So, inflation is rising fast, and central banks are under pressure to take drastic action. But their only real option is to reduce demand, by raising interest rates and withdrawing liquidity. These measures have already spurred a massive repricing of assets, including currencies, and they threaten to push global growth below potential, with lower-income economies suffering disproportionately, and to reduce investment in the energy transition.
There is another way: supply-side measures. Trade and investment have long enabled supply to expand rapidly in response to growing global demand. But, for nearly two decades – and especially in the last few years – proliferating trade barriers have been adding friction to this process. Creeping protectionism must be reversed, with US President Joe Biden removing the tariffs imposed by his predecessor, Donald Trump, and Europe accelerating the integration of its services markets.
At the same time, efforts must be made to improve productivity. Digital technologies will be crucial here. While the pandemic helped to accelerate the digital transformation, many sectors – including the public sector – are lagging, and concerns about the effects of automation on employment persist.
But in a supply-constrained world characterized by persistent labor shortages, productivity-boosting digital technologies, together with higher wages for workers, would go a long way toward improving the balance between supply and demand. For example, artificial-intelligence-based tools can perform a wide range of functions, from screening luggage more efficiently at airports to analyzing medical imaging to detect cancers. Beyond digital technologies, regulatory regimes can be streamlined and improved, in order to reduce supply-side bottlenecks.
Such an agenda must be applied to both the public and private sectors. At the international level, efforts to facilitate trade, address supply-chain rigidities, and close data gaps will be essential. Otherwise, central banks will be left to deal with inflation alone – with dire consequences for the entire global economy.
Michael Spence, a Nobel laureate in economics, is Professor of Economics Emeritus and a former dean of the Graduate School of Business at Stanford University. He is Senior Fellow at the Hoover Institution, serves on the Academic Committee at Luohan Academy, and co-chairs the Advisory Board of the Asia Global Institute. He was chairman of the independent Commission on Growth and Development, an international body that from 2006-10 analyzed opportunities for global economic growth, and is the author of The Next Convergence: The Future of Economic Growth in a Multispeed World (Macmillan Publishers, 2012).