Central banks’ only real option for tackling inflation is to reduce demand – an approach that implies a significant drag on global growth. But even as interest rates rise, a recession can be avoided if policymakers recognize the large role that supply-side measures must play in restoring price stability.
Central banks’ efforts to contain high and rising inflation are fueling growth headwinds and threatening to tip the global economy into recession. But the proximate cause of today’s inflationary pressures is a large, broad-based, and persistent imbalance between supply and demand. Higher interest rates will dampen demand, but supply-side measures must also play a large role in inflation-taming strategies.
Over the past year or so, the rollback of pandemic-containment policies has spurred a simultaneous surge in demand and contraction in supply. While this was to be expected, supply has proved surprisingly inelastic. In labor markets, for example, shortages have become the norm, leading to canceled flights, disrupted supply chains, restaurant closures, and challenges to health-care delivery.
These shortages appear to be at least partly the result of a pandemic-driven shift in preferences. Many types of workers are seeking greater flexibility – including hybrid or work-from-home options – or otherwise improved working conditions. Health-care workers, in particular, report feeling burned out by their jobs.
If this is true, the inflation picture must include an adjustment in relative labor costs. To bring markets back into balance, wage and income increases will be needed, even for jobs for which there was previously an ample supply of workers.
This transition will generate some inflationary pressure. Yes, nominal prices and wages have limited downward flexibility. But at a time of excess demand, firms generally try to pass on higher costs via price increases – and they often get away with it, at least for a while.
Lingering blockages associated with the pandemic, especially in China, which remains committed to its zero-COVID policy, are also fueling inflation. But these blockages will eventually subside, as will short- to medium-term capacity constraints caused by shifts in the composition of demand (in terms of both products and geography), though some will persist for a while. Capacity – whether in ports or semiconductors – takes time to build.
But today’s inflation has deeper roots. Over the past several decades, the activation of massive amounts of underutilized labor and productive capacity in emerging economies has generated deflationary pressures. With those resources having now been significantly depleted, the relative prices of many goods are set to rise.
Moreover, there is a global push to diversify and, in some cases, localize demand and supply chains – a response to the increasing frequency of severe shocks and rising geopolitical tensions. A more resilient global economy is a more expensive one, and prices will reflect that.
The war in Ukraine has not only accelerated this supply-chain transformation, but also has caused energy and food prices to skyrocket, further exacerbating inflation, especially in lower-income countries. In the case of fossil fuels, a prior pattern of underinvestment in capacity at multiple points along the supply chain has compounded the problem.
But there is even more to the story. More than 75% of the world’s GDP is produced in countries with aging populations. Old-age dependency ratios are rising, and in some countries, the workforce is shrinking. Productivity gains could counter the contraction of labor supply relative to demand, but after nearly two decades of falling productivity growth, such gains are not forthcoming.
So, inflation is rising fast, and central banks are under pressure to take drastic action. But their only real option is to reduce demand, by raising interest rates and withdrawing liquidity. These measures have already spurred a massive repricing of assets, including currencies, and they threaten to push global growth below potential, with lower-income economies suffering disproportionately, and to reduce investment in the energy transition.
There is another way: supply-side measures. Trade and investment have long enabled supply to expand rapidly in response to growing global demand. But, for nearly two decades – and especially in the last few years – proliferating trade barriers have been adding friction to this process. Creeping protectionism must be reversed, with US President Joe Biden removing the tariffs imposed by his predecessor, Donald Trump, and Europe accelerating the integration of its services markets.
At the same time, efforts must be made to improve productivity. Digital technologies will be crucial here. While the pandemic helped to accelerate the digital transformation, many sectors – including the public sector – are lagging, and concerns about the effects of automation on employment persist.
But in a supply-constrained world characterized by persistent labor shortages, productivity-boosting digital technologies, together with higher wages for workers, would go a long way toward improving the balance between supply and demand. For example, artificial-intelligence-based tools can perform a wide range of functions, from screening luggage more efficiently at airports to analyzing medical imaging to detect cancers. Beyond digital technologies, regulatory regimes can be streamlined and improved, in order to reduce supply-side bottlenecks.
Such an agenda must be applied to both the public and private sectors. At the international level, efforts to facilitate trade, address supply-chain rigidities, and close data gaps will be essential. Otherwise, central banks will be left to deal with inflation alone – with dire consequences for the entire global economy.
Pentagon gives $35 million to subsidize MP Materials's rare earth mineral production
The White House on Tuesday featured a mining company partially owned by a Chinese mining conglomerate at an event dedicated to strengthening the domestic supply chain.
President Joe Biden announced at the event that the Pentagon would award $35 million to the Las Vegas-based MP Materials in an effort to boost U.S. rare mineral production. But MP Materials has arguably allowed China to tighten its grip on the world’s rare earth minerals supply chain. Shenghe Resources Holding, which is partially owned by the Chinese government, owns 8 percent of the company. Shenge spearheaded the deal in 2017 to help MP Materials purchase a mine at Mountain Pass, Calif., out of bankruptcy. The Chinese company is also MP Materials’s largest customer, accounting for nearly all of its $100 million annual revenue.
MP Materials’s links to China have long concerned American officials. The Department of Energy warned its scientists in 2020 not to collaborate with MP Materials executives because of China’s links to the company, Reuters reported.
“Clearly, the MP Materials ownership structure is an issue,” Tom Lograsso, an official with the Department of Energy’s Critical Materials Institute, told Reuters.
The Pentagon award will subsidize MP Materials’s production of heavy rare earth minerals at its mine at Mountain Pass. The minerals are used to produce high-powered magnets used in electric vehicle motors, wind turbines, and defense systems.
James Kennedy, a consultant in the rare earth minerals industry, has raised concerns about other Pentagon grants to MP Materials. Kennedy called Shenghe’s investment in MP Materials a “geopolitical ruse” that helps China maintain a monopoly on the rare earth minerals market.
Those concerns have not deterred the White House. MP Materials chairman James Litinsky spoke at the virtual White House event alongside Biden, Gov. Gavin Newsom (D., Calif.), White House infrastructure czar Mitch Landrieu, and Energy Secretary Jennifer Granholm.
Litinsky said MP Materials was “committed to bringing the supply chain home” to the United States but made no mention of his company’s links to Shenghe Resources Holding. He said MP Materials has partnered with General Motors to produce magnets for 500,000 electric vehicle motors.
It is unclear whether the Pentagon has placed any restrictions on MP Materials’s dealings with Shenghe going forward.
Shenghe’s investment in MP Materials is part of an ambitious plan to stabilize China’s supply of rare earth minerals. The company has also partnered with companies in Greenland and Australia to mine rare minerals, Quartz reported. One goal is to “consolidate the achievements of overseas cooperation projects.”
MP Materials did not respond to a request for comment.