Warsh Claims the Old Economic Playbook Is Outdated
“Well, times sure have changed. We’ve come to a hinge point in history.”
That was Kevin Warsh at Jackson Hole on Friday, quickly moving past the economic gloom that characterized the years following the financial crisis. He mentioned themes like secular stagnation, a global saving glut, the overwhelming flow of capital in search of valuable investments, and the nagging feeling that maybe all the groundbreaking innovations had already seen their day.
Warsh reiterated this point at the G20’s opening session on Monday.
Many, perhaps most, people probably overlooked a literal footnote in Warsh’s Jackson Hole speech. He noted that he took the phrase “hinge point” from George Shultz, who was a prominent figure as the former Secretary of State under Reagan, an economist, and a mentor to Warsh. Close acquaintances of Warsh often describe Shultz as a guiding influence in his life.
In his 2020 book A Hinge of History, co-written with James Timbie, Shultz suggested that the world has reached a pivotal moment, one that parallels the crucial years after World War II. Rapid technological advancements, shifting demographics, and outdated institutional frameworks are all signs of this transformation. “The near future is not going to be like the near past,” Shultz articulated in his book, which echoes what Warsh conveyed at Jackson Hole and the G20 meeting in Asheville.
For a long time now, economic policy has been shaped by a prevailing sense of demand scarcity. Weak growth seemed to be the norm, and opportunities for investment were limited. Policymakers frequently fretted over job creation in an environment where labor was plentiful, despite contradictory claims that there were roles Americans simply wouldn’t take. Consequently, the classic Keynesian strategy of leveraging government deficits to ignite demand gained traction. Globally, central banks slashed interest rates to near-zero levels to spur borrowing and investment, along with purchasing bonds to discourage the safety of holding cash. The dominant concern for U.S. policymakers and others in developed economies was the potential for economic stagnation due to insufficient demand.
A New Kind of Opportunity Society
However, we might now be stepping into an era that feels quite the opposite—a landscape filled with abundant opportunities for labor and capital alike.
Warsh highlighted the significant investments pouring into sectors like artificial intelligence, data centers, energy, and associated infrastructure. He pointed out that business capital spending is increasing at about nine percent, marking the most significant growth since 2021, yet without a prior economic downturn to rebound from. Experiencing rising investments during an economic recovery is historically unusual, but maybe this is what we’ll come to call the “new new normal.”
AI, still in its infancy, could evolve into a new production factor. Productivity growth has the potential to ramp up considerably, which, in turn, could enhance the economy’s growth capacity. We might soon realize that the Fed’s longstanding estimate of a two percent long-term economic growth potential is based on an outdated perspective.
Meanwhile, growth in the labor force has dramatically slowed. When the labor force expanded rapidly and unemployment rates were high, tracking job numbers was a relevant metric for assessing economic health. However, in an economy teetering on full employment with sluggish labor force growth, those comparisons can lose their significance. If one policy creates another million jobs by needing a million additional workers for the same output, while another achieves similar additional output using advanced machinery, software, and AI with minimal workforce expansion, the latter approach is economically superior. We need to shift our focus away from merely counting job creation towards understanding how much of our limited labor is required relative to the output produced.
A New Policy Mix for a New Economy
In the economic landscape Warsh describes, policy goals should increasingly center around improving output per worker, elevating wages, boosting capital investments, and accelerating productivity growth. Immigration policies should be stringent, alongside high visa fees, so that employers cannot lean on an ever-expanding pool of cheap labor at the expense of investing in technology and productivity improvements. Additionally, education policy must not prioritize college enrollment numbers as an economic goal in itself—a response to plummeting earnings for less-educated workers that often sacrifices productivity for credentials. Instead, a focus on apprenticeships and vocational training is becoming vital. The government’s student loan initiatives can be gradually phased out, and the reliance on student visas and post-graduation work programs—which have historically expanded the supply of educated labor—can diminish as the economic necessity for such measures declines. We should aim to cultivate domestic talent where it can truly enhance production and complement an increasingly capital-intensive economy.
Moreover, policies must ensure abundant energy, essential minerals, robust transport and power infrastructures, and the domestic ability to manufacture technologies vital for the new economy. Regulations concerning permitting, taxes, and other aspects should be evaluated based on their ability to spur investment and expand productive capacity.
Fiscal and monetary strategies will need to adapt as well. In an environment marked by limited investment opportunities and persistent weak demand, expanding government roles, deficit spending, and keeping interest rates low were justifiable as means to utilize idle labor and capital. In contrast, in a landscape rife with investment possibilities and scarcity of labor, government borrowing could compete with private capital investments, while low-interest rates risk triggering inflation. Efforts to downsize government roles, as President Trump has initiated, could free up labor for more productive private sector work.
If we navigate this transition correctly, we could uncover ways to tackle many long-standing challenges. Enhancing productivity might allow fewer workers to support a growing retiree population without imposing steep tax hikes, potentially resolving the Social Security crisis that many fear. Improved job security and wages may encourage younger individuals to form families sooner, akin to how the post-war Baby Boom blossomed. Labor scarcity could elevate incomes and diminish income inequality, reducing the kinds of divisive politics that have recently drawn younger demographics toward socialist ideals.
Needed: New Measures of Economic Success
This also signals that economists must significantly improve how they gauge the supply side of the economy. Warsh made this clear when mentioning the second principle of monetary policy. While we can observe economic activity, direct insights into aggregate supply remain elusive; we have to rely on inference. This challenges traditional understanding, as economic measures were shaped by experiences during the Great Depression and were primarily designed to monitor demand deficiencies.
We need more precise methods to evaluate the economy and a renewed lexicon for economic policy. Instead of merely querying how many jobs might result from a given policy, we ought to consider how much extra output it could generate and how much limited labor it would consume. Metrics like overall GDP and payroll growth offer diminishing insights into economic success in this context. Instead, indicators like GDP per capita, output per worker, productivity, real wages, and capital formation provide a clearer picture.
In Schultz’s view, a historical hinge signifies a moment where choices are critically important, as old systems falter and new ones have yet to be established firmly. While technology, demographics, and capital flows might be ushering us into a new economic age, they don’t dictate how that era will unfold. Policy, institutions, and the national character remain significant factors. The decisions we make now will shape whether accelerated growth leads to widespread prosperity or if we squander the chance by forcing the new economy into outdated frameworks.
