​No shortage of shortages

richardcropper Nov 16th, 2021

Tim Harford, economist, broadcaster and journalist, has been a regular provider of ideas for this blog. Writing in the Financial Times recently he has done it again. No prize for guessing his theme is shortages and their causes.

Market economies are supposed to resolve shortages by raising prices to bring supply and demand back into equilibrium. As a result, economic literature has little to say about actual shortages in a market economy.

There are clear examples of price spikes happening now, such as in energy and shipping costs.However, consumers have (so far) largely been insulated from them. As Harford points out, our experience was not that the price of electricity, toilet paper or petrol doubled. It was that there was no petrol or toilet paper. Electricity still flowed, but the supplier who promised to provide it cheaply had gone bust.

In 1986, more old favourites of mine, Daniel Kahneman, Jack Netch and Richard Thaler published an explanation of why prices do not shift in a crisis: customers hate it when they do. They found that, whilst economists traditionally view price adjustments:

“as natural as water finding its level - and as ethically neutral. The lay public does not share this indifference”.

Businesses understand this: they could raise prices to ensure there is always a supply, but a few days of extra profit are overwhelmingly outweighed by the bad press and customer ire that would follow. Business would rather allow supplies to run out.

Over time, prices usually do adjust, as consumers are more tolerant of slower shifts: interestingly though, the price of a bottle of Coca-Cola was five cents in 1886 and it remained so until the late 1950’s.

But that is not the whole story. Few understand the true complexity of what we consume, particularly how dependent we are on largely obscure processes. The production of cars has been restricted by a lack of basic computer chips. The production of vaccines has been threatened by a lack of giant plastic bags. The production of meat has been jeopardised by a lack of carbon dioxide.

In each case, the item is a minor part of the product, but lack of it causes loss of the whole. There is of course a tragic and infamous example of this from 28th January 1986; at 11.38am the Space Shuttle Challenger took off from Cape Canaveral in Florida. Seventy three seconds later the shuttle broke apart, leading to the death of seven astronauts. The physicist Richard Feynman sensationally demonstrated his finding of the cause of the disaster: a rubber seal O-ring, which had become brittle in unseasonably cold weather.

Harford poses the question of whether ‘O-ring failures’ are in fact all around us. In other words, more attention ought to be paid to complex supply chains when the whole lot depends on the weakest link.

Two solutions are put forward. One is to ensure that every link in the chain is made by the same organisation (a single vertically integrated supplier). The second, and far more common, is to ensure more competition at every stage so that when one link fails, there is a ready replacement available.

There is another factor at work here too. Since the 1950’s, manufacturers have been moving to a ‘just in time’ system of inventory management. Toyota started it to prevent parts shortages by better co-ordination with suppliers. Smaller inventories were a welcome side effect for shareholders.

It may seem logical to expand inventories, moving from ‘just in time’ to ‘just in case’. Harford argues this is precisely what motorists did when they all queued to fill up their cars at the same time.

Governments could take action here and there but, in most cases, the complexity and interconnectedness of supply chains make it hard to see how governments might actually help.

Harford refers to ‘Chaos Monkey’, created a decade ago by software engineers at Netflix. They devised a system to randomly disable Netflix servers. The point of this was to push engineers to build more resilient systems. Having concluded that these random acts of self-sabotage were producing the desired response, Netflix followed up with ‘Chaos Kong’, which simulates a much broader service failure.

To quote directly from Harford:

Late in 2019, the British people decided that Chaos Kong would make a good prime minister and elected Boris Johnson by a large margin. Johnson has now decided to make a virtue of his own recklessness. After initially claiming that the shortage of truck drivers in the UK was entirely unconnected to Brexit, the government now boasts that the shortage is indeed Brexit-related and was the plan all along. True to the spirit of Chaos Kong, this tough love for the British economy is the only way to get it to shape up. In preventing the easy recruitment of truck drivers, abattoir workers and care-home staff from the EU, the UK government is actively blocking the most straightforward way to get the economy running smoothly again. (To ensure everyone got the message, Johnson compared immigrants to heroin, complaining that businesses had been able to “mainline low-wage, low-cost immigration”.) The assertion is that if the government deliberately constricts the supply of essential workers, the economy will come out stronger in the long run. Chaos Kong worked for Netflix. Will it work for the UK?

The government’s independent Migration Advisory Committee surveyed the latest evidence on productivity and immigration in 2018. The estimates of benefits (to productivity) were so large that the committee could not quite believe them.

A revolutionary technology could transform the outlook, leading to a rise in investment and productivity, and rising real wages. However, past experience indicates such changes tend to take a long time to bring real benefits.

Harford concludes:

Boris Johnson is betting that if he gives the UK economy a shock, something will turn up — just as when you give your television a thump, it might work better. And it might. But Chaos Kong does not seem to have a clear idea of what opportunities might materialise.

Food for thought indeed.