MainStreet Macro: Scarcity

I often get the question, “What do economists do?”  Simply put, we study how people deal with scarce resources.

The concept of scarcity drives economic theory because we don’t live in a world where resources are free-flowing and abundant. Scarcity requires people and businesses to make constant tradeoffs to get what they want.

The role of scarcity in economic activity has been highlighted by the pandemic. Supply shortages are everywhere. From new cars to chicken wings, inventories are running low.

In this week’s MSM, we dive deep into the idea of scarcity in the context of our current supply shortages by answering three big questions just in time for the holiday shopping season.

Why are we seeing supply shortages?

Let’s just say there’s no dearth of explanations. 

Extreme weather has disrupted transportation and slowed delivery of important components, such as semiconductors used to make cars, refrigerators and other big-ticket items. Factories had to slow or even stop their assembly lines while they waited for parts and materials.

Then there’s the global economy, which has regained its strength — and then some — since last year’s downturn. The flip side of our strong economic growth is a big increase in demand for goods.

High demand and weak supply are being aggravated by yet another wrinkle – labor shortages. Companies desperately need workers to move goods from place to place and load and unload them at ports around the world. Even the containers used to ship stuff are in short supply. 

The White House announced last week that two California ports have committed to working around the clock to help reduce logjams.

What is the effect?

There are two big consequences of supply shortages.

First, when supply decreases and demand increases, prices rise. It’s one of the more intuitive concepts taught in Economics 101.

And that’s exactly what we saw last week. The Consumer Price Index, which tracks the cost of a broad-based basket of consumer goods and services, rose by 5.4% in September after slowing by 5.3% the previous month. That’s a much higher rate of inflation than before the pandemic, when supply disruptions were infrequent and less widespread. Inflation averaged 2.1% in the three years preceding 2020.

Food and housing accounted for more than half of September’s inflation growth. Poultry and meat in particular have been rife with supply disruptions, and the U.S. has had a chronic undersupply of housing for a decade. The pandemic-fueled boom in home sales made the tight market even worse.

Gasoline prices, too, have shot up due to limited production. Oil, at around $50 at the start of the pandemic, is now over $80.

Second, price increases tied to supply bottlenecks will likely slow consumer spending, which could dampen the overall global recovery. The International Monetary Fund last week downgraded its U.S. GDP growth forecast to 6% from 7% in July, in large part due to supply disruptions.

How long will it last? 

ADPRI’s latest quarterly small business survey, released last week, revealed that supply chain woes were second only to hiring difficulties when it came to challenges facing our small business clients.

Twenty-one percent of companies reported supply chain frustrations, up from 17 percent in May. It’s a signal that supply constraints will be with us a while longer and are likely to affect the holiday shopping season.

The good news is that economics also tells us that supply shortages usually aren’t permanent. As prices go up, more companies are lured into the market. Others expand production to boost profits. Supply shortages fade over time because the profit incentive leads to more production.

There is another factor at play that will help topple supply constraints. The delta variant is still with us, but it’s playing a smaller role in the economy. As more of the global population is vaccinated, factory closures and labor shortages likely will lessen over time.  

That doesn’t mean store shelves will be stocked overnight. It does mean that the drag on growth and pull on prices is temporary. (Though my advice is to start shopping now for the holiday season. It could take a while to get the most prized gifts.)

My Take

Most economists agree on a few cornerstone tenants. Free trade historically has been one of them. The ability of countries to lean into their own comparative advantage — be it low-cost labor, abundant commodities, or technological prowess — has lifted global incomes, lowered the cost of consumer goods and services, and made businesses more profitable. Classic economics asserts that free trade is the world’s solution to the problem of scarcity.

That narrative has been challenged recently. Even before the pandemic, globalization was sometimes seen as a competitor to American labor instead of an ally of the American consumer.  

Our current supply woes are proof of our integrated world, where the ability of one country to produce is helped or constrained by the output of another. The pandemic has disrupted the global symbiosis of free trade in a world of scarcity, but it’s also highlighted its value.

Footnote: Here’s a sign of the times – prices for women’s suits fell 2.9% from a year ago. With more people working from home, there’s apparently less demand for office apparel and more demand for Zoom-friendly yoga pants.