Supply-Side Schooling from Shale

Some recent developments in shale gas production speak powerfully to the invisible hand’s ability to solve even some of what seem to be the trickiest problems.

We here at MarketMinder are big free-market capitalism fans—the freer, the better—and generally (though not rigidly) subscribe to a supply-side model which would argue against the notion demand is the end-all, be-all when it comes to economic growth. In fact, in my view, the opposite is generally true—supply typically creates demand. For example, see the recent developments in the liquid natural gas (LNG) world, specifically those tied to shale gas production.

Five years ago (or maybe even five months ago for some), most probably hadn’t heard of shale gas. And now, it could very well be the next energy revolution—at the very least, production is ramping up dramatically in places like Pennsylvania, Louisiana, Ohio and Texas (with resulting improvements in employment). And more states are likely to feel the impact as other sources are developed (HT: Mark J. Perry).

How does this relate to the world of supply-side economics? Couple ways. First, the shale gas story thus far speaks to the invisible hand’s seemingly mystical power—i.e., it’s the result of what happens when the price for a good goes up. In this case, easily accessible, conventional sources of both oil and gas globally had been generally tightening for some time. Enterprising energy companies who recognized this day would come began devoting resources to research and exploration for alternatives years ago. So not only are conventional oil and gas prices generally going up, but the costs affiliated with shale gas drilling and refining have gone down as the technology has improved. That double whammy makes shale gas a highly economically efficient alternative (or substitute, in economist-speak).

And that’s how efficient markets ideally work—as prices for one good rise tied to supply (whether because of decreasing availability, increasing production costs, etc.), producers are incentivized to invest in alternatives. It doesn’t take government rationing access to the supply-constrained good, and—when natural market pressures are allowed freer reign—it doesn’t require government subsidies to encourage an alternative (*ahem, Solyndra). In fact, provided government stays mostly out of the way, the market does it all by itself—a concept Adam Smith explained over 200 years ago but most politicians (of any stripe) struggle mightily with to this day.

So successful have shale gas extraction efforts been thus far, the US is poised to become a liquefied natural gas exporter, as evidenced by the first deal to export US shale gas inked not long ago. And in the long run, that likely helps put a bit of downward pressure on global gas prices—which are currently significantly lower in the US than elsewhere because of over-supply in the States. Who’d have thought that would be the case just a few short years ago? Few. Consider: The (now) export terminal in Louisiana was initially built as an import terminal.

But shale gas tells the supply-side success story in yet another way: As energy companies have created an estimated 600,000 jobs, those new workers have created demand for all sorts of downstream goods—like housing, food and clothing. Not only that, but the shale gas industry itself requires specialized inputs—like steel tubes, excavators and rigs. And that’s creating a whole new source of demand for steel companies, who are building new plants to support that demand (and hiring workers to build those plants, who consequently need housing, food, on and on and on).

It’s not hard to imagine all the coincident business and jobs created as shale gas drilling continues growing—and it points perfectly to the supply side’s success in creating demand, not just for goods no one previously even knew they needed, but also for workers.

I certainly don’t disagree unemployment’s been higher than anyone would like recently—but I strongly disagree with those who suggest the reason is a lack of demand. Arguing against that are consumer spending numbers, which have not only been strong in recent quarters, but have notched all-time highs. And US GDP has now logged nine consecutive positive quarters—not always gangbusters numbers, but positive growth nonetheless.

So if it isn’t much a demand problem, that seemingly leaves supply—but the nascent shale gas revolution speaks eloquently to the power of supply side-created demand and private-sector innovation. We can only hope government largely stands aside and lets the magic of the invisible hand work—it’s worked wonders so far.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.