Recently enough there was a massive shortage of baby food formula in the United States. Prices surged (as they would in times of acute scarcity) if at all supply was available in the first place. The roots of that crisis can be traced back to warnings made in 2018 in the wake of the re-cast NAFTA which correctly predicted that it could lead to precisely a situation where Canadian producers would not be able to sell available production to the US. Further, a concentration of production in the hands of just 4 major producers in the entire US coupled with underinvestment led to a capacity crunch and a jump in prices. It was resolved only through government intervention (specifically the President) who arranged for supplies to be flown in from Europe (35 tons immediately) and invoked the Defence Production Act to increase domestic production. The US government also went after profiteering companies who were taking advantage of the shortfall. The lessons from this crisis are applicable in many ways to the overall inflation and supply side blockages that affect the globe now and the solutions also are translatable. Some thoughts on why:
1. Inflation is global. It isn’t limited to just the US. And it is affecting developing nations more than it affects developed economies. The chart below attests to the differences between the two.
Fig. 1: Global Inflation between Developed and Developing Economies
Source: World Bank Group
The origins of this inflationary spiral can largely be traced back to the disruptions caused by the Covid pandemic of 2020-21 and which still affect us today (for example, in China with continuing lockdowns of critical centres of global production- the latest being in the Si County of Anhui province, an area critical to the production of solar panels, semiconductor chips and medicines). An additional shock has been the Russian invasion of Ukraine which affected the available supply of Ukrainian grain to many developing countries along with other essentials. Embargoes on Russian oil and counter threats from Russia on Russian gas have driven up energy prices. Shipping costs rising have driven up landed costs and further driven inflationary pressures. So, despite the general narrative of ‘pent-up demand’ for services and stimulus money adding demand pressure we can see that it is largely a supply side issue.
2. Central banks have evolved over decades to interlink their policies as well as coordinate policy responses to a certain extent. This has become necessary because of the increased mobility of free capital movement and growth in global trade. But they have limited mandates and limited control over the instruments available to tackle the situation. They have price-stability mandates and monetary tools at hand. Since the problem is global, and they are all following the same playbook (barring China and Japan) of raising rates and squeezing liquidity. They have no choice: they target inflation at a particular rate, and they need to be seen to act if actual inflation runs above that target range.
Fig. 2: Central Banks are in the same boat.
Source: The World Bank Group
But, as we have seen in the example of the US baby food formula shortage, the solutions lay in fixing the supply side, not through killing demand!
3. This is a job for government intervention on a multi-pronged front. But this will also be politically difficult. Whilst nothing can be done about the Chinese lockdowns affecting supply chains directly action can be taken to reduce the landed price of goods- by attacking the tariff barriers erected by the previous President. Shipping companies have raised their prices by up to 10-fold- not because of increased costs but because they could get away with it. Their profit gains need to be brough under a windfall tax to discourage the practice. Diversification of sourcing- through ‘onshoring’ or sourcing through other low-cost centres will take time- for capacity build-out and setting the arrangements but this has been an ongoing concern since 2020 and should be delivering tangible results by the end of the year by most estimates.
4. Similarly, oil prices can be tackled by letting Iranian and Venezuelan supplies back with access to the global market- and it is entirely thanks to the United States that they are not. Food supply problems can be alleviated by using some Russia friendly nations (India and China) to negotiate passage through the Black Sea for its grain exports to African nations.
5. The other major issue that needs to be addressed is the question of debt forgiveness for developing nations. This is critical from a humanitarian perspective. The rising rates in the US are pressuring sovereign foreign currency debts across the globe and the increase in rates, decrease in local currency values against the US Dollar on top of the domestic problems of food and energy scarcity are driving vulnerable nations to crisis point.
Fig. 3: Debt pressures and Vulnerability
Source: IMF (via Bloomberg)
And the vulnerable are not just the poorer nations but also middle-income nations: Argentina, Bahrain and Turkey are by no means poor nations. Debt crises tend to create a domino effect of default- a contagion that, in this environment, will be hard to counter. There is some $237 billion of sovereign debt due to foreign bondholders that are trading in distress currently out of a total of $1.4 trillion of EM debt denominated in USD, Euros or Yen. Debt forgiveness by lenders is a supply-side intervention and becoming critical. This is not so much to tame inflation but to mitigate the damage it can do to the most vulnerable.
6. Probably the most politically charged supply side interventions would have to be the balance between corporate profitability and wage demands. In the US, blame is being placed on the lap of wage demands driving up prices and part of the intended effect of raising rates is to slow the economy down and shed some of the tightness in the labour market to ease the pressure on inflation. But this neglects the tightness may be due to low participation rates because wages have not kept up with inflation. Moreover, record corporate profits are being reported as they hike prices (blaming but also causing inflation) but there is little political will to take on corporates who have political clout. But they have a direct impact on the inflation rate print. And this applies to retail chains and consumption goods manufacturers as much as oil companies. Another reason for a windfall tax perhaps?
Rates are likely to continue to rise in the immediate future. Central Banks are on a mission- using the only weapons they have in their arsenal. But the battle against inflation is now causing widespread damage and needs governments to step up and use some supply-side intervention to attack it from another angle.