While current supply chain problems are unpleasant, they really should not be a surprise to anyone that understands the fundamental problem of economics, the knowledge problem. The knowledge problem, originally characterized by Hayek:
"The economic problem of society is not merely a problem of how to allocate given resources....it is a problem of utilization of knowledge which is not given to anyone in its totality."
This can be understood by recognizing that 'know how' and 'know what' are spread across many minds to paraphrase some of the work by economist Kenneth E. Boulding and as discussed in Peter Boettke's Living Economics. The knowledge problem is also exemplified in the words of Leonard E. Read's pencil in his essay I, Pencil, "Not a single person on the face of this earth knows how to make me."
How does this apply to our supply chain issues? Well because 'know how' and 'know what' are spread across so many minds, not a single person on the face of the earth knows how to make anything. As a result, no one has the knowledge to fix our supply chains. Our supply chains are the result of human action but not human design. They are the product of a hidden emergent order. Of course this is a feature and not a bug. As a result most consumers and policy makers usually remain comfortably blind to the knowledge problem and only briefly opened their eyes to notice when the meat counter was empty during the early days of COVID. Many refuse to see on the grounds of political or philosophical reasons, and employ rhetoric and support policy that bites the invisible hand that literally feeds them.
If planners and policy makers have viewed our economy as an engine that would automatically restart after shutting down like the engine of a car at a traffic light, they have committed the folly of every social planner in history. Instead of thinking of our economy and the supply chains that sustain it as a mechanical system that can be engineered by technicians, a better analogy is an evolving ecosystem. Each product we consume and its components have evolved to fit into very specific niches. We must think of our supply chains as habitats that have been threatened by COVID and our response to it.
Just as restoring an ecosystem after an environmental disaster requires an understanding of ecology, we must understand the ecology of our markets and supply chains in order to restore our economy and avoid an even worse ecological disaster. We must recognize that the knowledge problem post COVID is more challenging than pre covid made evident by recent price spikes and shortages that some people are calling inflation. We have to understand that our supply chains evolved over a number of years, even decades, and ‘regrowth’ will take time and things may not grow back to look like they did before.This could mean higher prices now and well into the near future for a number of goods, with some items reaching new higher equilibrium levels as tastes, preferences, and production practices may have changed post COVID.
But this is not a monetary phenomenon. The stance of monetary policy cannot necessarily be determined simply by the level of interest rates but is a function of money supply relative to demand. Increasing the cost of credit in response to price changes that have non monetary but very micro foundational causes related mostly to supply chain disruptions could be a recipe for disaster. In the same way, we won’t print our way out of the supply chain crisis we are seeing.
We should also be very careful on the fiscal policy front. Lawmakers are debating a 4 trillionish dollar spending package. We need to go through this with a fine tooth comb to understand how any changes might exacerbate demand given the current supply constraints and ensure that we don’t add additional frictions that would prevent workers from taking a job or businesses from expanding output. It goes without saying that should be very cautious about any hint of price controls during this period of transition.
Additionally we should consider all other supply side frictions including taxes and regulations. We learned during the pandemic the potential of relaxing prohibitions such as those in healthcare which allowed supply to creatively meet demand using telemedicine. What other opportunities exist to help rebuild our supply chains?
Policy makers must think carefully about how to respond going forward. We don't want to add fuel to the fire with misguided monetary, fiscal, and energy policy responses and must be willing to allow new species to emerge as different sustainable patterns of specialization and trade evolve post COIVD. If anything, COVID has reminded us all of the words of Frederick Hayek:"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."
Notes and References:
