Supply surprise

Forty years ago most people had never heard of supply side economics. During the 1980s, however, governments in the US and UK promised a supply side revolution by cutting taxes and regulation to allow economies to work more efficiently and thus increase prosperity. Together with the extension of globalisation and advances in technology, this has radically changed the way in which companies operate.  Just-in-time inventory management is now the norm as production chains have grown to encompass the world and the manufacturing process itself is much less vertically integrated than was the case 40 years ago. But whilst the consumer has generally benefited from improved efficiency it has come at the cost of resilience as disruptions in one part of the world quickly ripple out to affect others.

Indeed the problem that supply side proponents never fully addressed was the ability of a deregulated economy to respond to shocks. As the 2008 crisis highlighted, when the deregulated banking sector encountered problems, only governments were able to marshal sufficient resources to ensure rescue packages of the requisite size. In the wake of the crisis, the business community accordingly became much more sensitive to political concerns. As the political climate became increasingly attuned to concerns that local jobs were being shifted to cheaper locations abroad, businesses began to embrace the concept of nearshoring – the process whereby supply chains are shortened to ensure that goods and services are sourced more locally. This was also facilitated by the fact that traditional offshore locations no longer offered such cheap sources of labour as global competition for local resources pushed up wages. This is one of the factors behind the slower pace of globalisation evident in recent years as evidenced by the KOF Globalization Index.

Covid has placed another spanner in the works. Supply chains have been under pressure like never before with the recent surge in global inflation largely attributable to issues arising from supply side disruption. Early on in the pandemic it was realised that Asian based semiconductor manufacturers would face significant disruptions in 2020 which would manifest in 2021, and that is exactly what has happened. This has impacted on industries such as autos, where prices have risen to such an extent that around one-third of the change in the US CPI over the summer could be attributed to second hand vehicles.

No supply network in the world could reasonably hope to escape unscathed in the wake of such a shock. But the nature of the system that has been created across the industrialised world in recent years is particularly vulnerable, and in many cases the problems are compounded by poor policy choices. We can illustrate this by looking at two particular cases.

The lorry driver shortage problem

Over the last few weeks the British media has been reporting on the rising trend of empty supermarket shelves as retailers are unable to secure enough produce to satisfy demand. This in turn is largely due to the fact that there is a shortage of HGV drivers to ensure delivery of the product. It is important to highlight at the start that this is not solely a British problem. According to a survey by Transport Intelligence, it is a Europe-wide problem. In fact, Poland reported the highest number of unfilled vacancies in the logistics sector, estimated at 123,000 with the UK occupying second place with between 60,000 and 76,000 vacancies. Adjusted for population size, there are around 0.33 vacancies per head in Poland compared with 0.09 in the UK and 0.05 in Germany (chart below).

This has arisen for a variety of reasons, not the least of which is that the outflow of older workers from the logistics industry is higher than the number of entrants due in large part to the poor conditions associated with working in the haulage sector. In the UK, however, these underlying structural problems have been compounded by Brexit. According to a survey by the Road Haulage Association, 58% of respondents attributed the shortage of HGV drivers primarily to the UK’s decision to leave the EU. By contrast, only 38% perceived that the problems were mainly due to Covid. That said, Covid is exacerbating the problem because it has significantly slowed the pace at which HGV driving tests can be conducted.

Whilst problems in the logistics sector are long-standing, Brexit has highlighted the lack of resilience in the sector. The UK was heavily dependent on drivers from other EU nations – the RHA estimates that prior to the pandemic around 10% of all drivers employed in the UK were nationals of other EU countries. This was in large part due to the fact that pay and conditions in the sector are perceived as poor and the jobs on offer were unattractive to locals. However, the UK industry was able to pay workers from some of the less wealthy EU countries more than they could have earned in their home market thus alleviating the shortage. But many of them recently appear to have returned home, either because of a perception that they were no longer welcome in the UK or because they feared being stranded on this side of the channel due to Covid. One thing is clear: The UK logistics sector benefited from the freedom of movement enshrined in EU membership and now it must learn to cope without it.

The energy problem

Similar supply problems are looming in the energy sector. Wholesale gas prices have risen by 250% since the start of the year and are up 70% since August alone (chart below). A number of factors are affecting prices: A cold winter in Europe last year had already put pressure on supplies and the amount of stored gas is far below normal levels. We have been warned for some time that there is insufficient storage capacity but this year it really seems to be coming home to roost. There is also increased global competition for liquefied natural gas, particularly from Asian countries. Unfortunately, too, the race to exit fossil fuels has proceeded at a faster pace than investment in alternatives. This was not helped by the collapse in investment activity in 2020 for Covid-related reasons. However as the IEA has pointed out “the USD 750 billion that is expected to be spent on clean energy technologies and efficiency worldwide in 2021 remains far below what is required in climate-driven scenarios.”

This will have a number of knock-on effects. Rising wholesale gas prices have caused producers of carbon dioxide to cease production, which will in turn have a major impact on the food and drink sector (see here for an explainer). Consumers will face a double whammy because they are set to face a huge rise in household energy tariffs which are expected to rise by around 12% next month. They may well rise further later in the winter when Ofgem further lifts the price cap on household bills. For the record, the prime minister did promise in 2016 that “fuel bills will be lower for everyone" when the UK leaves the EU.

As far as the energy industry is concerned, a number of smaller gas suppliers have already gone bust after failing to hedge the big rise in wholesale prices. It is intended that clients of these companies will be supplied by existing companies. However, this will require them to supply gas to customers for whom they have not budgeted in their wholesale market negotiations which in turn is likely to mean they will require government financial support.

What to make of it all?

To the extent that the energy problem is a global one, we cannot lay it at the door of Brexit. To a large extent, it is the result of a state sponsored dash for renewables coupled with a failure of the private sector to make the necessary investment in alternative energy sources. Similarly, the lorry driver shortage issue is not wholly a Brexit related phenomenon although it has exacerbated it. But both are examples of supply chain failures which have been made worse by government policy choices.

Irrespective of the underlying causes, the optics for the UK government are not good. Far from delivering increased prosperity, as Brexit’s proponents promised, consumers face the prospect of empty shelves in the shops and much higher energy bills. Voters may start to draw conclusions about the economic consequences of Brexit and start to ask some awkward questions of government. If and when that happens, Boris Johnson will be in need of some good news to assuage the electorate.