Economic demand is back. Supply is the problem
What a difference a year makes for many corporate bosses in advanced economies. Some 12 months ago, they were dealing with the sudden and brutal disappearance of demand for their products. Today, demand is not a problem for most of them; it is surging. Rather, they are struggling to secure supplies, including the raw material inputs and workers needed to meet this demand — the consequences of which will determine much more than corporate success.
Strong consumption and investment, enabled by economic reopenings and solid corporate and household balance sheets, are bolstering aggregate demand to a degree that has surprised many, be they executives, economists, policy makers or Wall Street analysts. It is a phenomenon that is likely to persist in the months and quarters ahead, especially in those countries that are able to contain Covid-19 infections, vaccinate many citizens and guard against new variants of the virus.
The supply side is much more of challenge. Indeed, it is quite a mess.
Bottlenecks and other rigidities are disrupting many supply chains. Shipping, including the availability of containers, has become much harder to secure. Covid outbreaks in certain countries that are embedded in global supply chains — such as Bangladesh, India and Vietnam — and geopolitical uncertainties, including periodic tensions between China and the US and Europe, add to the headaches facing those not just trying to get raw materials to their factories in a timely and cost-effective manner but also to meet seasonal demand for their final products.
Compounding that issue is the seemingly puzzling labor shortage which, only last week, resulted in the biggest data forecasting error on record for US nonfarm payrolls. Already, Amazon.com Inc. and McDonald's Corp. have raised entry-level wages as they try to counter a growing shortage of workers. Many other companies are sure to follow. This may help attract some people who are benefiting from unemployment benefits back into the workforce, but it is unlikely to overcome different factors that keep potential workers out of employment such as lack of child care, closed schools and skill mismatches.
The more I hear from companies dealing with all of this, the less convinced I am that the supply-side problems will dissipate soon. Instead, the situation will probably worsen before it improves.
Seeking to protect their profit margins, many companies will be tempted to pass the higher input costs through to final prices. The likelihood that such price increases will persist is high given buoyant demand and the Covid-related industrial concentration that has protected and, in some cases, enhanced many companies' pricing power. As a case in point, Warren Buffett remarked recently that many companies have raised the prices they charge Berkshire Hathaway and that his own companies are increasing their prices. All of this is sticking.
Understanding these dynamics is critical not only for corporate leaders but also for economists, Wall Street analysts and policy makers. One big lesson from recent big data misses — especially the jobs report and consumer price index for April — is that all have to pay much more attention to the aggregation of company- and sector-level evidence rather than resorting to broad top-down proclamations.
When it comes to policies, the multiplying supply-side disruptions make it even more important for Congress to move urgently in considering the infrastructure proposals put forward by the Biden administration. Not only do they try to improve the functioning of supply chains and increase productivity, but they also contain measures to encourage higher labor force participation and reduce the problem of skill mismatches over time.
Then there is the Federal Reserve, which repeatedly insists that inflationary pressures are both temporary and reversible. While it is true that it will take several more months of data to assess the nature and persistence of higher inflation, there is already sufficient corporate and macroeconomic evidence to question the assertion that rising prices will be "transitory." Rather than vocalizing this as a mantra and attributing a high probability to a single baseline scenario, the Fed would be well advised to consider a range of possible outcomes. This would enable it to develop and cautiously communicate its preparedness for more responsive and timely policy responses should they be required.
For years, many analysts and policy makers felt that the most important economic challenge facing many advanced countries was the stubborn deficiency of aggregate demand. Today, and for the next few quarters, the supply side will be the chief determinant of success for companies, policy makers and the economy as a whole.
Mohamed A El-Erian is a Bloomberg Opinion columnist
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement
