Inflation is—by common agreement—the primary issue faced by American voters today.  However when you ask people what’s causing inflation, things are quickly not so clear. 

Republicans will say immediately say that it’s all due to overspending by the profligate Democrats. Democrats will talk about worldwide trends that are beyond the scope of what the Biden administration can control.  In neither case do you turn the important issue of inflation into useful steps going forward.  That needs to be done, and we give it a shot here.  The result may be a little different than expected.

First of all inflation necessarily involves both supply and demand, and both are clearly in play here.  The Democrats’ desire to keep people whole at the end of the pandemic did put extra money in the hands of consumers., and that extra money was chasing a limited supply of available products and services.   But it also turned out that as the pandemic eased, we became conscious of all kinds of production bottlenecks that people hadn’t anticipated.  Some of those bottlenecks have gotten a lot of press, integrated circuits required for production of new cars for example.  Other bottlenecks involved consequences of Covid, such as the breakdown of daycare systems. 

The Covid payments certainly had an initial effect. However at this late date, when any Covid benefits are long-gone, the continuing pervasiveness of bottlenecks has got to be viewed as the major issue.  Car prices for example represent a third of measured inflation. What are we to make of bottlenecks persisting even now?  (Gas and food prices are now directly tied to the Ukraine war, so they are their own story.)

The most prevalent reaction has been xenophobia.  We’ve got problems because we’ve let ourselves get too dependent on the Chinese.  Bring it all home and we’ll be fine.  That sounds nice, and we certainly do have continuing problems with Chinese sources, because of their zero-Covid policies today.

But that conclusion is actually wrong. We give two examples.  One example we’ve given before:  the single worst problem during the first stage of the Covid crisis was a lack of testing equipment—because the American manufacturer with a CDC contract to produce the tests had decided they could make more money doing something else.  The second example is active today—the baby formula crisis.  Consolidation in the industry was such that a single vendor’s contaminated equipment led to a massive shortfall in supply. Without rules of fair play “our people” aren’t necessarily going to be so much better than the Chinese. Furthermore the idea that we are somehow going to deliver the best of everything available worldwide to our own businesses is manifestly false.

There are two simple facts to be acknowledged:

1.  Unbridled capitalism is simply NOT robust.  Consolidations, monopolies, and risk-blindness are private sector facts of life.  Even Adam Smith understood that.

2.  The much-expressed desire to decouple from some or all of the rest of the world is both unworkable and unproductive.

There is no substitute for solving both of these problems.  We give examples for each:

1.  The SEC has got to do a better job of making companies confront risk.  Climate change is a good example where work is underway.   Anti-trust activities are also clearly relevant. Then there is the need to limit the power of the consolidated financial sector over the companies they own.  It is established fact that companies today invest less and return more of their profits to their investors—which directly affects robustness.  What all of this comes down to is that today’s inflation is another example of the dangers of unfounded faith in a deregulated private sector.

2.  The world needs a working system of international trade so that international corporations can be transparent and effective.  The Biden administration’s work on international taxation is an important step.  Turning todays moribund WTO into an effective organization is another necessary goal.

It is most important that we stop using inflation as just one more excuse to search for scapegoats.  Even in the near term, we should be looking for more, not less, cooperation with China, as the bottlenecks hurt both countries. And in the longer term, there really are lessons from today’s inflation that can make the world a better place for us and everyone else.