May 07, 2021 | 13:49
Supply is Now the Problem
The post-shutdown experience shows that when the economy reopens, it does so with gusto, fuelled by pent-up demand and policy stimulus. The biggest threat to the expansion now, apart from the uncertain pandemic, is rising inflation. And, besides raging resource prices, ramping house prices, and gobs of fiscal stimulus, a key pressure-point here is supply-chain bottlenecks. At the very least, even if supply shortages do not fan higher inflation, they risk curbing the pace of recovery… as hinted at in the U.S. April jobs report.
Front and centre is the microchip shortage that has led to production delays for producers of automobiles, computers, digital devices, appliances and many other items. The shortage in part stems from companies cancelling chip orders during the worst of the pandemic in 2020 and not anticipating the rapid rebound in demand, leaving chipmakers scrambling to fill orders. Another factor was the wave of demand for electronic goods (iPads, video games) and home gear (Peloton bikes).
In the auto industry, the chip shortages have led to temporary plant closures and delays in some models, pushing buyers (including businesses) into the used vehicle market where inventories are tight. This has jacked up U.S. used auto prices 24% annualized in the past six months to record highs, pressuring the CPI despite still subdued new vehicle prices. The chip shortages could lead to a 7% reduction in U.S. auto production this year and a 17% cut-back in Canada, where the slowdown is already more acute. While auto production only accounts for about 1% of GDP in the two countries, the sizeable decline, along with spillover effects to other sectors, could dampen economic growth, possibly by 0.3% in Canada if the shortages persist. Recent announcements by the automakers suggest the production slowdown will extend through the first half of the year. However, there is some optimism that chip output will ramp higher in coming months, easing the pressure on production and prices. Intel has committed to start making chips for the auto sector, though it will need time to transition. TSMC, the major Taiwanese microchip producer that supplies roughly 70% of global auto chips, said it would meet automakers' minimum needs by the end of June. As well, the President’s infrastructure plan includes $50 billion for semiconductor research and manufacturing, though this will take some time to impact production.
Apart from chip shortages, the pandemic has led to a wide range of disruptions and delays across the global supply chain. Business surveys show rising vendor delivery times (with the U.S. ISM factory measure hovering at four-decade highs) and concern about parts shortages and rising input costs. Many companies believe the supply issues will persist until year-end, curbing production, squeezing profits, and forcing many to raise prices in the face of surging pent-up demand. Meantime, global shipping costs have jumped nearly five-fold in the past year to the highest level in a decade, reflecting strong demand for resources and materials, as well as California’s clogged ports. Higher shipping charges often take time to unwind, suggesting the pressure on business costs and production will linger.
Besides the broad parts shortage, more U.S. companies are reporting trouble filling vacant positions, citing workers’ health concerns, child-care duties, a lack of skills, and even enhanced UI benefits that run until September. The U.S. participation rate remains well below pre-pandemic levels, though it should begin to climb faster as more people are vaccinated and more children attend school. A broad, sharp increase in average hourly earnings in April, led by restaurants and retailers, could mark an initial volley in companies competing for workers. The big shops have already raised their minimum wage to $15/hour, which is likely to compel smaller shops to follow.
As the pandemic eases, supply chains should start to flow more freely again. Labour shortages, however, might only intensify. If so, they will not only dampen the expected hearty economic expansion, but likely feed inflation as well. This could put the Fed and the Bank of Canada in the uneasy position of raising interest rates before achieving their maximum-employment and inclusive-recovery goals.