Thursday, December 23, 2021

Is Increased Demand Causing Supply-Chain Problems?

See An Insider Explains the Supply-Chain Crisis: Consumers flush with cash and pandemic restrictions combined to drive demand for goods through the roof. Economist Phil Levy doesn’t see a return to normal until at least 2023 by Tunku Varadarajan of The WSJ. 

He interviewed Phil Levy, chief economist for Flexport, a San Francisco-based tech company for global-logistic services. I like the point he makes about ports not being able to handle the surge in demand. It is like a restaurant that is sometimes so crowded you can't get in. Why not build it bigger? It might be too costly because that extra room might sit empty most of the time. Also, he makes a point about inelastic supply for some goods. That is a steep supply line, so any increase in demand will mean big price increases Excerpts:

"The pandemic is at the root of the supply-chain crisis. Covid-19 has led to work disruptions at factories and ports in China, with quarantines and shutdowns hitting the production and movement of goods. Mr. Levy cites the monthlong shutdown owing to Covid cases in May 2021 at the Chinese port of Yantian, which handles a third more volume than the Port of Los Angeles.

“It’s one of the major Chinese ports. And every time you shut down at one of those places, you’re interrupting the flow of containers.” Buildups and backlogs accumulate. “How do you ever work them down?” Ports have fixed capacity: “You can’t suddenly process twice or three times as many ships once a lockdown is lifted.”

Ninety percent of all exported goods move over the ocean. These include not only finished goods but also parts. “So even if you’re manufacturing in the U.S.,” Mr. Levy says, “the odds are you’re using some imported parts.”

Ports are built “so you can just meet peak demand.” It’s too expensive to build at excess capacity, “because then most of the time you’d have lots of extra stuff sitting around.” The peak season is August through November, “when it’s, ‘How do you stock store shelves for the holidays?’ ” The problem is that a system that can “barely handle” a normal peak season has seen “above peak demand for about an entire year and a half,” placing it under “a cumulative strain it wasn’t really built for.”

A major cause is what Mr. Levy calls “the defining economic characteristics of the pandemic.” There has been a “marked tilt” in buying behavior, a shift from services toward goods. “We still buy more services than goods, don’t get me wrong,” he says. But whereas U.S. consumers spent 69% of their money on services before the pandemic and 31% on goods, the breakdown now is more like 65% to 35%.

The pandemic recession was unlike previous ones. “One of the ways that economists would normally have defined a downturn is that you get a decrease in production and a decrease in income.” But American pocketbooks “were a lot more full than they normally are with a downturn.” It’s not hard to see why, he says, pointing to the Cares Act in March 2020 and other government cash infusions in January and March 2021, “which were directly putting money in. Pretty much all the movements in income track the movements in government transfers.”

This meant that the pandemic “didn’t have the effect that you often would’ve expected with a downturn, which is people don’t have money to spend. They did. And then their preference of what they spend it on tilted towards goods.” Some of this income was saved, too, so that consumers were flush even after government support ended.

Demand for durable goods—those, like Mr. Levy’s oven, that last longer than three years—dropped briefly after the pandemic started, then “shot right up in the early summer of 2020.” So while U.S. gross domestic product gradually recovered in the second and third quarters of 2020, the recovery in U.S. imports was much more rapid—reaching pre-pandemic levels by October 2020 and continuing to increase."

"Whereas goods consumption previously “might move up or down by 0.2%, here you were seeing moves that were 10, 15 times that.”"

"As consumption shifted to goods, Mr. Levy says, the initial burst was in durables. That’s one reason why Federal Reserve Chairman Jerome Powell described inflation as “transitory,” a judgment he’s since withdrawn. “ ‘Transitory’ was transitory,” Mr. Levy chuckles, apologizing for the labored joke—“trade economist humor,” he says. “We find it where we can.”

Mr. Levy, who was a senior economist for President George W. Bush’s Council of Economic Advisers, isn’t entirely unsympathetic to Mr. Powell’s initial thinking. “It was based on what we saw with the surge in durables. If everybody had moved up their purchases of sofas or exercise machines, and so forth, by definition those aren’t the things you buy month after month after month. If I buy three years’ worth of sofas all in one year, our expectation is this will be short-lived.”

The durables spurt started in May 2020, and by month’s end they were “right back to what they were pre-pandemic.” They rose to 10% above that level in June 2020. “By the time you got to about March 2021, durables consumption was about 35% higher than it had been.” That was the peak; now it’s 18% above pre-Covid levels.

But there’s been another twist. The buying of nondurables—goods that last less than three years—has shot up. After a spurt in March 2020—remember the panic buying of toilet paper—nondurable consumption went down in April 2020, then made what Mr. Levy calls “a slow, steady climb to where they are about now—13% or so above pre-pandemic numbers.” With “inelastic supply and a big surge in demand, prices have to go up.”"

"A return to previous patterns of consumption would also reduce the strain on the supply chain. Yet for consumer demand to abate, people’s buying power would need to decline, or there would have to be a shift back toward buying services."  

"The supply-chain crisis, Mr. Levy contends, has no parallel in history. We’ve had shocks before, such as the oil crisis of 1973. But “global-trade liberalization and distributed specialization,” allied to an ease of shipping and transport, fueled by ideas like “just-in-time inventory”—that’s all new."

 Related posts:

Flushing out the true cause of the global toilet paper shortage amid coronavirus pandemic (2020)

Ventilators and the law of increasing opportunity cost (2020) 

Coins are more valuable right now than they normally are (2020) 

Does socially responsible investing make the world a better place? (2019) 

Supply, Demand and the High Price of Vanilla (2019)

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