Monday, October 25, 2021


The Revenge of Supply, at Project Syndicate

Surging inflation, skyrocketing energy prices, production bottlenecks, shortages, plumbers who won’t return your calls – economic orthodoxy has just run smack into a wall of reality called “supply.” 

Demand matters too, of course. If people wanted to buy half as much as they do, today’s bottlenecks and shortages would not be happening. But the US Federal Reserve and Treasury have printed trillions of new dollars and sent checks to just about every American. Inflation should not have been terribly hard to foresee; and yet it has caught the Fed completely by surprise. 

The Fed’s excuse is that the supply shocks are transient symptoms of pent-up demand. But the Fed’s job is – or at least should be – to calibrate how much supply the economy can offer, and then adjust demand to that level and no more. Being surprised by a supply issue is like the Army being surprised by an invasion. 

The current crunch should change ideas. Renewed respect may come to the real-business-cycle school, which focuses precisely on supply constraints and warns against death by a thousand cuts from supply inefficiencies. Arthur Laffer, whose eponymous curve announced that lower marginal tax rates stimulate growth, ought to be chuckling at the record-breaking revenues that corporate taxes are bringing in this year. 

Equally, one hopes that we will hear no more from Modern Monetary Theory, whose proponents advocate that the government print money and send it to people. They proclaimed that inflation would not follow, because, as Stephanie Kelton puts it in The Deficit Myth, “there is always slack” in our economy. It is hard to ask for a clearer test. 

But the US shouldn’t be in a supply crunch. Real (inflation-adjusted) per capita US GDP just barely passed its pre-pandemic level this last quarter, and overall employment is still five million below its previous peak. Why is the supply capacity of the US economy so low? Evidently, there is a lot of sand in the gears. Consequently, the economic-policy task has been upended – or, rather, reoriented to where it should have been all along: focused on reducing supply-side inefficiencies. 

One underlying problem today is the intersection of labor shortages and Americans who are not even looking for jobs. Although there are more than ten million listed job openings – three million more than the pre-pandemic peak – only six million people are looking for work. All told, the number of people working or looking for work has fallen by three million, from a steady 63% of the working-age population to just 61.6%. 

We know two things about human behavior: First, if people have more money, they work less. Lottery winners tend to quit their jobs. Second, if the rewards of working are greater, people work more. Our current policies offer a double whammy: more money, but much of it will be taken away if one works. Last summer, it became clear to everyone that people receiving more benefits while unemployed than they would earn from working would not return to the labor market. That problem remains with us and is getting worse. 

Remember when commentators warned a few years ago that we would need to send basic-income checks to truck drivers whose jobs would soon be eliminated by artificial intelligence? Well, we started sending people checks, and now we are surprised to find that there is a truck driver shortage. 

Practically every policy on the current agenda compounds this disincentive, adding to the supply constraints. Consider childcare as one tiny example among thousands. Childcare costs have been proclaimed the latest “crisis,” and the “Build Back Better” bill proposes a new open-ended entitlement. Yes, entitlement: “every family who applies for assistance … shall be offered child care assistance” no matter the cost. 

The bill explodes costs and disincentives. It stipulates that childcare workers must be paid at least as much as elementary school teachers ($63,930), rather than the current average ($25,510). Providers must be licensed. Families pay a fixed and rising fraction of family income. If families earn more money, benefits are reduced. If a couple marries, they pay a higher rate, based on combined income. With payments proclaimed as a fraction of income and the government picking up the rest, either prices will explode or price controls must swiftly follow. Adding to the absurdity, the proposed legislation requires states to implement a “tiered system” of “quality,” but grants everyone the right to a top-tier placement. And this is just one tiny element of a huge bill. 

Or consider climate policy, which is heading for a rude awakening this winter. This, too, was foreseeable. The current policy focus is on killing off fossil-fuel supply before reliable alternatives are ready at scale. Quiz: If you reduce supply, do prices go up or go down? Europeans facing surging energy prices this fall have just found out. 

In the United States, policymakers have devised a “whole-of-government” approach to strangle fossil fuels, while repeating the mantra that “climate risk” is threatening fossil-fuel companies with bankruptcy due to low prices. We shall see if the facts shame anyone here. Pleading for OPEC and Russia to open the spigots that we have closed will only go so far. 

Last week, the International Energy Agency declared that current climate pledges will “create” 13 million new jobs, and that this figure would double in a “Net-Zero Scenario.” But we’re in a labor shortage. If you can’t hire truckers to unload ships, where are these 13 million new workers going to come from, and who is going to do the jobs that they were previously doing? Sooner or later, we have to realize it’s not 1933 anymore, and using more workers to provide the same energy is a cost, not a benefit. 

It is time to unlock the supply shackles that our governments have created. Government policy prevents people from building more housing. Occupational licenses reduce supply. Labor legislation reduces supply and opportunity, for example, laws requiring that Uber drivers be categorized as employees rather than independent contractors. The infrastructure problem is not money, it is that law and regulation have made infrastructure absurdly expensive, if it can be built at all. Subways now cost more than a billion dollars per mile. Contracting rules, mandates to pay union wages, “buy American” provisions, and suits filed under environmental pretexts gum up the works and reduce supply. We bemoan a labor shortage, yet thousands of would-be immigrants are desperate to come to our shores to work, pay taxes, and get our economy going. 

A supply crunch with inflation is a great wake-up call. Supply, and efficiency, must now top our economic-policy priorities.


Update: I am vaguely aware of many regulations causing port bottlenecks, including union work rules, rules against trucks parking and idling, overtime rules, and so on. But it turns out a crucial bottleneck in the port of LA is... Zoning laws! By zoning law you're not allowed to stack empty containers more than two high, so there is nowhere to leave them but on the truck, which then can't take a full container. The tweet thread is really interesting for suggesting the ports are at a standstill, bottled up FUBARed and SNAFUed, not running full steam but just can't handle the goods. 

Disclaimer: To my economist friends, yes, using the word "supply" here is not really accurate. "Aggregate supply" is different from the supply of an individual good. Supply of one good increases when its price rises relative to other prices. "Aggregate supply" is the supply of all goods when prices and wages rise together, a much trickier and different concept. What I mean, of course, is something like "the amount produced by the general equilibrium functioning of the economy, supply and demand, in the absence of whatever frictions we call low 'aggregate demand', but as reduced by taxes, regulations, and other market distortions." That being too much of a mouthful, and popular writing using the word "supply" and "supply-side" for this concept, I did not try to bend language towards something more accurate. 


  1. This reads like a piece of narrative from Atlas Shrugged-- which is a commentary on the current situation more than anything.

    There is reason Casey Mulligan's blog is called "supply and demand (in that order)".

    MMT recommends cutting spending or raising taxes to stop inflation. Have I missed all the calls from MMT advocates for cutting spending or increasing taxes (without additional spending) to reduce inflation?

    1. We ARE living in Atlas Shrugged .. look at the shortages ...

  2. The irony of our terrible policy is the weakest among us are paying the price via inflation: those who don't own financial assets, don't have strong labor bargaining power, are on fixed incomes, etc. Amazing that this is tolerated by the "woke" crowd.

    1. Indeed. If your Marginal Utility of an Extra dollar is high, absorbing these price shocks hurts real bad.

  3. It's interesting the timing on this post because it relates to a game project my friend and I are working on. The biggest issues right now are instantiating supply and demand so there's price information to the market. But this post certainly clarifies a chicken and egg problem: supply really does matter. Sand in the gears is a good way of phrasing it. But I also see cost push and demand pull piling on top of one another to create these problems. Lots of money around and sand in the gears. Anyway, fundamentals don't go away, do they?

  4. I found it odd that you seem to believe that the current reality and evident policy failures might actually change peoples minds. I think it is equally likely that policymakers and commentators will concoct some fantasy counter-explanation or simply pretend that the evidence doesn't exist.

    I mean, I hope we can take this moment to clean the sand out of the gears and slow the federal govts printing and spending of money, but I am not very hopeful.

    1. Indeed. Throwing money at problems doesn't magically make them go away. Economies are subject to laws, policies, and operational competency.

      Are incentives really that messed up? My guess is that policies, like laws, grant *access* to realize benefits via incentive structures. This, of course, sets up a nasty condition to game the system in a way where externalities arise. The market may have an invisible hand, but what strings are attached to its fingers?

  5. John Cochrane is a world class economist, but as he demonstrates in his typical fashion, anyone with an iota of common sense and with even the most basic grasp of high school level economics could predict that the current predicament would not be transitory. But I believe that the policymakers in the current administration cannot be that dumb; they just want to destroy the our current economic system. Politicians like Pelosi who have a net worth of up to $300 million dont need to worry about the impacts of their legislation. Still, keep these essays coming; it is still comfort to enter a world of rationality.

  6. I probably agree with 90% of this blog post as usual. I do wish there was a mention of the $1 trillion a year spent on the Department of Defense and the VA, which will also increase demand but not provide for any additional supply.

    Perhaps a holiday on Social Security taxes on the first $50,000 of income would also increase Ssupply.

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  8. "We bemoan a labor shortage, yet thousands of would-be immigrants are desperate to come to our shores to work, pay taxes, and get our economy going." Why would the thousands or millions of immigrants not be subject to the same disincentives to work and ability to ride the benefit train just like the people already here? I see only two alternatives. One, immigration doesn't really fix anything because the incentives of the game set the ratio of contributors to sponges, not where the people are born. Or two, the immigration must necessarily be illegal so those immigrants can be treated as second-class "citizens" and not subject to the work disincentive that the rest of the populace enjoys.

  9. The way truck drivers are treated, it's obvious why there's a truck driver shortage, and it has nothing to do with checks. Have you been a truck driver? I have. The job sucks.

    1. So what? ... being a coal miner sucks, a waiter working on Saturdays, a construction worker, garbage collector ...

      We cannot all be poets, college professors on inclusiveness or politicians in Washington ... I guess

      Not so many years ago the same "so worried about social issues I am compelling to do something about (or pretend I am)" kind of people, were really worried about self-driving trucks making a job that sucks disappear ...

  10. The typical textbook presentation of supply/demand represents them as 2 dimensional when there is also the everpresent dimension of time. It may take time to create new supplies, but demand can change while the new supplies come online. Both supply and demand are dynamic.

  11. What a unique pile of garbage the Grump has managed to assemble. I might keep a copy of this as it’s not going to age well, like most of the Grump’s takes.
    RE: "... Surging Inflation ..."
    • I know, I know… money supply and all that nonsense. But the current inflation spike is largely focused on:
    • real estate (which is already popping),
    • temporary Covid related bottlenecks, and shortages as workers refused to expose themselves to Covid,
    • Surge in imports as consumers with cash shifted to importable goods, instead of Covid-exposing services,
    • Chip shortage as a result of Covid shutdowns in China, and their effect on car supplies,.
    • In short: it’s all temporary. The Grump will look foolish in 9 months. Aaahhhh!!!! Hyperinflation!!!!!!! Zimbabweeeee!!!!! Weimer Republicccc!!!!!

    RE: "... But the Fed’s job is – or at least should be – to calibrate how much supply the economy can offer, and then adjust demand to that level and no more. ..."
    • Total bullcrap. Monetary policy is the wrong tool to calibrate demand. It’s like pushing on a string, and small increases in interest rates offset their depressionary effect by injecting more money into the economy (through higher interest payments on government bonds), possibly increasing spending and inflation.

    RE: "... chuckling at the record-breaking revenues that corporate taxes are bringing in this year...."
    • If record-breaking revenues were relevant, the Govt is swinging into surplus isn’t it? Oh. It isn’t? oh.

    RE: "... hear no more from Modern Monetary Theory, whose proponents advocate that the government print money and send it to people. ..."
    • MMT is a description of how the monetary/fiscal system works. It does not espouse sending out checks, as was the Trump policy. The logical policy prescription, once MMT is understood, is the Job Gty, which would have made the downturn into a 4 day news cycle, although checks to keep people home in view of the pandemic was n excellent response preventing spiraling into depression. (It worked.) Stephanie Kelton never denied that inflation could materialize, in fact she was clear in several interviews in the past year that a lockdown in production while maintaining incomes risked a spike a temporary inflation, which was a small price to pay to alleviate suffering and maintaining demand where people COULD work. She also pointed out that inflation is easily managed.

    RE: "... Although there are more than ten million listed job openings – three million more than the pre-pandemic peak – only six million people are looking for work. ..."
    • People aren’t looking for work because most of the jobs are for Covid-risking positions. The pandemic is not over (thanks mostly to anti-vaxxer Libertarian clowns. But once we shove them against the car, pull their pants down, and jab their asses, things will get better.)
    • Companies always post more jobs than they actually want to fill. It’s a strategy popularized by GE – fire the bottom 15% of their staff every year, to constantly improve their DNA.

    RE: "... Childcare ..."
    • Obviously if a family gets assistance and can afford childcare, they have an overwhelming incentive to go to work to earn more money.

    RE: "... climate policy..."
    • Perhaps if fossil fuel prices continue to rise, an oil tax won’t be necessary and private sector can get off their asses and develop more alternative (cleaner) energy sources.

    RE: "... where are these 13 million new workers going to come from ..."
    • Hmmm… Where can we get a bunch of fresh workers, ready, willing, and able to work??? Maybe…… what are al those people doing on our southern border????
    • Import them.
    • Have our lazy ass job creators train them.

    Pretty weak effort. What a Grump!


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