An electoral battle for the supply side

The writer, an FT contributing editor, is chief executive of the Royal Society of Arts and former chief economist at the Bank of England

Obscured from view by political sloganeering, an ideological war is quietly being waged on both sides of the Atlantic. This is a conflict about how best to design and execute policies to boost medium-term economic growth. Welcome to the battle of the supply-siders.

For most of the past half-century, the supply-side agenda of economic policy has been owned by the political right in the UK and US. The intellectual seeds of this revolution were sown in the early 1970s by free-market economists-cum-philosophers such as Friedrich Hayek and Milton Friedman. They were watered by the Great Inflation of the 1970s which laid bare the shortcomings of demand-oriented Keynesian policy in the face of adverse supply shocks. Indeed, the work of Friedman and others suggested that supply-side stimulus was the only sustainable, non-inflationary, recipe for medium-term growth.

This policy revolution then swept all before it under Margaret Thatcher and Ronald Reagan. Its twin pillars were tight money (to keep a lid on demand and inflation) and low taxes (to unlock incentives to invest and work). Courtesy of the Laffer curve, some believed tax cuts might even pay for themselves.

The pendulum has swung decisively during the 21st century. Unprecedented state intervention followed the global financial crisis, pandemic and cost of living crisis, causing taxes to rise. Nonetheless, as elections have neared and a second great inflation has befallen us, a tax-cutting, supply-side agenda has re-emerged on the political right. 

In the UK, recent budgets by the Conservative party have seen rises in tax allowances to encourage business investment and cuts to national insurance rates to encourage people into work. The party’s recent manifesto centred on a carrot-and-stick combination of large-scale cuts to both benefits and taxes to reinforce work incentives.

There is little doubt that the current growth malaise is rooted in supply-side problems — a slowing in both productivity and workforce growth, caused by ageing populations, years of under-investment and fractured global supply chains. What does not follow is that the earlier tax-cutting prescription is appropriate now.

There is another way, which the political left in a number of countries is pursuing with vigour. In the US, Janet Yellen’s “modern” supply-side agenda has resulted in blockbuster industrial strategy programmes. On most economic criteria, these have been an astonishing success. Many millions of new US jobs have been created since 2019, economic growth has exceeded the G7 average and productivity growth has bucked international trends.

This modern supply-side agenda is now the centrepiece of the UK Labour party’s manifesto. Industrial strategy is its foundation stone, supported by an array of new institutions and quangos — Great British Energy, Skills England, the National Infrastructure and Service Transformation Authority and a National Wealth Fund.

The contrast with 1970s-style supply-side policies could scarcely be starker. Then, the measures were narrow and fiscal. Now, they are broad and structural. The strength of the evidence base is incomparable. There is not a scintilla of proof that tax cuts, by themselves, would be sufficient to shift work and investment incentives. The many other barriers to people working (such as poor skills) and businesses investing (such as weak infrastructure) are now more important. As for the Laffer curve, evidence is flimsier than the napkin on which it was first sketched.

Effective modern supply-side policies focus on lifting those barriers to work and investing at source. The popularity of industrial strategies in doing so has exploded. These measures are no quick fix. Nor do they guarantee success — there are as many bad as good examples and a quangocracy does not a growth plan make. But the body of international evidence suggests well-targeted industrial strategies have had success in revitalising the supply side in a growing number of countries. In some, such as South Korea and Singapore, they have generated something approaching a supply-side miracle.

It would be naive to think this year’s elections in Britain and the US will be a battle of economic ideas won, 1970s-style, by the party whose policies boast the greatest conceptual coherence and empirical support. But dare to dream. For if the scales of electoral justice were to be tipped decisively by economic evidence, we would witness a centre-left landslide on both sides of the Atlantic.

Letter in response to this comment:
A well tar­geted indus­trial strategy just isn’t enough / From James Sproule, UK Chief Eco­nom­ist, Han­dels­banken, Lon­don E1, UK