To Fix the Supply Chain, Get the Economists Out of the Way
AP Photo/Eric Risberg
To Fix the Supply Chain, Get the Economists Out of the Way
AP Photo/Eric Risberg
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Ships passing through the Suez Canal carry 12 percent of the world’s goods from Asia to Europe and North America.(1) But last March, the container ship Ever Given got stuck sideways in the canal. Container ships backed up for miles, creating a potential economic crisis.

To avoid price spikes associated with diverting ships around the Cape of Good Hope in South Africa, authorities and logistics experts worked around the clock to free the ship from the sandbar. Within a week, the ship was freed and the crisis was resolved.

Perhaps there is an alternative universe in which pundits and policymakers offered a different solution. There, it took longer to free the Ever Given. Shortages of goods began to appear and prices of scarce goods rose to cover the extra cost of shipping. As inflation rose, the Federal Reserve and the media delivered the somber message that the problem facing us was that we were trying to live beyond our means. Monetary policy had kept interest rates low and the government’s relief efforts during the Covid pandemic had elevated household incomes. The canal being blocked, these policies had pushed demand above the level that shippers could handle. The more government pumped money into the economy, the more we would try to buy, the more ships would back up in the Canal, and the higher prices would skyrocket.

But if the Fed just raised interest rates and Congress pared back spending, demand for goods and services would fall to match the number of ships that could make it through the canal, customers would stop pulling goods from supermarket shelves, and prices would stabilize.

If you think this policy response would have been absurd, you are right. Thankfully, policymakers did not take this approach to resolving the Ever Given crisis, because we do not live in this alternative universe.

Or do we?

Today our economy is beset by an Ever Given crisis on a massive scale. Ships are backed up at ports in California because of Covid protocols and a shortage of truckers. Bottlenecks have appeared in other sectors of the economy as well. Covid outbreaks abroad have created a global semiconductor shortage that has pushed the price of cars up. Lumber mills drastically scaled back operations during the pandemic and have struggled to ramp up production in response to resurgent demand. Restaurants seeking to reemploy workers laid off during the pandemic have encountered a workforce made reluctant to return to work by concerns about the pandemic and a lack of child care. They have been forced to raise wages and pass the higher costs along to consumers. The result of these bottlenecks across the economy has been a dramatic rise in inflation.

Concerned about inflation, the Federal Reserve has signaled that it is poised to tighten monetary policy. Following the Fed’s September meeting, Chair Jay Powell suggested that the Fed could begin tapering bond purchases as early as November. Also in that meeting more members of the Fed’s policymaking committee penciled in interest rate increases in 2022 than had in previous meetings. Meanwhile, Joe Manchin and other moderate Democrats are demanding that the Biden Administration’s spending proposals be pared down to avert higher inflation. Policymakers seem to be headed down the road not traveled in my parable above.

Of course the Fed has a statutory responsibility to maintain price stability as well as maximum employment. When spending pushes beyond the economy’s productive capacity, these goals are not in conflict. Employment rises to unsustainable levels, inflation increases, and policymakers properly act to reduce demand through interest rate increases and (sometimes) restraint on spending.

But that is not the case today. Every indicator suggests that the economy is producing below capacity, not pushing up against the economy’s long-term capacity. Theunemployment rate is considerably higher than it was before the pandemic and the labor force participation rate is lower. Factories are operating at lower capacity than they normally do when the economy is strong. Most dramatically, there are over 5 million fewer people working today than before Covid hit, over eight million fewer than would be working if employment had increased at its 2019 pace up to now. We have the unused productive resources to satisfy the current level of demand. The problem is supply chain problems that need to be fixed.

Let’s think clearly about what the proponents of monetary and fiscal contraction are proposing. Ships are backed up at ports in California: let’s use budget cuts and interest rate increases to reduce Americans’ incomes so they seek to purchase no more goods than can be unloaded at the ports under current conditions. Ships loaded with goods Americans can no longer afford to buy will head back to their home countries, the problem at the ports will be resolved, and prices will begin to fall. Automobile manufacturers can’t produce enough cars to satisfy demand because of the shortage of semi-conductors, and soemployment in the automobile sector remains 70,000 below its pre-pandemic level. Let’s reduce people’s incomes so they no longer can afford to buy cars and so don’t need to bring those workers back. Restaurants can’t find the workers they need to be fully staffed, so let’s make it so people can’t afford to eat out. This is a tremendously destructive way to resolve our inflation problem.

What is the alternative? It is to work as hard as we can to resolve the supply chain issues, to get the global economy off of the sandbar on which it is currently grounded.

The Biden administration has created a task force to address supply chain issues, and their efforts may be of some use. But the bulk of the solution will come from the efforts of private sector businesses, motivated precisely by the strong demand for their products and the rising costs of inputs and transportation.

Already companies are making progress in overcoming bottlenecks. When lumber prices skyrocketed in the spring, companies responded by reopening shuttered mills, and by the end of the summer prices had fallen most of the way back to pre-pandemic levels. Procter & Gamble has relocated production, changed shipping routes, and reformulated products in order to get around supply chain problems. Venture capital firms are investing in companies that are coming up with innovative solutions to bottlenecks. A company called Flock Freight, for instance, recently raised over $200 million to fund investment in a shipment-pooling algorithm and machine learning technology to help shippers bypass clogged freight hubs. After prodding from the Biden administration, ports in southern California plan to move to 24/7 operations. These plans depend on railroad and trucking companies resolving logistical problems of their own, but in a hopeful sign Union Pacific Railroad has announced that it will expand its operating hours at the Port of Los Angeles. A recent survey of automobile manufacturers and suppliers finds that a large number of companies are investing in new technologies to manage supply chains and diversifying their sources of critical components or moving production back to their home countries.

One of the hopeful developments coming out of the Covid pandemic is the ability of newly empowered workers to extract higher wages and better working conditions from their employers, especially in sectors such as the restaurant industry. Average wages in the leisure and hospitality sectorrose by almost 10 percent from January to September of this year, compared to an average annual increase of just 2.5 percent in the decade before the pandemic. Contracting policy now will not only delay the transition back to work for these people. It will pull the rug out from under a working class that finally has a living wage in its sights after decades of stagnating incomes.

Finally, rising rents are one of the biggest reasons for the increase in inflation this year. Higher rents are especially painful to the poor and working class. But a withdrawal of income support through fiscal contraction and a slowdown in growth through higher interest rates will hurt the poor and working class as well. Rents are high because housing is scarce, a result of a slowdown in construction since the housing bubble burst in 2006. The solution to the housing shortage is to build more housing. Are we really contemplating a “solution” that involves throwing the people who can’t afford current rents out of work and removing the incentive to build more houses by raising interest rates and lowering incomes?

Fiscal and monetary policy contraction is not a sensible solution to the inflation problem we currently face. Businesses are making innovations in distribution and production processes to blast through the bottlenecks in the supply chain. Why would we remove their incentives to do this by reducing demand for their products? Inflation hurts people with low incomes. Why are we contemplating solutions that involve taking their jobs away instead?

We have the unemployed resources to produce our way out of our inflation problem while maintaining the current level of demand. That is what we should do.

Charles Weise, professor of economics at Gettysburg College, focuses his scholarship on macroeconomic issues such as the political influences on U.S. monetary policy. 

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