2023 recession? Time for more industrial policy, not less

The temptation among mainstream commentators will be that the impending recession requires reduced government spending. This is because unlike a typical recession, this one has been caused by monetary policy to alleviate inflationary pressures. And while this is has mathematical elegance, it is probably wrong.

Why? Because it is pretty evident that most of the inflationary pressures have been caused by ill-thought out global trade policies and flimsy supply lines. Raising interest rates to depress domestic aggregate demand will reduce inflationary pressures caused by wages. But this assumes that global supply chains will fix themselves. Will they? Doesn’t appear to be the case.

Similarly, when will the Russia-Ukraine war end? Who knows. And even when it does end, will this mean a business-as-usual situation for the flow of fertilizers and grains from the two countries? I seriously doubt it.

There is no going back. Covid taught us all that cheap t-shirts from Asia are nice, but necessities need to be produced closer to market just in case. And this requires industrial policy.

For political reasons, nearly all governments facing inflation will have to moderate fiscal expenditures in the short to medium term. But hopefully, the appropriate industrial policies can be introduced to alleviate supply chain-induced inflation. This could include:

  • Reallocating research spending (whether through national research organizations or higher education) to tackle issues related to the supply chain. For instance, can substitute goods be created for materials that are difficult to access? Can agricultural innovations be accelerated or diffused to deal with the shocks to the food system?
  • Existing government outlays on business supports need to be better thought through. The ambulance chasing going on in North America for EV battery plants is overshadowing more serious industrial policies for the domestic production of essential/critical goods.
  • Additional fiscal tools need to be employed to reduce inflation, with the funds reallocated to industrial policy priorities. I’m talking to you, excess profits tax.

More than likely, governments will follow the orthodoxy and stay on the sidelines while a short recession plagues workers. But hopefully, somewhere out there, a visionary and truly progressive government will seize upon this opportunity to start remaking their local economy.

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