COVID-19 variants, semiconductor shortages, labor-force issues … there’s a lot of uncertainty in our economic future. Tanya Ott asks Ira Kalish to break down the factors that will influence the global economy over the next year.
Tanya: Welcome to the first Press Room of 2022. I’m Tanya Ott and today we’re checking in Ira Kalish, chief global economist for Deloitte Touche Tohmatsu. I’ve asked him to give us the outlook for the year. We’re going to talk supply chain, inflation, and wages … but first, Omicron—which is causing recording-setting levels of infection here in the US and beyond. It’s affecting individuals, companies, and entire systems. So, what are you seeing, Ira?
Ira Kalish: This is very difficult to talk about, given the speed at which things are happening. As we speak, today on January the third, the number of new daily infections in the US has doubled from what it was exactly a week ago. In fact, all the commentary you hear about this is dramatically different than what we saw just two weeks ago. Most public health officials now suggest that the numbers could increase dramatically in the coming weeks before starting to fall. So, it poses—at the very least—a public health problem, which could lead to an economic problem. What we do know already is that here, in the US, and in Western Europe—where we've seen this sharp rise in Omicron infections—we've also seen many people not showing up for work, especially in critical industries like health care and transportation. This is in part because of the fear of contagion, which is very rational, and in part because a large number of people, who are infected, have to quarantine. So that, at the very least, might have a significant negative impact on economic activity, and have a disruptive effect on supply chains. At the same time, there's already evidence that in the last two weeks in December, there was a sharp drop in consumer mobility, and in the number of people making restaurant reservations, or showing up through airport security checkpoints, or getting on the New York subway. So, these indicate a possible deceleration in the growth of demand, which had been pretty strong before this episode.
Tanya Ott: One of the things that you mentioned was supply-chain problems, and I'll just say I ordered all three of my adult daughters these adorable pajamas. It's now almost two months since I ordered them. They're not here yet, and I look at the tracking and it's coming from China. So, we have some real significant supply-chain problems still, and I expect that's going to continue.
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Ira Kalish: Well, it probably will continue, but there are some indications of things starting to improve. We did have a surprising degree of disruption in 2021 for two reasons. One, there was a massive increase in consumer demand for goods. This was partly due to massive government stimulus, which put more money in consumers’ pockets. But, also very importantly, during the pandemic, there was a dramatic shift in spending away from services and toward goods. When people couldn't leave their homes and couldn't go out or were afraid to interact socially, they spent more money on things for the home, like big-screen TVs or home appliances or furniture or fitness equipment, which they didn't necessarily use. At the same time, the pandemic had a disruptive effect on the supply end of things. In China, for example, there is a zero-tolerance policy toward the virus. If one person in a factory is infected, they shut the factory down.
Changes in consumer spending patterns led businesses to adjust their supply chains to meet changing demand patterns. We saw disruption to transportation. We saw disruption to commodity markets. It was sort of a perfect storm of bad things [happening], with rising demand and limited supply. The end result was the supply-chain disruption that you're experiencing, which in turn contributed to the much higher inflation that we're now experiencing as well.
However, there are some positive signs. We're starting to see a decline in consumer spending on goods, because, at the end of the day, there are only so many big-screen TVs that you can have in your home. And at the same time, there is some anecdotal evidence that supply chains are starting to move more efficiently. We did see in November, for example, a very sharp increase in industrial production in Japan and South Korea, including a very big increase in production of automobiles, which had been disrupted by a shortage of semiconductors. So, it appears that that may be starting to change. And, if so, perhaps by the end of this year, or early in 2023, we'll see more normal supply chains and that, in turn, could help reduce some of the [existing] inflationary pressures.
Tanya Ott: What were some of the factors that went into what you call a change we're starting to see with semiconductor chips? I know that it was a real issue and there was at least one factory that burned down, which was significant, and that the rebuild was projected to take a couple of years. So, are we getting there faster than we thought we would?
Ira Kalish: Well, during the pandemic, we saw a dramatic increase in the demand for semiconductors, partly because during the pandemic, we shifted toward doing more things online, [such as] working from home and shopping from home. That led to a big increase in investment by both businesses and people in information technology. All of that required semiconductors. At the same time, the automotive industry is heavily dependent on semiconductors, and as the industry recovered rapidly from the doldrums of the pandemic, automotive companies found it difficult to acquire the semiconductors that they needed. So, there was this massive disruption that affected the automotive industry and affected overall inflation too. What we do know is that some of that demand for goods is starting to abate, and semiconductor production is starting to pick up pace—although it does take time to get that type of production up and running. So, we're not yet where we need to be. But it seems like we might have turned the corner.
Tanya Ott: What's the bullwhip effect?
Ira Kalish: Well, the bullwhip effect is when—let's say a company is aware of the fact that there is a shortage of semiconductors, and they find that they can get their hands on some. They go and buy as many semiconductors as they can, far beyond what they need, and just hoard them, store them; and that's a rational decision on the part of one company. But if every company does that, the net effect is to exacerbate the shortage and the inflationary pressure that comes from that shortage. And it is believed that we've seen that happen for a number of commodities and key inputs in the global manufacturing sector. That bullwhip effect probably prolongs supply-chain disruption and exacerbates inflation.
But I think, over time, it kind of fixes itself. Beyond a certain point, businesses stop hoarding. And then, as other aspects of supply chains start to become resolved, businesses feel less incentive to hoard. And, so, the bullwhip effect ultimately should go away. But temporarily, it is problematic.
Tanya Ott: I found it really interesting when you were talking about the auto industry. I had an emergency auto car purchase about a month ago, and it was nearly impossible to find cars on the lot. And, not only that, in looking at the inflation data, it looks like the cost of used cars is up dramatically because new car dealers were purchasing used cars to have things on their lots. And it's just kind of set that sector into an interesting place, shall we say.
Ira Kalish: And it all stems from that semiconductor shortage. You had a shortage of semiconductors. Automotive companies couldn't produce as many new cars as they wanted. In fact, many of them shut down some factories. Consumers couldn't get many of the new cars they wanted at a price that was reasonable to them, so they started looking for used cars. And yet, at the same time, rental car companies, which had sold off much of their fleets early in the pandemic, seeing demand return, were starting to try to buy up a fleet. They couldn't get new cars, so they tried to buy used cars. So, the end result was everybody buying used cars. The prices of used cars go through the roof and contribute substantially to inflation. In fact, during the summer, the increase in used-car prices accounted for a third of the overall inflation we were experiencing in the US, which is really staggering. The situation has improved somewhat since then, but the average price of a used car today is dramatically higher than it was just a year ago.
Tanya Ott: So, let’s talk about inflation. I've got to say, I was in a not high-end grocery store the other day and king crab legs were going for $50 a pound, which I don't think I've ever seen. I certainly didn't buy any. What's it going to look like in 2022?
Ira Kalish: Well, I think we'll have fairly high inflation this year, but I think it may be the case that inflation has either peaked or is close to peaking. We did see a very dramatic increase in inflation in 2021, and it did set off a debate as to whether it was a temporary phenomenon or if we were at the start of a new 1970s-style era of long-term higher inflation. My own view is it's more likely to be temporary. The reason is, it seems that the major factor contributing to the higher inflation was this supply-chain disruption in the market for goods. That's reflected in the fact that it's the prices of goods rather than services that have increased so much. Plus, consumers saved a very large share of those payments, and there is a lot of money in the bank. Some people make the argument that in the coming year, they'll spend a lot of that money, but historical experience suggests that's not necessarily the case. If you look at what happened at the end of World War II—during the war, people had saved a lot of money because consumer goods were not available. Everybody had a job when the war ended, and consumer goods became available. [But] consumers didn't suddenly go out and spend with abandon. They still held on to most of their savings. My expectation is that, over the next year or year and a half, we'll see this supply-chain disruption recede, because consumer demand for goods will recede. It's already starting to happen. Manufacturers and transport companies will improve the efficiency of their supply chains. And again, there's some evidence this is starting to happen. Once that supply-chain disruption goes away, one can reasonably expect that the inflationary pressures will go away as well. So, I think on average, inflation this year will still be high, but I think it will come down quite a bit by 2023.
Now, I could be wrong. What would make me wrong? One thing is that if the virus situation is prolonged, it will prolong the supply-chain disruption. Another possibility is that as inflation persists, people's expectations of inflation change in ways that change their behavior. So, if workers expect very high inflation, they will seek higher wages, and businesses will provide those higher wages. And that, in turn, itself will be inflationary. So, you know, there is a plausible scenario in which inflation is a serious problem, but I think a good baseline forecast is that over the next two years, it will largely recede.
Tanya Ott: The supply-chain issues, you say—they're looking like they're starting to resolve, but I'm wondering if they uncovered some systemic issues that perhaps the US needs to address in terms of how ports work, how things get in and out across the water, things like that lack of shipping containers. Is this more of a systemic thing?
Ira Kalish: There are some systemic problems. You know, one problem is maybe too much dependance on one market—China. And we’re starting to see companies beginning to diversify their supply chains so they're less vulnerable to disruption in one country. Another problem is our ports—and the current US administration has sought to get important ports to operate 24 hours, rather than just daytime. We do have a shortage of truck drivers, which preceded the pandemic by the way, and has only worsened during the pandemic. It's not clear how that’s going to be resolved, because wages for truck drivers have gone up quite a bit and there’s still a shortage of truck drivers. So, there are a lot of moving parts here. I think initially we will get some of that supply-chain disruption resolved, but some of it will persist, especially where it concerns the labor market. What we've seen during the pandemic is a sharp drop in labor-force participation, and it hasn't reversed. And, while I think it will partly reverse, there are some people that will never return. A lot of older workers retired early. They’re probably not coming back. A lot of people quit jobs, and they may not come back as well, unless wages in those businesses go dramatically higher. So, we may face some labor-force disruption that will limit the efficiency of supply chains in the coming years. I'm not sure what the ultimate answer to that is. It might partly be more investment in labor-saving technology so that things can be done efficiently with less labor.
Tanya Ott: Speaking of the labor-force issues, does that situation put workers in a position of greater power?
Ira Kalish: Yes. If we do have a shortage of labor, theoretically, it should lead to dramatically higher labor costs and wages, and that should give workers more leverage. And we’ve seen that to some extent in some industries and professions. But surprisingly, given the scale of the labor shortage that we’re experiencing right now, we haven’t seen a dramatic increase in wages yet. It may come later, but so far, that hasn’t been one of the factors.
Tanya Ott: We’re dealing with a whole lot of uncertainty. We had a lot of uncertainty in 2021. We still have uncertainty going into 2022. How do we deal with, you know, just the uncertainty of everything?
Ira Kalish: Well, that’s more than an economics question. It's a sociological, psychological, theological question. (laughs) Speaking as an economist, the problem with uncertainty is that it leads people and businesses to delay some decisions in ways that affect economic activity. If businesses are uncertain about the path of the virus and the impact it might have on consumer behavior, they may delay investments or hiring, and that would have an impact on the overall economy. So, how do we manage that uncertainty? I guess the best thing to do is to do some scenario-planning. Just figure out what are some plausible and likely scenarios, and what do we need to do to be prepared for each of those scenarios? What are some common things that we should do related to all of those scenarios? But really, at the end of the day, uncertainty sucks, and there’s not a whole lot we can do about it until we know a little bit more about what’s going to happen.
Tanya Ott: Wow. Okay, so, I guess we’re going to leave this conversation on “uncertainty sucks.”
Ira Kalish: It’s a technical term.
Tanya Ott: Yes, yes. I remember that from Economics 101 back in college. So maybe you can come back in a couple of months and give us an update on how things go.
Ira Kalish: Absolutely.
Tanya Ott: Ira, so great to have you on the show again today.
Ira Kalish: Thank you. Happy to be here.
Tanya Ott: Ira Kalish is chief global economist for Deloitte Touche Tohmatsu. You can find more insights and analysis from Deloitte’s global team of economists in the weekly economic update on Deloitte Insights.
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I’m Tanya Ott. Thanks for listening.
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