bit of a different argument than the first three, since it’s not pointing to a directly observable macro phenomenon. But it’s important here, because it means that we can’t assume that businesses are already using the lowest-cost technique and increasing output will cause unit costs to rise. One way of thinking about this is to imagine a cost landscape that is rugged, not smooth. Moving from one locally low-cost position to another may require traversing a higher cost region, which will appear as supply constraints during the transition. A clear example of this is the transition from carbon to renewable energy sources.

We also argue that this perspective is more consistent with a sociologically realistic view of what “the economy” is. Real economies are not homogeneous “factors” being added to a “production function” which then spits out some quantity of output. They are complex systems of cooperation between human beings, which are embedded in all kinds of other social relationships and the reproduction of households and other social organisms. These relationships cannot be torn up and recreated at any moment — changing them is costly. They evolve only gradually over time. From this point of view, it is wrong to divide the facts about the economic world into a set of long-run, fundamental, exogenous factors and short-run endogenous factors. Who is actually working, and at what, is as much a part of the economic data, no less easily shifted, than the number of people who are potentially available for work.

This way of thinking about the supply side has several implications for policy. First, rising prices and other signs of supply constraints cannot be taken as evidence for the long-run limits on the economy’s productive potential. In general, we should be skeptical of suggestions that recent rises in the prices of energy, food and other essential commodities reflect the “end of abundance”.

On the positive side, our view suggests that the response to positive output gaps should include not only conventional “supply side” measures, but measures to overcome the coordination and information problems and other frictions that limit rapid changes in productive activity. This implies planning of some sort, though not necessarily central planning in the traditional sense. Another implication is that because prices can adjust more quickly than productive activity can (the emphasis on price stickiness is backward in our view), rapid shifts in activity can generate large price spikes that are not informative about long-run production possibilities and produce undesirable shifts in income. This suggests that price regulation has an important role in smoothing the transition fro one pattern of activity to another.

Specific examples and evidence on all these points are in the paper. You should read it! A final point I want to emphasize here is that we are not saying that supply constraints are limits on adjustment speed in an absolute, universal sense. We are saying that insofar as we need a simple, first-cut description of the supply side, we will usually do better to imagine a constraint on adjustment speed rather than on the level of output and employment.

 

At Barron’s: What We Don’t Talk About When We Talk About Inflation

(I am now writing a monthly opinion piece for Barron’s. This one was published there in July.)

To listen to economic policy debates today, you would think the U.S. economy has just one problem: inflation. When Federal Reserve Chairman Jerome Powell was asked at his last press conference if there was a danger in going too far in the fight against inflation, his answer was unequivocal: “The worst mistake we could make is to fail—it’s not an option. We have to restore price stability…because [it’s] everything, it’s the bedrock of the economy. If you don’t have price stability, the economy’s really not going to work.”

Few would dispute that rising prices are a serious problem. But are they everything?

The exclusive focus on inflation acts like a lens on our view of the economy—sharpening our attention on some parts of the picture, but blurring, distorting, and hiding from view many others.

In the wake of the Great Recession, there was a broadening of macroeconomic debates. Economists and policy makers shifted away from textbook truisms toward a more nuanced and realistic view of the economy. Today, this wide-ranging conversation has given way to panic over rising prices. But the realities that prompted those debates have not gone away.

In the clamor over inflation, we’re losing sight of at least four big macroeconomic questions.

First, does the familiar distinction between supply and demand really make sense at the level of the economy as a whole? In the textbooks, supply means the maximum level of production in the economy, labeled “full employment” or “potential output,” while demand means total spending. The two are supposed to be independent—changes in spending don’t affect how much the economy can produce, and vice versa. This is why we are used to thinking of business cycles and growth as two separate problems.

But in the real world, supply often responds to demand—more spending calls forth more investment and draws people into the labor force. This phenomenon, known by the unlovely name “hysteresis,” was clearly visible in the slowdown of labor force and productivity growth after the Great Recession, and their recovery when demand picked up in the years before the pandemic. The key lesson of this experience—in danger of being forgotten in today’s inflation panic—was that downturns are even more costly than we thought, since they not only imply lost output today but reduced capacity in the future.

Hysteresis is usually discussed at the level of the economy as a whole, but it also exists in individual markets and industries. For example, one reason airfares are high today is that airlines, anticipating a more sustained fall in demand for air travel, offered early retirement to thousands of senior pilots in the early stages of the pandemic. Recruiting and training new pilots is a slow process, one airlines will avoid unless it’s clear that strong demand is here to stay. So while conventional wisdom says that rising prices mean that we have too much spending and have to reduce it, in a world with hysteresis a better solution may be to maintain strong demand, so that supply can rise to meet it. In the textbook, we can restore price stability via lower demand with no long-run costs to growth. But are we sure things work so nicely in the real world?

The second big question is about the labor market. Here the textbook view is that there is a unique level of unemployment that allows wages to grow in line with productivity. When unemployment is lower than this “natural rate,” faster wage growth will be passed on to rising prices, until policy makers take action to force unemployment back up. But in the years before the pandemic, it was becoming clear that this picture is too simplistic. Rising wages don’t have to be passed on to higher prices—they may also come at the expense of profits, or spur faster productivity growth. And not all wages are equally responsive to unemployment. Younger, less-educated, and lower-wage workers are more dependent on tight labor markets to find work and get raises, while the incomes of workers with experience and credentials rise more steadily regardless of macroeconomic conditions. This means that—as Powell has acknowledged—macroeconomic policy has unavoidable distributional consequences.

In his classic essay “Political Aspects of Full Employment,” the great Polish economist Michal Kalecki argued that even if it were economically feasible to eliminate unemployment, this would be unsustainable, since employers’ authority in the workplace depends on “the threat of the sack.” Similar arguments have been made by central bank chiefs such as Alan Greenspan, who suggested that low unemployment was sustainable in the 1990s only because workers had been traumatized by the deep recession of the decade before.

Some would argue that it’s unnecessarily wasteful and cruel to maintain labor discipline and price stability by denying millions of people the chance to do useful work—especially given that, prior to the pandemic, unemployment had fallen well below earlier estimates of the “natural rate” with no sign of accelerating inflation. But if we wish to have a permanent full-employment economy, we need to answer a difficult question: How should we manage distributional conflicts between workers and owners (and among workers), and motivate people to work when they have little to fear from losing their job?

A third set of questions concerns globalization. There are widespread fears that renewed Covid lockdowns in China may limit exports to the U.S. and elsewhere. Seen through the inflation lens, this looks like a source of rising prices and a further argument for monetary tightening. But if we take a step back, we might ask whether it is wise to organize the global economy in such a way that lockdowns in China, a war in Ukraine, or even a factory fire in Japan leave people all over the world unable to meet their basic needs. The deepening of trade and financial links across borders is sometimes presented as a fact of nature. But in reality it reflects policy choices that allowed global production of all kinds of goods—from semiconductors to Christmas decorations and latex gloves—to be concentrated in a handful of locations. In some cases, this concentration is motivated by genuine technical advantages of larger-scale production, in others by the pursuit of low wages. But either way, it reflects a prioritization of cost minimization over flexibility and resiliency. Whatever happens with inflation, this is a trade-off that will have to be revisited in coming years, as climate change makes further disruptions in global supply chains all but inevitable.

Then there is climate change. Here, the inflation lens doesn’t just recolor the picture but practically reverses it. Until recently, the conventional wisdom was that a carbon tax was the key policy tool for addressing climate. An Obama-era economist once quipped that the big question on climate was whether a carbon tax was 80% of the solution, or 100%. A carbon tax would increase the prices of energy, which still mainly comes from fossil fuels, and of travel by private car. As it happens, this is exactly what we have seen: Autos and energy have increased much faster than other prices, to the point that these two categories account for a majority of the excess inflation over the past year. In effect, we’ve seen something like a global carbon tax. But far from welcoming the disproportionate rise in the prices of carbon-intensive goods as a silver lining of inflation, both policy makers and the public see it as an urgent problem to be solved.

To be clear, people are not wrong to be unhappy at the rising cost of cars and energy. In the absence of practical alternatives, these high prices inflict real hardship without necessarily doing much to speed the transition from carbon. One reasonable lesson, then, is that a carbon tax high enough to substantially reduce emissions will be politically intolerable. And indeed, before the pandemic, many economists were already shifting away from a carbon-price-focused approach to climate policy toward an investment-centered approach.

Whether via carbon prices or investment, the only way to reduce carbon emissions is to leave fossil fuels in the ground. Yet an increasing swath of the policy conversation is focused on how to encourage more drilling by oil-and-gas companies, not just today but into the indefinite future. As a response to today’s rising energy prices, this is understandable, given the genuine limitations of renewable energy. But how can measures to boost the supply of fossil fuels be consistent with a longer-term program of decarbonization?

None of these questions have easy answers. But the danger of focusing too single-mindedly on inflation is that we may not even try to answer them.

Climate Policy from a Keynesian Perspective

(This is the extended abstract for a piece I am writing for “The Great Turnaround,” a collection of essays on the economics of decarbonization from ZOE-Institute for Future-fit Economies and the Heinrich Böll Foundation.) 

In the world in which we live, large-scale cooperation is largely organized through payments of money. Orthodox economics conflates these money flows, on the one hand with quantities of real social and physical things, and on the other hand with a quantity of wellbeing or happiness. One way of looking at Keynes’ work is as an attempt to escape this double conflation and see money as something distinct. Eighty years later, it can still be a challenge to imagine our collective productive activity except in terms of the quantities of money that organize it. But this effort of imagination is critical to address the challenges facing us, not least that of climate change.

The economic problems of climate change are often discussed, explicitly or implicitly, in terms of the orthodox real-exchange vision of the economy, in which problems are conceived of in terms of the allocation of scarce means among alternative ends. 

In the real-exchange framework, decarbonization is a good which must be traded off against other goods. From this point of view, the central question is what is the appropriate tradeoff between current consumption and decarbonization. The problem is that since climate is an externality, this tradeoff cannot be reached by markets alone; the public sector must set the appropriate price via a carbon tax or equivalent. In general, more rapid decarbonization will be disproportionately more costly than slower decarbonization. A further problem is that since the climate externality is global, higher costs will be borne by the countries that move more aggressively toward decarbonization while others may free-ride. 

This perspective does leave space for more direct public action to address climate change. Public investment, however, faces the same tradeoff between decarbonization and current living standards that price-mediated private action does. It is also limited by the state’s fiscal capacity. Governments have a finite capacity to generate money flows through taxation and bond-issuance (or equivalently to mobilize real resources) and use of this capacity for decarbonization will limit public spending in other areas. 

The claims in the preceding two paragraphs may sound reasonable at first glance. But from a Keynesian standpoint, none are correct; they range from misleading to flatly false. In the Keynesian vision, the economy is imagined as aa system of monetary production rather than real exchange, with the binding constraints being not scarce resources, but demand and, more broadly, coordination. From this perspective, the problem of climate change looks very different. And these differences are not just about terminology or emphasis, but a fundamentally different view of where the real tradeoffs and obstacles to decarbonization lie.

In this paper, I will sketch out the central elements that distinguish a Keynesian vision of the economics of climate change. For this purpose, the Keynesian monetary-production framework can be seen as involving three fundamental premises.

1. Economic activity is coordination- and demand-constrained, not real resource-constrained. 

2. Production is an active, transformative process, not just a combining of existing resources or factors. 

3. Money is a distinct object, not just a representative of some material quantity; the interest rate is the price of liquidity, not of saving. 

These premises have a number of implications for climate policy.

1. Decarbonization will be experienced as an economic boom. Decarbonization will require major changes in our patterns of production and consumption, which in turn will require substantial changes to our means of production and built environment. In capitalist economies, these changes  are brought about by spending money. Renovating buildings, investing in new structures and equipment, building infrastructure, etc. add to demand. The decommissioning of existing means of production does not, however subtract from demand. Similarly, high expected returns in growing sectors can call forth very high investment there; investment can’t fall below zero in declining sectors. So even if aggregate profitability is unchanged, big shift in its distribution across industries will lead to higher investment. 

2. There is no international coordination problem — the countries that move fastest on climate will reap direct benefits. While coordination problems are ubiquitous, the real-exchange paradigm creates one where none actually exists. If the benefits of climate change mitigation are global, but it requires a costly diversion of real resources away from other needs, it follows that countries that do not engage in decarbonization can free-ride on the efforts of those that do. The first premise is correct but the second is not. Countries that take an early lead in decarbonization will enjoy both stronger domestic demand and a lead in strategic industries.  This is not to suggest that international agreements on climate policy are not desirable; but it is wrong and counterproductive to suggest that the case for decarbonization efforts at a national level is in any way contingent on first reaching such agreements. 

3. There is no tradeoff between decarbonization and current living standards. Real economies always operate far from potential. Indeed, it is doubtful whether a level of potential output is even a meaningful concept. Decarbonization is not mainly a matter of diverting productive activity away from other needs, but mobilizing new production, with positive spillovers toward production for other purposes. The workers engaged in, say, expanding renewable energy capacity are not being taken away from equal-value activity in some other sector. They are, in the aggregate, un- or underemployed workers, whose capacities would otherwise be wasted; and the incomes they receive in their new activity will generate more output in demand-constrained consumption goods sectors. 

4. Price based measures cannot be the main tools for decarbonization.  There is a widely held view that the central tool for addressing climate should be an increase in the relative price of carbon-intensive commodities, through a carbon tax or equivalent. This make sense in a vision of the economy as essentially an allocation problem where existing resources need to be directed to their highest value use. But from a Keynesian perspective there are several reasons to think that prices are a weak tool for decarbonization, and the main policies need to be more direct. First, in a world of increasing returns, there will be multiple equilibria, so we can not think only in terms of adjustment at the margin. In the orthodox framework, increasing the share of, say, a renewable energy source will be associated with a higher marginal cost, requiring a higher tax or subsidy; but in an increasing-returns world, increasing share will be associated with lower marginal costs, so that while even a very large tax may not be enough to support an emerging technology once it is established no tax or subsidy may be needed at all. Second, production as a social process involves enormous coordination challenges, especially when it is a question of large, rapid changes. Third, fundamental uncertainty about the future creates risks which the private sector is often unwilling or unable to bear.

5. Central bank support for decarbonization must take the form active credit policy. As applied to central banks, carbon pricing suggests a policy to treat “green” assets more favorably and other assets less favorably. This is often framed as an extension of normal central bank policies toward financial risk, since the “dirty” asset suppose greater risks to their holders or systematically than the “green” ones. But there is no reason, in general, to think that the economic units that are at greatest risk from climate change are the same as the ones that are contributing to it. A deeper and more specifically Keynesian objection is that credit constraints do not bind uniformly across the economy. The central bank, and financial system in general, do not set a single economy wide “interest rate”, but allocate liquidity to specific borrowers on specific terms. Most investment, conversely, is not especially sensitive to interest rates; for larger firms, credit conditions are not normally a major factor in investment, while for smaller borrowers constraints on the amount borrowed are often more important.  Effective use of monetary policy to support decarbonization or other social goals requires first identifying those sites in the economy where credit constraints bind and acting to directly to loosen or tighten them. 

6. Sustained low interest rates will ease the climate transition. A central divide between Keynesian and orthodox macroeconomic theory is the view of the interest rate. Mainstream textbooks teach that the interest rate is the price of saving, balancing consumption today against consumption in the future — a tradeoff that would exist even in a nonmonetary economy. Keynes’ great insight was that the interest rate in a monetary economy has nothing to do with saving but is the price of liquidity, and is fundamentally under the control of the central bank. He looked forward to a day when this rate fall to zero, eliminating the income of the “functionless rentier”. As applied to climate policy, this view has several implications. First, market interest rates tell us nothing about any tradeoff between current living standards and action to protect the future climate. Second, there is no reason to think that interest rates must, should or will rise in the future; debt-financed climate investment need not be limited on that basis. Third, while investment in general is not very sensitive to interest rates, an environment of low rates does favor longer-term investment. Fourth, low interest rates are the most reliable way to reduce the debt burdens of the public (and private) sector, which is important to the extent that high debt ratios constrain current spending.

7. There is no link between the climate crisis and financial crisis. It is sometimes suggested that climate change and/or decarbonization could result in a financial crisis comparable to the worldwide financial crisis of 2007-2009. From a Keynesian perspective, this view is mistaken; there is no particular link between the real economic changes associated with climate change and climate policy, on the one hand, and the sudden fall in asset values and cascading defaults of a financial crisis, on the other. While climate change and decarbonization will certainly devalue certain assets — coastal property in low-lying cities; coal producers — they imply large gains for other assets. The history of capitalism offers many examples of rapid shifts in activity geographically or between sectors, with corresponding private gains and losses, without generalized financial crises. The notion that financial crises are in some sense a judgement on “unsound” or “unsustainable” real economic developments is an ideological myth we must reject. This is the converse of the error discussed under point 6 above, that measures to protect against the financial risks from climate change and decarbonization will also advance substantive policy goals. 

8. There is no problem of getting private investors to finance decarbonization. Many proposals for climate investment include special measures to encourage participation by private finance; it is sometimes suggested that national governments or publicly-sponsored investment authorities should issue special green bonds or equity-like instruments to help “mobilize private capital” for decarbonization. Such proposals confuse the meaning of “capital” as concrete means of production with “capital” as a quantity of money. Mobilizing the first is a genuine challenge for which private businesses do offer critical resources and expertise not present in the public sector; but mobilizing these means paying for them, not raising money from them. On the financing side, on the other hand, the private sector offers nothing; in rich countries, at least, the public sector already borrows on more favorable terms than any private entity, and has a much greater capacity to bear risk. If public-sector borrowing costs are higher than desired, this can be directly addressed by the central bank; offering new assets for the private sector to hold does nothing to help with any public sector financing problem, especially given that such proposal invariably envision assets with higher yields than existing public debt.

These eight claims mostly argue that what are widely conceived as economic constraints or tradeoffs in climate policy are, from a Keynesian perspective, either not real or not very important. Approaches to the climate crisis that frame the problem as one of reallocating real resources from current consumption to climate needs, or of raising funds from the private sector, both suffer from the same conflation of money flows with real productive activity. 

I will conclude by suggesting two other economic challenges for climate change that are in my opinion underemphasized.

First, I suggest that we face a political conflict involving climate and growth, this will come not because decarbonization requires accepting a lower level of growth, but because it will entail faster economic growth than existing institutions can handle. Today’s neoliberal macroeconomic model depends on limiting economic growth as a way of managing distributional conflicts. Rapid growth under decarbonization will be accompanied by disproportionate rise in wages and the power of workers. There are certainly reasons to see this as a desirable outcome, but it will inevitably create sharp conflicts and resistance from wealth owners that has to be planned for and managed. Complaints about current “labor shortages” should be a warning call on this front.

Second, rapid decarbonization will require considerably more centralized coordination than is usual in today’s advanced economies. If there is a fundamental conflict between capitalism and sustainability, I suggest, it is not because the drive for endless accumulation in money terms implies or requires an endless increase in material throughputs. Rather, it is because capitalism treats the collective processes of social production as the private property of individuals. (Even the language of “externalities” implicitly assumes that the normal case is one where production process involves no one but those linked by contractual money payments.) Treatment of our collective activity to transform the world as if it belonged exclusively to whoever holds the relevant property rights, is a fundamental obstacle to redirecting that activity in a rational way. Resistance on these grounds to a coordinated response to the climate crisis will be partly political and ideologically, but also concrete and organizational. 

Inflation for Whom?

A point I’ve been emphasizing about inflation (see here and here) is that it is just an average of price changes; it doesn’t have any independent existence.

One implication of this is that there is not, even in principle, a true inflation rate. Pick any basket of goods and measure their prices over time; that is an inflation rate. The “all urban consumers” basket used by the BLS for the headline CPI inflation rate is a useful benchmark, but it’s just one basket among others. Any individual household or subgroup of households will have its own consumption basket and corresponding inflation rate.

Because a small number of items have gone up in price a lot recently, the average price increase in the CPI basket is greater than increase in wages over the past year. In this sense, real wages have gone down. I am not convinced this is a meaningful statistic. For one thing, car prices are almost certain to come back down over the next year, once the current semiconductor bottleneck is relieved and manufacturers ramp up output. Wage gains, on the other hand, have a lot of inertia. This year’s wage gains are likely to continue; certainly they will not be given back.

But there’s another reason the “falling real wage” claim is misleading. When price increases are concentrated in a few areas, the inflation rate facing people who are buying stuff in those areas will be very different from the rate facing those who are not. Most Americans do buy a car every few years, but relatively few need to buy a car right now.1 And even averaged over time, different groups of people spend more or less on cars relative to other things. The same goes for other categories of spending.

The BLS’s Consumer Expenditure Survey (CEX) tries to measure the distribution of consumption spending by different demographic groups. In principle, you could construct a separate CPI for each group, like CPI-E the BLS reports for elderly households. (For what it’s worth the CPI-E increased by 4.8 percent over the past year, a bit slower than the headline rate.) In practice the challenges in doing this are formidable — for the headline measure weights can be based on retail sales, but the weights for demographic group have to be based on household surveys, which are slower and much less reliable. (I have some discussion of these issues in Section 7 of this paper.) Still, the CEX can give us at least a rough sense of the difference in consumption baskets and inflation rates across different groups.

It’s particularly interesting to look at consumption baskets across income groups. One of the central arguments for running the economy hot is that it tends to compress wages. From this point of view, an increase in prices paid disproportionately by lower income households is more concerning than a similar aggregate increase in prices paid more by the better off.

For this post, I chose to focus on the consumption basket of households with pre-tax income below $30,000 a year — about one quarter of the population.

In the table below, I show 20 items, accounting for almost 95% of the CPI basket. The first column shows its share of the CPI-U basket, taken from the most recent CPI Table 2. The second column shows the difference between the weight of the item in consumption by households earning less than $30,000 and its weight in total consumption.2 So a positive value means something that makes up a larger share of consumption for households with incomes under $30,000 than of consumption for the population as a whole. This comes from the most recent Consumer Expenditure Survey, covering July 2019 through June 2020. The third column shows the price change of that item from July 2020 to July 2021, again from CPI Table 2. The items are ordered from the ones that make up the largest relative share of the consumption basket for low-income households to the ones that make up the smallest relative share. So it gives at least a rough sense of the different inflations experienced by lower versus higher income families.

Expenditure Category Overall share (CPI) Relative share, income <$30k (CEX) Inflation, July 2020-July 2021 (CPI)
Rent of primary residence 7.6 8.3 1.9
Food at home 7.6 2.4 2.6
Electricity 2.5 1.5 4
Medical care services 7.1 1 0.8
Medical care commodities 1.5 0.35 -2.1
Recreation commodities 2.0 0.35 3.2
Water and sewer and trash collection 1.1 0.3 3.7
Education and communication services 6.1 0.2 1.2
Motor fuel 3.8 0.2 41.6
Utility (piped) gas service 0.7 0.2 19
Apparel 2.7 0.2 4.2
Motor vehicle parts and equipment 0.4 0.05 4.3
Fuel oil and other fuels 0.2 0.05 30.9
New vehicles 3.7 -0.15 6.4
Transportation services 5.3 -0.15 6.4
Lodging away from home 1.0 -0.3 21.5
Used cars and trucks 3.5 -0.3 41.7
Alcoholic beverages 1.0 -0.3 2.4
Food away from home 6.2 -0.35 4.6
Recreation services 3.7 -0.6 3.7
Household furnishings and supplies 3.7 -0.7 3
Owners’ equivalent rent 22.4 n/a3 2.4

As you can see, the items that are increasing at less than 2 percent a year — highlighted in blue — are all things disproportionately consumed by lower-income households. Rent, in particular, makes up a much higher share of spending for low-income households. Rent growth slowed sharply during the pandemic and, unlike many other prices, it has not so far accelerated again. Rent growth over the past year is about half the average rate in the three years before the pandemic.

Medical goods and services also make up a larger share of spending for lower-income households; prices there have grown slowly or income cases actually fallen over the past year. Prescription drug prices, for example, fell by 2 percent over the past year. Finally, education services, including childcare, have pulled inflation down over the past year, rising by about 1 percent (college tuition was flat.) Education inflation has been slowing for a long time — a trend I don’t recall seeing discussed much — but it slowed even more during the pandemic. Education and childcare make up a slightly higher fraction of spending for low-income households than for others.

On the other side, almost all the sectors where inflation is notably high — highlighted in red — make up a larger share of spending for higher-income households. Lodging away from home, for example, where prices are up over 20 percent, makes up less than 1 percent of the consumption basket for households with incomes under $30,000, but 2.5 percent of the basket for households with incomes over $200,000. Transportation services, food away from home, and new and used cars, which account for  the majority of non-energy inflation, are also disproportionately consumed by higher income households.

In general, it seems clear that lower-income households are facing less inflation than higher income ones. The biggest price increases are in areas that are disproportionately consumed by higher-income families, while several of the most important consumption categories for lower-income families are seeing prices rise more slowly than before the pandemic. Any discussion of “falling real incomes” that ignores this fact is at best incomplete.

There is, of course, one big exception: energy. Gasoline especially, but also electricity and heating gas, are seeing big price increases and make up a larger share of consumption for lower-income families. And unlike auto purchases, energy consumption can’t be postponed. If you want to tell a story about higher prices eating up wage gains, it seems to me that energy is your best bet.

Except, of course, that these are prices that we want to see rise, if we are serious about climate change. Many of the same people fretting about inflation eroding real wages, are strong supporters of carbon taxes or permits. If you think a goal of policy is to raise the relative price of fossil fuels, why object when it happens via the market?

At the end of the day, perhaps the current debate about inflation and real wages doesn’t belong in the macroeconomics box at all, but in the climate box. The difficult problem here is not how to keep demand strong enough to raise wages without also raising prices. The price spikes we’re seeing right now are mainly about short-term supply constraints. I am confident that prices for autos and many other goods will  come back down or at least stabilize over the next year, even if demand remains strong. The really difficult problem is how we make the transition away from fossil fuels without unacceptably burdening the people who are currently dependent on them.

UPDATE: I am getting some very confused readers, who note that historically rent, education and health care have historically risen in price faster than most goods, while in this post I’m saying they are rising more slowly. The original post, should have, but did not, make clear that the pattern of price changes over the past year or so is quite different from what we are used to. That said, this is not all about the pandemic. As I did note, inflation in education has been slowing for a long time; health care inflation has fallen dramatically during the pandemic but was also slowing before that, arguably thanks to the ACA. But the key point is that I am not saying that poor people face lower inflation in general; I’m saying this is a distinct feature of the inflation we’re experiencing now.

The Roaring 2020s: Further Reading

Mike Konczal and I have a piece in the New York Times arguing that the next few years could see a historic boom for the US economy, if policy makers recognize that strong demand and rising wages are good things, and don’t get panicked into turning toward austerity. 

Mike and I and our colleagues at the Roosevelt Institute are planning a series of papers on “planning for the boom” over the coming year. The first, asking how high employment could plausibly rise under conditions of sustained strong demand, will be coming out later this month. In the meantime, here are some things I’ve written over the past few years, making the case that there is much more space for demand-led growth in the US economy than conventional estimates suggest, and that the benefits from pursuing it are broader than just producing more stuff.

In my recent post on the economics of the Rescue Plan, I highlighted the way in which the expansive public spending of the Biden administration implicitly embraces a bigger role for aggregate demand in the longer term trajectory of the economy and not just in short-run fluctuations:

Overheating may have short-term costs in higher inflation, inflated asset prices and a redistribution of income toward relatively scarce factors (e.g. urban land), but it also is associated with a long-term increase in productive capacity — one that may eventually close the inflationary gap on its own. Shortfalls on the other hand lead to a reduction in potential output, and so may become self-perpetuating as potential GDP declines.

I’ve continued making this argument in an ongoing debate with the University of Chicago’s Harold Uhlig at this new site Pairagraph. I also discussed it with David Beckworth on his excellent macroeconomics podcast. 

In many ways, this story starts from debates in the mid 2010s about the need for continued stimulus, which got a big impetus from Bernie Sanders first campaign in 2016. I tried to pull together those arguments in my 2017 Roosevelt paper What Recovery? There, I argued that the failure of per-capita GDP to return to its previous trend after 2009 was a striking departure from previous recessions; that an aging population could not explain the fall in labor fore participation; that slower productivity growth could be explained at least in part by weak demand; and the the balance of macroeconomic risks favored stimulus rather than austerity.  

In a more recent post, I noted that the strong growth and low unemployment of the later part of the decade, while good news in themselves, implied an even bigger demand shortfall in the aftermath of the recession:

In 2014, the headline unemployment rate averaged 6.2 percent. At that time, the benchmark for full employment (technically, the non-accelerating inflation rate of unemployment, or NAIRU) used by the federal government was 4.8 percent, suggesting a 1.4 point shortfall, equivalent to 2.2 million excess people out of work. But let’s suppose that today’s unemployment rate of 3.6 percent is sustainable—which it certainly seems to be, given that it is, in fact, being sustained. Then the unemployment rate in 2014 wasn’t 1.4 points too high but 2.6 points too high, nearly twice as big of a gap as policymakers thought at the time. 

I made a similar set of arguments for a more academic audience in a chapter for a book on economics in the wake of the global financial crisis,  Macroeconomic Lessons from the Past Decade”. There, I argue that

the effects of demand cannot be limited to “the short run”. The division between a long-run supply-side and a short-run demand-side, while it may be useful analytically, does not work as a description of real world developments. Both the size of the labor force and productivity growth are substantially endogenous to aggregate demand. 

This set of arguments is especially relevant in the context of climate change; if there is substantial slack in the economy, then public spending on decarbonization can raise current living standards even in the short run. Anders Fremstad, Mark Paul and I made this argument in a 2019 Roosevelt report, Decarbonizing the US Economy: Pathways toward a Green New Deal. I made the case much more briefly in a roundtable on decarbonization in The International Economy:

The response to climate change is often conceived as a form of austerity—how much consumption must we give up today to avoid the costs of an uninhabitable planet tomorrow? … The economics of climate change look quite different from a Keynesian perspective, in which demand constraints are pervasive and the fundamental economic problem is not scarcity but coordination. In this view, the real resources for decarbonization will not have to be withdrawn from other uses. They can come from an expansion of society’s productive capabilities, thanks to the demand created by clean-energy investment itself. 

If you like your economics in brief video form, I’ve made this same argument about aggregate demand and climate change for Now This.

The World War II experience, which Mike and I highlight in the Times piece, is discussed at length in a pair of papers that Andrew Bossie and I wrote for Roosevelt last year. (Most of what I know about the economics of the war mobilization is thanks to Andrew.) In the first paper, The Public Role in Economic Transformation: Lessons from World War II, we look at the specific ways in which the US built a war economy practically overnight; the key takeaway is that while private contractors generally handled production itself, most investment, and almost all the financing of investment, came from the public sector. The second paper, Public Spending as an Engine of Growth and Equality: Lessons from World War II, looks at the macroeconomic side of the war mobilization.

Among the key points we make here are that potential output is much more elastic in response to demand than we usually assume; that both the labor force and productivity respond strongly to the level of spending; that the inflation associated with rapid growth often is a sign of temporary shortfalls or bottlenecks, which can be addressed in better ways than simply reducing aggregate spending; and that strong demand is a powerful force for equalizing the distribution of income. The lessons for the present are clear:

The wartime experience suggests that the chronic weak demand the US has suffered from for at least the past decade is even more costly than we had realized. Not only does inadequate spending lead to slower growth, it leads to lower wage gains particularly for those at the bottom and reinforces hierarchies of race and sex. Conversely, a massive public investment program in decarbonization or public health would not only directly address those crises, but could also be an important step toward reversing the concentration of income and wealth that is one of the great failures of economic policymaking over the past generation. 

I also discuss the war experience in this earlier Dissent review of Mark Wilson’s book Destructive Creation, and in a talk I delivered at the University of Massachusetts in early 2020.

Alternative approaches to inflation control isn’t something I’ve written a lot about —  until recently, the question hasn’t seemed very urgent. But Mike, me and our Roosevelt colleague Lauren Melodia did write a blog post last month about why it’s a mistake to worry about somewhat higher inflation numbers this year. One aspect of this is the “base effect” which is artificially increasing measured inflation, but it’s also important to stress that genuinely higher inflation is both a predictable result of a rapid recovery from the pandemic and not necessarily a bad thing. 

A few years ago, Mike and I wrote a paper arguing for a broader toolkit at the Fed. Our focus at the time was on finding more ways to boost demand. But many of the arguments also apply to a situation — which we are definitely not in today, but may be at some point — where you’d want to rein demand in. Whichever way the Fed is pushing, it would be better to have more than one tool to push with. 

Another important background debate for the Times piece is the idea of secular stagnation, which enjoyed a brief vogue in the mid 2010s. Unfortunately, the most visible proponent of this idea was Larry Summers, who … well, let’s not get into that here. But despite its dubious provenance, there’s a lot to be said for the idea that recent decades have seen a persistent tendency for total spending to fall short of the economy’s productive potential. In this (somewhat wonkish) blog post, I discussed this idea in terms of Roy Harrod’s model of economic growth, and suggested a number of factors that might be at work:

for secular, long-term trends tending to raise desired saving relative to desired investment we have: (1) the progressive satiation of consumption demand; (2) slowing population growth; (3) increasing monopoly power; and (4) the end of the industrialization process. Factors that might either raise or lower desired savings relative to investment are: (5) changes in the profit share; (6) changes in the fraction of profits retained in the business sector; (7) changes in the distribution of income; (8) changes in net exports; (9) changes in government deficits; and (10) changes in the physical longevity of capital goods. Finally, there are factors that will tend to raise desired investment relative to desired saving. The include: (11) consumption as status competition (this may offset or even reverse the effect of greater inequality on consumption); (12) social protections (public pensions, etc.) that reduce the need for precautionary and lifecycle saving; (13) easier access to credit, for consumption and/or investment; and (14) major technological changes that render existing capital goods obsolete, increasing the effective depreciation rate. These final four factors will offset any tendency toward secular stagnation.

Hysteresis — the effect of demand conditions on potential output — and secular stagnation are two important considerations that suggest that big boost in spending, as we are looking at now, could permanently raise the economy’s growth path. A third, less discussed consideration is that demand itself may be persistent. I discuss that possibility in a recent blog post.  

An important aspect of an economic boom which we unfortunately could not fit into the op-ed is the way that faster growth and moderately higher inflation reduce the burden of debt for both the private and public sector. Historically, growth rates, inflation and interest rates have had a bigger effect on the household debt ratio than household borrowing has. This is a major focus of my scholarly work — see here and here. The same thing goes for public debt, as I’ve discussed in a blog post here. The degree to which both the past year’s stimulus and a possible future boom has/will strengthen balance sheets across the economy is seriously underappreciated, in my view.

The question of public debt has moved away from center stage recently. Criticism of public spending lately seems more focused on inflation and supposed ”labor supply constraints.” But if the anti-boom contingent shifts back toward scare stories about public debt, I’ve got pre-rebuttals written here and here.

For the broader economic perspective I’m coming from, I haven’t done a better job laying it out than this interview with the Current Affairs podcast. The ostensible topic is Modern Monetary Theory, but it’s really a general conversation about how we should think about the economy. You could also look at the teaching materials on this website. On the more concrete debates about economic potential and the limits to public spending, Arjun Jayadev and I have written a couple of stock-taking pieces: Strange Defeat: How Austerity Economics Lost All the Intellectual Battles and Still Won the War, and more recently The Crash of Austerity Economics.

Finally, I want to highlight something I wrote about a year ago: The Coronavirus Recession Is Just Beginning. There, I argued that the exceptional reduction in activity due to the pandemic would probably be followed by a conventional recession. You will note that this is more or less the opposite of the argument in the Times piece. That’s because my post least year was wrong! But I don’t think it was unreasonable to make that prediction at the time. What I didn’t take into account, what almost no one took into account, was the extraordinary scale of the stimulus over the past year. Well ok! Now, let’s build on that.

Video: Finance and Decarbonization

Here is a roundtable hosted by the Jain Family Institute on finance and decarbonization.

What’s the best way to fund the massive investments the green transition will require? Saule Omarova and Bob Hockett make the case for a specialized National Investment Authority (NIA), which would issue various kinds of new liabilities as well as lend to both the public and private sector. Anusar Farooqui and Tim Sahay present their proposal for a green ratings agency, to encourage private investment in decarbonization. I speak for the Green New Deal approach, which favors direct public spending. Yakov Feygin and Daniela Gabor also take part. Yakov is another voice for the NIA, while Daniela criticizes a private finance-based approach to decarbonization, which effectively puts her with me on team Green New Deal. The panel is moderated by Adam Tooze.

My part starts at around 38:00, if you want to skip to that, but the whole thing is worth watching.

 

Video: The Macro Case for the Green New Deal

(Earlier this week, I gave a virtual presentation at an event organized by the Roosevelt Institute and the Green New Deal Network. Virtual events are inferior to live ones in many, many ways. But one way they are better, is that they are necessarily on video, and can be shared. Anyway, here is 25 minutes on why the economic situation calls for even more spending than the (surprisingly ambitious) proposals from the Biden administration, and also on why full employment shouldn’t be seen as an alternative to social justice and equity goals but as the best way of advancing them.)

Can We Afford a Green New Deal?

[I was at an event the other night bringing together people from the economic-policy and climate activism worlds. I was asked to talk about the macroeconomic case for a Green New Deal, and the question of “how do we pay for it?” Here is a somewhat extended and edited version of my remarks.]

Most of the Democratic candidates now have plans for major public investment programs to deal with the challenge of climate change. These involve spending on the order of 2 percent of GDP on average, ranging from half a percent for Beto O’Rourke up to 4 percent for Bernie Sanders.  

A question that will get asked about any of these plans is, how do we pay for it? Can we afford it?

We might simply reject the question, on the grounds that what we cannot afford is to continue dumping carbon into the atmosphere. Any plan to substantially reduce carbon emissions will pass any reasonable cost-benefit test.

But I think we should answer the “pay for it” question. It has a good answer!

The question is really two questions:

– How can federal government finance it? – what new money coming in will match the new money going out?

– Are the real resources available, or will we have to sacrifice production in other areas?

On first question, given that low interest rates now seem to be a permanent feature of our world, it is very hard to make a an argument that additional borrowing on the scale of 2, 3 or even 4 percent of GDP would be economically costly. When interest rates are below GDP growth rates, the debt-to-GDP ratio stabilzies on its own, even if you run deficits forever. Unlike in the 1980s and 1990s, when interest rates were higher, today it is impossible for public debt to snowball out of control.

If it has no effect on growth, additional debt-financed spending of 2 percent of GDP would bring the debt-GDP ratio to about 105 percent in 2030. Debt-financed spending of 4 percent of GDP would bring the ratio to 125 percent. Looking around the world, or at history, there is just no evidence that debt at that level has any economic costs. The US ended World War II with a debt ratio of about 120 percent of GDP, the UK over 200 percent. Japan today has a debt ratio of 250 percent of GDP, while France and Belgium have debt ratios around 100 percent. None of these countries have seen any of the negative consequences – spiking interest rates, rising inflation, a collapsing exchange rate — that are supposed to follow from excessive government debt. Quite the opposite, in fact.

And if there is any boost to growth from additional spending – any role for what economists call called hysteresis — then the debt ratio would be even smaller. If we take a standard estimate of the multiplier — the boost to GDP from an additional dollar of public spending — of 1.5, and assume half of that effect is permanent, then debt-financed public spending can actually leave the debt ratio lower than it would be otherwise. In which case the new spending would fully pay for itself, even without any new revenue. Of course there is a lot of uncertainty around these questions – I wouldn’t promise an effect on growth that large. But it doesn’t seem crazy to think that a program public investment could substantially raise the economy’s productive potential. 

If we do want to raise revenue, there is also plenty of space for taxes on very high incomes and wealth, or a carbon tax, or other taxes that are socially desirable for their own sake, to finance some substantial portion of a decarbonization program. A recent very thorough study of the space for high-end income and wealth taxes by a couple of professors at NYU identified taxes that could raise over 2 percent of GDP on a very targeted base of the highest incomes. A wealth tax, again targeted at the very richest households, could raise another 2 percent or so. These are taxes we would like to raise anyway, because great concentrations of income and wealth are bad for our democracy and for our society. (There’s even evidence they are bad for our health.) So if we can finance decarbonization this way, we shouldn’t see it as a cost.

We often hear that it’s a fantasy to say that decarbonization will be economically costless, that it isn’t realistic to talk about spending on this scale without broad-based tax increases, without sacrifices by the middle class households. But this is crackpot realism. Of course there will be costs in particular carbon-intensive sectors of the economy. But the notion that investing in decarbonization necessarily requires sacrifices by working people in general, or painful choices about the federal budget, is just not borne out by the numbers. 

On the real resources side, the critical point is that by any measure, the US economy has operated below potential for the large majority of the time in recent decades. Taking official statistics at face value, since 1980 there have been 192 months when the unemployment rate was more than one point above the NAIRU – the unemployment rate targeted by the Fed. There have been only 18 months when it was more than one point below. It took a full seven years after the last downturn for output to return to official estimate of potential. The total shortfall equaled 25 percent of GDP. 

Even the most ambitious climate plan would have been barely enough spending to fill that gap.

And there are lots of reasons to think that these official measure understates economic potential. GDP today is more than 10 percent below what was forecast a decade ago. Labor force participation still significantly down from a decade, even among those 25-54 – prime working-age adults. Inflation is still below target. Wage growth is still slow. Almost any alternative measure you can think of suggests that the economy is running well below potential even today, and that there is enough slack for a substantial program of public investment without the need to reduce production of anything else.

Even if we think the economy is operating at normal capacity today, there are major social benefits to letting demand push up against capacity – to running the economy hot. There is strong evidence that the only way you get a rise in the wage share and especially a rise in wages at the lower end, is with sustained very low unemployment – what people call a high-pressure economy. Consistent with that, we’ve begun to see some recovery in wages at the bottom of the distribution in the past couple years. This is welcome, but it’s nowhere enough to make up for losses in previous years. For that, we still need more spending, stronger demand.

And that’s today. In a few years, we are likely to want more spending much more. 

Today many people are talking about the possibility of recession within next year or so. Nobody except for a few cranks is talking about a sudden surge of inflation, or sudden takeoff of wages.

If there is a recession, the ability of the Fed and other central banks to offset a fall in demand is gong to be even more limited this time than it was in the last recession. In past recessions, the Fed has typically reduced rates by 5 points, and this has still not been enough to stabilize demand. Now we will be starting from a federal funds rate of only 2 percent, giving room for only 2 points of cuts. And there is good reason to think that the economy is less sensitive to changes in the policy rate than we used to believe. Central bankers themselves are quite clear that we will need more public spending in a recession. When Fed chair Jay Powell testified before Congress earlier this summer, Alexandria Ocasio-Cortez asked him what he would do in the event of another deep recession. He said monetary policy would not be enough, that the Fed would need help from fiscal policy – from the federal government spending more. Christine Lagarde, in her first public comments after being appointed head of the European Central Bank, said the same thing, that governments in the eurozone needed to spend more to boost demand. The central bank can’t be “the only game in town,” she said.

One of the big lessons of the stimulus debates in the last recession is that it is very hard to ramp up public spending in a hurry. There are not a lot of “shovel ready” projects out there waiting for someone to just start writing checks. So if we think we are going to need a big boost to public spending in the near future, we had better begin ramping it up now. 

Many discussions of the cost of responding to climate change start from the idea that we are fully using our resources. If this were true, we’d have to ask how much consumption is worth giving up today in order to maintain a habitable planet in the future. Obviously the answer should be: A lot! But we don’t have to ask the question, because it isn’t true. We are living in a world where we are not using all our real resources, because of a lack of demand. Some people call this secular stagnation.  We are living in a world where the central macroeconomic problem is that there is too little spending to fully utilize the economy’s productive potential – not just occasionally in recessions, but all the time, or at least on average. 

Some people will say to this: Ok, we agree that the economy is running below capacity. We agree there is space to add more federal debt, and to raise taxes on the rich. Still, you could use that space for anything. It’s not a case for Green New Deal specifically.

This sounds superficially reasonable, but I don’t think it’s right. Because the evidence of recent history suggests that we won’t use that space.

Almost everyone today agrees that stimulus in last recession was too small — and that even if it might have been big enough in the abstract, it was offset by massive anti-stimulus at the state-local level. The situation in Europe is even worse, with deep austerity almost everywhere, with the result that countries like Italy have lower GDP than a decade ago. Even when mainstream economists say there is actually a case for deficit spending and not to worry about balanced budgets, it turns out to be very hard to get the political system to listen.

If we don’t use our productive capacity and our financial capacity for a Green New Deal, it’s very likely we won’t use it for anything.

The discussion  of public budgets, among economists and much of the media and policy world, has not caught up to reality. We still talk about governments being subject to deficit bias – that’s a term of art in the macroeconomics literature, used to justify all kinds of rules to restrict government spending. We have this idea that without some sort of hard external constraint, elected officials are going to declare it’s Christmas every day and shovel money out the door on anything popular. We assume that you need some sort of disciplining device to force policymakers to make hard choices, or else they will just try to spend without limit. But governments today don’t suffer from deficit bias. On the contrary: The problem is austerity bias. For whatever reason governments refuse to spend even when the economic case for it is overwhelming. 

This isn’t just a wasted opportunity for all sorts of valuable public spending. It imposes real costs in slower growth, fewer jobs, lower wages. And slow growth and low employment and wages have political costs too, as we know. 

In this environment, it’s wrong to think about tradeoffs and making hard choices. This may sound strange coming from an economists, but it’s wrong to think about opportunity costs. The question is not, why should we do this rather than that? The question is, how do we break through the logjam that stops us from doing anything at all?

One of the unique things about climate change is that it may be a crisis urgent enough to overcome the entrenched austerity bias of governments, and to push public spending up toward the level needed to get true full employment. It may be the only thing urgent enough other than a major war — which we certainly do not want. 

So when we look at the cost of the climate proposals out there against today’s macroeconomic background, the question should not be, are they too expensive? The question should be: Are they expensive enough?