Macro Roundup

James Pethokoukis, "What do we know about climate change? My long-read Q&A with Steven Koonin," American Enterprise Institute, December 30, 2021, https://www.aei.org/economics/what-do-we-know-about-climate-change-my-long-read-qa-with-steven-koonin/

What do we know about climate change? My long-read Q&A with Steven Koonin

Pethokoukis: Your book is titled “Unsettled” and the point is that climate science is not settled; science is never settled. But has the science grown stronger? Has it grown more certain since the early ’90s when Al Gore came out with his “Earth in the Balance” book, or maybe the early 2000s when he came out with “An Inconvenient Truth”? Do we know more and do you feel more confident in the science?

Koonin: Certainly given the passage of 30 years and spending of God knows how many tens of billions of dollars, of course we understand much more about the climate system now than we did when Al Gore wrote his book. Some things have become more certain. And at the same time, we’re starting to realize the limits of our current understanding.

What have we become more certain about and what have we become less certain about? And does the combination of both make you more concerned about the climate?

So for example, again, going back 30 years, there was still some doubt about what the global average temperature anomaly was doing. There were conflicting measurements on the ground. It’s gotten much better now. We know that the globe has warmed about 1.1 degrees since 1900. We also have good confidence now that the planet is gaining energy — that there’s more energy being absorbed from sunlight than the planet is radiating out into space. That’s a very tricky thing to measure. It’s a fraction of a percent effect, but nevertheless, we’re quite confident that that’s happening.

Are there things that people were really confident of 30 years ago or 15 years ago that we’ve become less confident of? 1) Are we becoming less confident about some things? 2) What are the big questions where we need a lot more research and we’re not sure at all?

I think one of the big questions is the natural variability of the climate system. Maybe not so much for the global temperature, but that in some ways is a theoretical construct of interest only to scientists. What’s really of interest is what’s happening with local weather, sea level rise, storms, floods, droughts, and so on. And there I think we’re starting to understand just how variable all of those things are on a multi-decade or century timescale.

Let’s put aside the worst projections. Should what we have learned make us more concerned than we were 20 years ago because either the potential outcomes are worse or we’re more certain about those outcomes?

I think we should be less concerned. And of course, your matter of concern depends a little bit on where you sit. And so I sit as a citizen of a developed world country and I’m not starved for energy. If I were somebody in China and India, I might have a different set of concerns, but my own concern has been tempered by realizing just how adaptable human society is. Again, if you look at the 20th century, as the globe warmed a degree, we saw the greatest improvement in human welfare ever as the population quadrupled from two billion to roughly eight billion people.

And if you look at the projections of what’s going to happen with the global temperature by the end of this century, we’ll see another one and a half degrees roughly, and that’s not going to make civilization fall apart. Come on, it’s not going to happen at all. And in fact, the IPCC says that. It’s says that compared to other forces, demographics, technology, regulation, trade and so on, climate is a relatively small impact on the economy.

You’re living in a developed country, and you were born in the 20th century. If you were going to be born early in the next century, would you be more concerned?

I think we should believe that our great-great-grandchildren will be every bit as adaptable and more clever and better off than we are. And again, let’s remember that those of us in the developed world are only 1.5 billion people. There are 6.5 billion people that are scrambling up the developmental ladder. They are going to need energy and the more of it that they can get, the better they’re going to be by the end of the century.

I want to read a quote from a paper by the late economist Martin Weitzman called “Some Basic Economics of Extreme Climate Change.” You’re probably familiar with it. And again, the listeners love when I read so I always try to read at least once during the podcast: "Climate change is characterized by deep structural uncertainty in the science coupled with an economic inability to evaluate meaningfully the welfare losses from high temperature changes. The probability of a disastrous collapse of planetary welfare from too much CO2 is non-negligible, even if this low probability is not objectively knowable."

Does that make sense to you? And if it does, does it suggest action?

There’s a famous quote by Lord Kelvin, I think: “If you can’t measure it, your knowledge is of the most meager kind.” And unless you can quantify those probabilities, it hardly makes sense to think about them. Of course, all kinds of crazy things can happen, but unless you can put a number on it and say, “There’s a one-in-10-to-the-fifth chance of something happening and it will cost this much,” you can’t sensibly think about it. All you have is emotion.

There are many crazy things that could happen (the proverbial asteroid, etc.) and we just get on with life. With respect to the climate system itself, there was a paper last summer in which four noted mainstream economists analyzed eight different tipping points, including the proverbial outcasting of the permafrost, the slowing down of the Atlantic circulation, the desertification of the Amazon, and so on. And it turns out that those add about 1 percent or 2 percent to the economic damages at the end of the century, which were already a couple percent for a couple of degrees temperature rise. So at least the best mainstream economic thinking is the economic damages of rising temperatures including tipping points are at the percent level, a nothing burger.

Do you think about climate science in a way that’s different from full-time climate scientists, or is it that what they say to each other is different than what ends up being filtered through the media and through non-experts?

It is the latter. Of course, you can’t generalize to everybody, but the conversations I’ve had about the science (as opposed to the emotion or the concern, if you like) are quite fine and no different than what I’ve written in the book. It’s when you start talking to the public or they start talking to the public either individually or institutionally that you start to get the exaggerations.

Well, I would assume that is because they feel the problem is serious enough that some action needs to be taken. But given that perhaps the most severe consequences would not happen for some time — it’s tough enough to get people to act about near-term problems, much less problems that could really escalate in 100 years — without a more severe or dystopian scenario, nothing will be done. I imagine that would be the reason. Is that your take?

For sure, I think it’s some of that. In other cases it’s prominence, it’s funding, and so on. I’ve given scientific advice in many other forums, fields, about things very different than climate. I think it’s advisory malpractice to be misportraying the certainties and uncertainties in the service of getting something to happen. Because, in fact, what you would like to happen depends upon where you sit.

I keep coming back again to the six-plus billion people who don’t have adequate energy. And if you’re going to force them to go to forms of energy that are less convenient or more expensive or less reliable, I would say that that’s immoral. And so I think our jobs as scientists are to represent the certainties and uncertainties as completely and as neutrally as we can and let the decision-makers, the political sphere, the private sector make the decisions.

Are the climate models better than they used to be?

I would say they are more sophisticated, but in terms of providing actionable information, they’re not much good at all. And again, this is not Steve talking. I can point you to papers written by mainstream climate modelers who say people trust their local predictions, storms, droughts, sea level rise, and so on, much more than vthey should.

We spoke a little bit about the temperature rise. What are some other impacts? What do we know about those? Whether some areas may be drier, maybe some wetter, melting ice caps... So what do we know about all the sort of spillover effects from that overall aggregate rise in temperature?

We look historically. What we’ve observed so far: There are no long-term trends in hurricanes or more generally tropical cyclones, as they’re called technically. And I think many people find that as a surprise. Over the last, roughly almost a century, we see no detectable trends in hurricanes. We do see for about the last 70 years some intensification of precipitation over the land. And we see that in the US rainfall has gotten more intense, but not necessarily more plentiful, in the Northeast, the upper Midwest, and the Northwest.

In terms of record-high temperatures in the US, they’re no more common today than they were 100 years ago. Yes, sea level rise globally has been accelerating for the last several decades, but it was also doing the same thing in the 1930s when, in fact, human influences were much smaller. So a lot of what we’re seeing can be put down to natural variability, or at least we need to show that it’s not natural variability. And that’s pretty hard without long-term and precise records.

Going forward, we predict the temperature will go up. And there are predictions, but it’s pretty difficult with a lot of uncertainty, about faster sea level rise, 10 percent more hurricanes, for example, some intensification of floods and droughts, but we haven’t seen it yet. And the temperature has already gone up by a degree. So it remains to be seen.

On whom should the burden of proof fall? Certainly some would say that we’re doing something unusual to the planet; we may not fully understand the impacts of this thing we’re doing, and we only have one planet. There are worst-case scenarios in the average temperature rise. So should the burden of proof be on the climatologists who are worried, or should it be on people who think it’s not as bad of a problem and we should be very cautious before acting?

I don’t think the scientists need to prove anything. The scientists just need to state what we know and what we don’t know. And your question is, what do we do about it? And that is very much, as I’ve emphasized in the book and other presentations, a values discussion. It depends upon development, intergenerational equity, North-South equity, and things of that sort. And of course, what can you really do to make a difference? And I think we’ve reached a stage in the climate and energy discussion where people who advocate doing something are starting to realize just how difficult it’s going to be to reduce or even slow the growth of human influences on the climate.

Has the “doing something” argument, and maybe you are suggesting it has, been changing? Is it something different now than it was 30 years ago or 10 years ago?

Oh yeah. I think there’s, at least among the experts, a better understanding of just how difficult it is to change the energy system or to build a reliable energy system in the developing world. I’ve been reading recently a seminal paper by a guy named Anthony Downs, who was writing in the ’70s. And he talked about the cycle of issue acceptance or issue prominence. Public issues, at least in the West, go through a series of five phases where at first it’s only among the experts, then suddenly the public realizes that there is a problem and great enthusiasm for solving it. Stage three is they realize just how difficult it’s going to be to solve it. Stage four, then stage five: It fades into the background.

I think we are well into stage three now, when you look at what happened in Glasgow where basically China and India and a couple of the other developing countries said, “We need energy and we’ve got the wolf at the door. We got to worry about that. And maybe a couple of generations from now we’ll worry about our emissions.” And that’s not an unreasonable attitude for them to take. We in the US, EU will have a different attitude, but unfortunately, the US is only 13 percent of global emissions. And even if we went to zero, it would be wiped out by the growth in the rest of the world within a decade.

In developed countries — Europe, United States, Japan, Korea — how strong is the push that we need to do something and that something needs to be living very different kinds of lives? Yes, we need to change the power mix (more solar and wind) but life as the West has lived it needs to be different.

Well, there are certainly some people who say that. But I think if you put that to a poll in the US or in Europe, the answer would be, “Hell no.” Downs has this wonderful quote; I’ll see if I can repeat it. That, “An environmental problem for the elites is just the common man catching up.” In the ’40s and ’50s people were worried about pollution from automobiles. Before that, it was only the elites who had automobiles and pollution was not an issue. It passed out of the periphery in the US, and suddenly everybody got concerned about air pollution. And so I think the greenhouse gas problem has got something of that flavor when you compare the different stances of the developed versus developing worlds.

Speaking of elites, where do you think the policy debate is right now in Washington? How much interest do you sense is there in policies that are about us changing our way of life versus policies that are about, “Well, let’s be worried about dirty power; we’ll try to create more clean power, but we’re going to create more power”?

I think the policies that the Biden administration has put out are too much too fast. There’s an optimal pace for decarbonization. If you do it too rapidly, you create a lot of disruption because energy is very important and is central to society. If you do it too slowly, you incur more risk from growing human influences. But what is being proposed — zero emissions from electrical power by 2035, the effective disappearance of all internal combustion engines being sold for vehicles — I think most people would say that that’s much too fast and it’s not going to happen anyway.

We can’t build a clean grid with today’s technology unless either storage technology gets a lot better to buffer wind and solar, or we deploy a lot more nuclear power than we have deployed, or we deploy a lot more carbon capture and storage. And neither the electrical storage with batteries nor nuclear power nor carbon capture nor storage can be deployed rapidly enough and economically enough to reach the 2035 goal.

So the politicians have just gotten out over their skis. Somebody needs to sit down and formulate an integrated plan for decarbonization that includes technology development, regulation, economics (people still need to make money by providing energy), and consumer or public perception. Nobody has done that yet. And I would think that that’s a necessary prerequisite if we’re going to achieve any significant emissions reductions in the US.

Do you think we do need to decarbonize?

I think on the longer time scale, whether we need to or not, we probably will. Coal is just disappearing. Natural gas is better than coal. Whether natural gas will disappear or not, I don’t know. But again, the “we” maybe is the US, but as I mentioned, this is a global issue. You’ve got to get China and India and the rest of the six billion people out there to decarbonize. And I don’t see great enthusiasm for that.

Some people might view any critique of the popular, non-scientific consensus as saying, “We should do nothing. It doesn’t matter how much carbon we pump into the atmosphere because it doesn’t make a difference.” Is that what you’re saying?

No, I wouldn’t say that. I think we do need to reduce our emissions, but I would do it on a centennial timescale. Look, this is just one more issue. And it’s not the existential threat that everybody believes it is — not everybody. If you read carefully the IPCC report that just came out in August, you don’t find the words “climate catastrophe,” “existential threat,” or “climate disaster” in it at all. You find “climate crisis “once in the report, and that refers to how the media have dumbed down the description rather than any scientific finding. So it’s not a crisis. It’s a problem to be dealt with in the most graceful way that we can.

Do you have thoughts about geoengineering or climate engineering as a kind of a break-the-glass option if we’re all wrong and things get bad fast?

Yeah, I just did geoengineering for my climate science class at NYU last night, so it’s fresh. Although, I wrote or convened the writing of a report back in 2007 that dealt with some aspect of geoengineering. So I’ve been thinking about this for 15 years or so. So there are two modes. One is that we suck carbon dioxide out of the atmosphere, and it’s hard to be against that. We could do that by planting more trees or by physical, chemical methods. Planting trees is kind of a no-brainer. Why not? And Congress is thinking about or it has already allocated money: the Trillion Trees Act as it’s called. But it takes a long time to grow the trees up and so on.

The other mode is to make the Earth a little bit more shiny to reflect a little bit more sunlight. You don’t need to reflect much more. The Earth right now reflects about 30 percent of the sunlight. If it were 31 percent, it would counteract almost all the warming effect of greenhouse gases produced by humans that we’ve seen so far. And there are schemes to do that. You could put particles up in the stratosphere. You could try to make particles over the ocean a little bit more common, things of that sort. I think it’s a subject that needs to be researched. And compared to 15 years ago, you can now talk about it in polite company, because people are starting to realize how hard it is to reduce emissions.

I think it needs to be researched. I think we need trials, experiments, not on a global scale, but locally. And then we would know whether or not we’ve got that as a tool to deploy, but doing the research is very different than actually putting it into practice. That is a very tricky situation having do with equity among nations, close monitoring of the effects if you started to do it, things of that sort. So I’m all for the research. I’m very much against deployment except in an extreme situation and with full discussion among all the world’s nations about doing that.

What is the argument you would make or the policy advice that you would give that might be persuasive to lawmakers, Democrats, folks on the left who are probably very concerned and are probably always being flooded with information from activists painting a very apocalyptic scenario? What is sort of the advice and message you would give those folks?

I would say the first thing to do is to cancel the climate crisis, namely to tell people there is no emergency here. This is a complex problem that has different facets and different solutions. So first of all, let us stand back and take a much better understanding of the problem. Climate literacy and energy literacy are woefully lacking among policymakers. And the second thing I would do is let us sit down and formulate a plan that will gracefully let us reduce emissions without disrupting the economy, employment, the way people live their lives as you mentioned, or the nation’s geopolitical standing and its dependence upon foreign sources of energy, which of course are coming back into prominence as this administration has cut back on domestic fossil fuel production.

First of all, declare there’s no crisis. Stand back, think it through, get everybody to agree on a path forward, and then implement that. I mean, that’s not so specific, but I think elements of those plans to get a little more specific will be the development of small modular nuclear reactors, a push to develop battery storage longer term, a push on fusion energy, which has seen some interesting progress in the last year or so, things of that sort. But is the world going to end in 10 years or 20 years? Absolutely not. Come on.

Steve, thanks for coming on the podcast.

Great to be talking with you.

Koonin, “…I think one of the big questions is the natural variability of the climate system. Maybe not so much for the global temperature, but that in some ways is a theoretical construct of interest only to scientists. What’s really of interest is what’s happening with local weather, sea level rise, storms, floods, droughts, and so on. And there I think we’re starting to understand just how variable all of those things are on a multi-decade or century timescale…. I think we should be less concerned. And of course, your matter of concern depends a little bit on where you sit. And so I sit as a citizen of a developed world country and I’m not starved for energy. If I were somebody in China and India, I might have a different set of concerns, but my own concern has been tempered by realizing just how adaptable human society is. Again, if you look at the 20th century, as the globe warmed a degree, we saw the greatest improvement in human welfare ever as the population quadrupled from two billion to roughly eight billion people. And if you look at the projections of what’s going to happen with the global temperature by the end of this century, we’ll see another one and a half degrees roughly, and that’s not going to make civilization fall apart.Come on, it’s not going to happen at all. And in fact, the IPCC says that. It’s says that compared to other forces, demographics, technology, regulation, trade and so on, climate is a relatively small impact on the economy….”

Joseph Politano, "Are Rising Corporate Profit Margins Causing Inflation?"Apricitas, January 1, 2022, https://apricitas.substack.com/p/are-rising-corporate-profit-margins

Are Rising Corporate Profit Margins Causing Inflation?

America has experienced an explosion of inflation over the last year. The Consumer Price Index (CPI) has increased nearly 7% over the last year, with gasoline prices up nearly 60% and used car prices up 30%. At the same time, corporate America appears to be doing as well as ever. The S&P 500 is hitting record highs and many companies are posting eye watering profits.

The coinciding rise in inflation and corporate profits has caused some to blame corporate actions for the recent rise in prices. Massachusetts Senator Elizabeth Warren blamed oil companies and grocery store chains for taking advantage of the pandemic to boost prices in order to juice their profit margins. Matt Stoller at the American Economic Liberties Project posited using some back-of-envelope math that 60% of the rise in inflation is driven by corporate profits. The White House pinned the blame for rising meat prices on the meat processing oligopoly.

With this situation, some have pushed for unconventional action to reign in corporations and combat rising prices. The White House is tapping trustbusters throughout the federal government to find ways to use antitrust policy in order to lower prices. Stoller and others have proposed excess profits taxes in addition to robust antitrust measures. Economist Isabella Weber called for World War II-style price controls in order to combat inflation.

But are corporate profits even really to blame for the rise in inflation? In short, no. High profit margins do not cause, and are often not correlated with, high inflation—and the jump in profit margins is not particularly large. Would antitrust actions help reduce inflation? In the short run it is possible, but not by any significant amount. The items experiencing idiosyncratic price increases due to the pandemic are mostly not in monopolistic or oligopolistic markets. And would price controls be an useful tool in combatting inflation? Not at all.

Prices and Profits

Before we move on here, it is worth acknowledging that aggregate profit margins are plagued by methodological and theoretical issues. For one, Bureau of Economic Analysis is forced to adjust for capital consumption (depreciation) and inventory valuation. Inventory valuation adjustments are of particular interest: the BEA attempts to adjust for a company producing a good at one cost and sale price, keeping the item as inventory for a period of time, and then selling the item at a new cost and sale price. The adjustment brings the unit profit of previously manufactured goods to match the unit profits of goods manufactured at the new cost and sale prices. This adjustment has likely gotten significantly more difficult with rising production costs, shrinking inventories, and increasing prices for final sales. Then the BEA essentially lumps all corporations together to craft total profit margins, so variation between and within industries is completely lost.

The data itself is also subject to revision, so current estimates may be changed as better data sources are incorporated into the BEA’s sample. The National Income and Product Accounts Handbook explains it best: "However, financial-accounting information is more timely than the tax-return data, so it is used by BEA to derive the estimates for the most recent year and for the current quarters. Neither set of accounting data is entirely suitable for implementing the NIPA concept of profits from current production. Consequently, BEA’s procedure for estimating NIPA corporate profits mainly consists of adjusting, incorporating, and supplementing these data."

I would not be surprised if corporate profit margins are adjusted downward when more tax-return data is incorporated, even if they still remain high. Nevertheless, Matt Stoller would point out that total corporate profits are up nearly 40% since the start of the pandemic, meaning that aggregate corporate profits could be pushing up inflation even if profit margins aren't un dramatically.

First, it is worth acknowledging that corporate profits are extremely sensitive and can fluctuate dramatically from year to year. Pre-tax profits jumped 30% from 2011 to 2012 during a period without abnormal inflation. Additionally, the jump in profits is a direct consequence of the jump in federal spending caused by pandemic stimulus measures. When the federal government spends deficit-financed money it definitionally increases the surpluses of the private sector. In other words, when the government borrows and spends money that money has to go to private sector actors (businesses and households) who see a corresponding bump in income. The rise in corporate profits is largely attributable to this increase in spending: money first went from the government to households in aggregate, and now those households are spending money and sending it to corporations in aggregate. The jump in aggregate corporate profits is no more responsible for the rise in inflation than the prior jump in household income.

Finally, I want to dissect Stoller’s methodology in claiming that profits drive 60% of inflation increases. By his own admission it is only a back-of-the-envelope calculation, but I still think it is a calculation that should not have been attempted given his methodological errors. Stoller takes the total corporate profit per person ($3,081 pre-pandemic, $5,207 today for an increase of $2,126) and then compares it against a 6.8% increase in nominal GDP per capita ($4,752) designed to represent the effect of the increase in the CPI. After removing “normal” inflation (for which he uses 2019’s 1.8% inflation rate) Stoller claims that profit growth is responsible for 60% of inflation.

First, let me just stress that you cannot just compare growth is a quarterly measurement of profits (a flow variable) with growth in a price index (a stock variable). The whole exercise should be moot because of that point, but there are more methodological issues I want to discuss. You also can’t compare GDP per capita (which covers total output in the economy) to the Consumer Price Index (which only covers the discretionary spending subset of the economy). The GDP Implicit Price Deflator, which would have been the proper price index to use, is only running at 4.57%. It is also just number padding to take “normal” inflation as 1.8% instead of the Federal Reserve’s 2% target, and Stoller makes no effort to account for imports, exports, or differences between industries. Finally, there is no causal analysis here. One could just as easily repeat this exercise by ascribing all inflation to the increase in income caused by the stimulus checks, because without good causal inference the whole thing is just conjecture about what “actually” caused inflation.

Antitrust and Inflation

Even if the rise in corporate profit margins are not causing inflation, is it possible that antitrust actions could alleviate price increases? Somewhat, but the applications are much more limited than necessary to bring inflation back to normal levels. Take meatpacking, which the Biden administration is taking aim at. It is likely true that meatpackers form a sort of oligopoly and that they have increased prices more than would be possible in a competitive market. Meatpackers are being sued for violations of antitrust law, as the packers appear to be taking advantage of the uncompetitive nature of the industry.

It is also true that meats represent only 1.1% of the CPI, so the 16% increase in prices over the last year is not boosting headline inflation that much. The UN Food and Agricultural Organization also estimates that global meat prices are up 17.6% since 2020, meaning domestic market power is not the only thing driving up prices. Antitrust actions in the meatpacking sector are simply not going to have meaningful impacts on inflation, even if they do significantly improve the meat market.

The car industry has struggled with production issues throughout the pandemic, and the result has been a shortfall of more than 3 million vehicles. This has driven up prices, but has unsurprisingly left most carmakers with meagre profits as they work their way out of the SNAFU. Profits at General Motors and Ford are slightly below normal despite the jump in prices, and no automaker is experiencing massive profit growth as a result of the crisis.

Gasoline is mostly the same, but with some key differences. At the start of the pandemic large oil and gas companies began picking up distressed rivals in a wave of consolidation across the industry. Given the massive drop in oil prices at the start of the pandemic and long standing concerns about profitability and green transition risks, the majors imposed strict capital discipline and profitability requirements. The result has been a drop in output—but with good reason. The radical swings in oil prices in recent months reveal the risks that most oil companies are planning around.

Of course, oil is one area where oligopolistic market structure matters a lot—just not in a way that the US can do much about. The Organization of Petroleum Exporting Countries Plus (OPEC+) controls approximately half of global oil supplies and sets explicit production targets to control prices (though there are intra-cartel conflicts). Changes in OPEC+ decisiomaking can dramatically affect short term inflation, but the Biden administration can’t simply use the Sherman antitrust act to break them up.

Command and Control

"The difficulty with wage-price controls and a wage board as you well know is that the God damned things will not work. They didn’t work even at the end of World War II. They will never work in peacetime."
-Richard Nixon, 6 months before instituting wage and price controls

At the most extreme end of the scale, some economists have advocated for a regime of price controls to reign in inflation. Economist Isabella Weber wrote in the Guardian that “strategic price controls” like those implemented during WWII should be used to combat price increases given the rise in corporate profit margins.

I want to state in no uncertain terms that this is an extremely bad idea. From a practical perspective, COVID-19 is not the kind of mass-mobilization crisis that WWII was. At it’s peak, more than 40% of total economic output was going to national defense during the war, easily dwarfing any mobilization efforts the CDC or other federal agencies deem necessary today. The core problem throughout most of the pandemic was preserving household and business income in the face of shutdowns, not mobilizing resources for government consumption. The war came with extreme forced savings and financial repression mechanisms as well, both of which would be counterproductive in an economy where the principal goal is renormalizing consumer purchasing patterns.

In sectors that are truly experiencing transitory supply-shock-driven price increases—such as food, energy, oil, and vehicles—price controls will do nothing to solve the underlying issues. There is a shortage of millions of cars relative to pre-COVID trends—will price controls furnish new automobiles or buy time for capacity to catch up? What about gasoline? Are we banking that price caps will induce additional domestic oil output or somehow coax OPEC+ to boost their production targets? Will price caps satiate the across-the-board increase in demand for groceries or resolve production imbalances in food supply chains? Are we truly expecting Americans to accept government rationing for goods as critical as gasoline and food?

The government doesn’t have boundless knowledge of the quantities and cost structures of each product in the economy. It doesn't even have much of it, in fact. If it did, it could help out the companies that are shortchanged and stop inflation, or increase supply in non-neutral ways. But because it doesn't, and can't have enough information, policies to stop inflation are basically just guesses

Maia, “Will price controls end Argentina's uncontrollable inflation?”

Even more practically, the federal government does not have the capacity to implement price controls—the wartime Office of Price Administration and related agencies had 160,000 employees at their peak, which is more than any non-defense department has today. The amount of work necessary to develop, monitor, and enforce price controls in today’s economy is likely orders of magnitude more complex than it was in 1940, requiring extreme administrative intervention. The President would need congressional approval to begin price freezes—and it is unlikely that Joe Manchin will support that, to say the least.

The situations in which price controls work are extremely limited—usually only including natural monopolies and government administered services like healthcare or education. Nor are anti price-gouging rules, used with great effect in early 2020 to obtainppE and medical supplies during the onset of COVID, easily applicable to years-long increases in commodity and food prices. Price controls on gasoline, used vehicles, or groceries are simply recipes for quickly developing robust black markets for all of those goods.

Conclusion

That doesn’t mean the government should simply sit on its hands and wait for inflation to go away. There are concrete steps that the administration could take to combat short term inflation. For example, they could unwind some of the counterproductive tariffs that the Trump administration created. The Department of Commerce recently followed through with plans to double tariffs on Canadian lumber, to the detriment of homebuilders and homebuyers. Repealing the Jones Act, which bans non-American ships from moving goods between US ports, would alleviate some pressure on shipping prices. Keeping the ports of Long Beach and Los Angeles running 24/7 should be viewed as a success, and the administration should further pursue boosting public infrastructure efficiency to help the economy. Antitrust actions can play a role as well, as long as it is acknowledged that they will only marginally tamper inflation and that their main benefits come from increase competition, investment, and innovation. As long as policies are grounded in the real causes of inflation, they can help alleviate the problem.

Joseph Politano argues that despite Elizabeth Warren claims, rising corporate profits have nothing to do with current inflationary pressure, "...Let’s start with corporate profits. Since 2020, profit margins for domestic nonfinancial corporations have appeared to hit all-time record highs. But it is worth noting that margins, by themselves, have very little correlation with inflation. American corporate profit margins have been near all-time highs for the bulk of the last decade—a decade that saw inflation well below the Federal Reserve’s 2% inflation target. Profit margins can be rising in a low-demand environment and funnel money away from workers and towards higher-income individuals with lower marginal propensities to consume, thereby lowering inflation. This is not happening now, but reveals the flaws in reasoning from a change in profit margins. Anybody who predicted that 2010’s high profit margins portended rising inflation would have been seriously wrong. Plenty of sources have also been conveniently using after-tax profit margins instead of pre-tax margins. The last few decades have seen a steady decrease in effective corporate tax rates, making the jump in after-tax margins unnaturally inflated by historical standards. Pre-tax margins are well within historical levels, though high by modern standards... it is clear that firms are generally absorbing some of the rise in input costs caused by the pandemic. At each stage of production, firms are absorbing additional input cost increases and not simply passing them directly onto consumers. There is likely some double-marginalization, whereby separate firms markup their products through a combined supply chains in ways that would not be optimal if the supply chain was within a single firm, but it is hard to say that corporations are simply passing costs onto consumers or taking advantage of the pandemic to implement large markups..."

Anuser Farooqui, "Superstar Stocks," Policy Tensor, December 21, 2021, https://policytensor.substack.com/p/superstar-stocks

Superstar Stocks

‘Only ten stocks really matter’, declared Robert Armstrong in a recent FT Unhedged newsletter. He showed that the returns on the 10 largest stocks have handily beaten the S&P 500 index over the past two years. Apple is closing in on a $3tn valuation. That’s larger than the GDP of India, France, the United Kingdom, Canada or Australia. Indeed, it is larger than the GDP of all but the four largest national economies in the world. At $2.5tn, Microsoft is not far behind. Following close on the heels, Amazon is at $1.8tn and Tesla at roughly $1tn (all market caps and returns are as of Dec 15, 2021). The top 10 stocks account for $12.5tn of market capitalization. That’s 30 percent of the market cap of the largest 500 companies, and 25 percent of the market cap of all publicly-traded American companies. The US stock market has never been this top heavy since at least 1992.

A portfolio that rebalances monthly to track the largest ten stocks has doubled in value since the beginning of 2020, even as broader portfolios that track large-cap stocks have increased by roughly 50 percent. The dramatic outperformance of the very largest companies is due to the structural changes that ensued in the economy after the arrival of Covid-19.

Following up on Robert Armstrong’s note on the outperformance of the ten largest US firms Anuser Farooqui reports that skewness in equity returns of those firms has increased in the aftermath of the pandemic. He looks at a monthly rebalanced portfolio of the 10, 100 and 500 largest US stocks and finds the outperformance of the top 10 is a recent phenomenon (see second chart 2012-2022), "... A portfolio that rebalances monthly to track the largest ten stocks has doubled in value since the beginning of 2020, even as broader portfolios that track large-cap stocks have increased by roughly 50 percent. The dramatic outperformance of the very largest companies is due to the structural changes that ensued in the economy after the arrival of Covid-19. Indeed, zooming out reveals that this is a new development. For most of the past decade, the top 10 portfolio has underperformed more diversified portfolios of the largest US equities. In fact, if we go back thirty years, we find that the top 10 portfolio usually lagged behind more diversified portfolios of large-cap equities. The size of companies has been one of the most commonly used investment factors since the 1990s when Fama and French documented the existence of a premium associated with this risk factor. But here’s the kicker: smaller stocks are supposed to sport a risk premium over larger stocks. So, the recent outperformance of the very largest companies is not only not to be expected, but the order of expected returns is upside-down. Just how much premium the largest companies have commanded is documented in what follows. Table 1 shows the mean annualized returns, volatility, Sharpe ratios, max drawdowns, tracking error and adjusted means for monthly-rebalanced portfolios of the largest US companies. The tracking error is the volatility of the difference between returns on the monthly-rebalanced portfolios and the market capitalization indices. Less diversified portfolios are harder to track, meaning that you may not, in practice, be able to match the returns on the index being tracked. The adjusted mean is the annualized mean return less the tracking error. You can think of it as a penalized expected return that accounts for the difficulty of tracking less diversified portfolios. Over the past two years, the top 10 portfolio has returned 39 percent per annum, compared to 24 percent per annum for the top 500 portfolio. It has outperformed the latter portfolio even in risk-adjusted terms, sporting a Sharpe ratio of 1.32 compared to 0.90 for the latter. Adjusted means also show a robust outperformance: 38 percent vs 23 percent. Over the past decade, the top 10 portfolio has returned 19 percent per annum, compared to 14 percent for the top 500 portfolio. The risk-adjusted performance is less dramatic: a Sharpe ratio of 1.0 vs 0.9. But over a longer period, the premium at the top vanishes. Since 1992, the top 10 portfolio has averaged a 10 percent return vs. 9.5 for the top 500 portfolio. The Sharpe ratio of the top 10 portfolio is actually lower over this horizon: 0.51 vs. 0.52. The max drawdown is also painfully larger: 70 percent instead of 57 percent. And the tracking error is much higher, 3.7 percent vs 1.9 percent, with the result that the adjusted mean return is much lower: 6.4 percent vs. 7.6 percent. So, there’s no outperformance of the top 10 since George H.W. Bush was last in the White House. What we have, in fact, is a brave new world dominated by the very largest corporations...."