Philip Cross: Welcome to our new economy of shortages, comrades

October 23rd 2021
Article by Philip Cross published on October 15, 2021 by the Financial Post     

Shortages imply that inflation is much greater than the official measures suggest

Since the pandemic began, governments have focused almost exclusively on boosting aggregate demand — in the belief that understandably cautious spenders were the main threat to economic growth. But it is becoming increasingly clear that the pandemic’s more enduring impact is disruption of supply. The result is price increases exceeding forecasts and the prospect that persistent shortages will fuel inflation well beyond the three or four months that would qualify as transitory. As is often the case with crises, the pandemic has unleashed unexpected and unintended effects, bedeviling government planners everywhere.

Few people foresaw shortages as a likely outcome. In summer 2020, the Bank of Canada predicted the “decline in supply is likely to be relatively short-lived” — even though shortages had been emerging in many regions and industries before the pandemic. With immigration plummeting as borders closed, it was predictable that COVID would trigger a drop in labour supply, yet policy-makers were fixated on propping up demand for fear slow growth would put downward pressure on prices.

The most obvious manifestations of shortages are soaring prices for housing and commodities, notably oil and gas. Housing prices across Canada took off during the pandemic. But housing demand has outstripped housing supply since early 2015, when the Bank of Canada lowered interest rates, and the imbalance between the two has been slow to resolve itself, which is usually the case when governments interfere in the market’s normal adjustment to high prices. Government regulations, often at the local level, have prevented housing supply from rising quickly enough to dampen prices. As for oil and gas prices, firms are reluctant to invest after prices cratered in 2020, partly because some governments are blocking further development of fossil fuels. Compare these clogged markets with the market’s quick resolution of this spring’s spike in lumber prices.

Pandemic shortages worsened when problems surfaced in the global supply chain. A shortage of semiconductor chips first appeared in the auto industry when a reduction in orders by manufacturers coincided with soaring demand from the technology sector as work and shopping shifted on-line. The shortage of new autos triggered a surge in used-vehicle prices, which on its own accounted for nearly half the increase in the U.S. CPI this summer. More recently, growing supply problems in Asia caused by pandemic-related government shutdowns and power outages have been compounded by transportation shortages, notably for container ships and truckers.

Shortages have spread this year to most sectors as many firms struggle to re-hire workers who either have left the labour force or moved to other jobs. The result is the unusual coexistence of both high rates of unemployment and job vacancies, a measure of the distortions introduced into our economy by the pandemic and government programs to support people. So far, labour shortages have not resulted in sharply higher wages, although firms are clearly feeling the pressure; just this week I received a postcard from Amazon offering employment at $17.10 an hour.

Shortages imply that inflation is much greater than the official measures suggest. Statcan’s CPI rose 4.1 per cent in the past year. But it was designed to measure prices in an economy where goods and services are abundant, not a Soviet-style economy of rampant shortages. Shortages are de facto price increases. Higher prices, longer wait times, fewer product options and lower quality of service all represent an increased cost to consumers, yet only list prices are incorporated into the CPI. Furthermore, Canada’s CPI does not include used-car prices, which alone account for the current gap between our 4.1 per cent inflation rate and the Americans’ 5.4 per cent.

There are ways to measure the cost to consumers of less choice or longer wait times, but they would be costly to implement. The Liberal government was quick to provide Statcan with funding to measure the pandemic’s unequal impact on various minorities in the Labour Force Survey, intentionally stoking woke feelings of victimhood. But money to improve the CPI, which affects everyone since the government’s entire tax-and-transfer system is indexed to it, was not forthcoming.

In Statcan’s latest Survey of Business Conditions, firms said the six largest impediments to their business were directly related to cost increases and supply shortages; just one quarter earlier, three of the six largest obstacles had been demand factors related to attracting customers. In some industries, shortages are pervasive; for example, 98.5 per cent of Quebec manufacturers cited shortages, which are forcing firms to pay penalties for being late or to turn down new contracts because they cannot meet demand.

Eventually, problems in the global supply chain should be resolved, especially once demand slows after Christmas. But high energy prices and labour shortages may not dissipate quickly, while the retirement of older workers will prove hard to reverse. And to judge by recent U.S. experience, not even withdrawal of emergency support programs and the start of a new school year will provide the hoped-for boost to labour supply. If labour shortages do necessitate higher wages, that will reinforce upward pressure on prices, pushing central banks to raise interest rates and slow demand to re-align it with constrained supply.

Philip Cross, former chief economic analyst at Statistics Canada, is a senior fellow at the Macdonald-Laurier Institute.

Photo by Bruno Kelzer on Unsplash

Click to close