Economic Update | Goods and Services

–Current supply chain challenges may boost subsequent demand

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

The recession last year produced a goods buying binge. Consumers converted record income and savings to goods purchases.  Lockdowns and social distancing led to a surge in all kinds of goods, ranging from recreational equipment to home improvement, or just about anything that led to comfort and added utility for the consumer.  Goods spending has come down from the peak in April 2021 but is still at record levels. Going back to at least 1998, the past year and a half saw the largest increase in goods spending. As a comparison, during the Great Recession, it took about 3 ½ years to match the level of goods spending that existed just prior to that slowdown. In the Covid recession, goods spending reached the pre-recession level in about three months.

In the past year and a half, spending on goods is approximately 16% higher than the level that existed at the start of the recession.   We see similar increases in retail sales spending. During the Great Recession, almost 9 years passed by before the level of goods spending matched the level that existed in late 2007, the start of that recession.

The surge in goods spending, and the impact on supply chains, is analogous to a pipe bursting due to too much pressure. The supply chain, due to a never seen before the surge in goods spending, simply cannot cope. In essence, the supply chain pipe has ruptured! Think of a 6-inch pipe that represents container ships coming from across the globe.  Then think what happens when that 6-inch pipe is reduced to 1-inch, which represents a port of entry.  That describes one source of current supply chain challenges.

Meanwhile, on the services front, spending has yet to match the level that existed at the start of 2020.    Spending on services is accelerating; this past year has seen the largest jump in spending since at least 1998.  The most recent ISM services index saw the measure jump to 66.7, a record high.    The previous all-time high in the services index was 62 in 1997.   The two indices for business activity and new orders both came in at almost 70, record highs.  The upshot from all this is we can expect additional growth in services spending.  The retrenchment of the Delta variant and an overall reduction in Covid cases, along with pent-up demand in services spending will combine to produce significant growth in spending on the services side of the economy.

On the services side of the economy, however, there is the labor bottleneck, and this could have an adverse impact on the growth in payrolls.   In the last national employment report, there was a small increase in the size of the labor force, but the labor participation rate remained flat at 61.6%.    This is a considerable change from the 63.3% that existed prior to the recession.   Labor participation hit a bottom of 60.2% during the Covid shutdowns and climbed back to 61.5% by the end of 2020.  Since that time, the rate has hovered around the current level, even with the suspension of the federal supplement to unemployment compensation.   The biggest decline in labor force participation has been in the 55+ demographic.  A big question is whether this reduction in labor force participation is more structural, implying more permanency or that of a “new normal”.  In my view, the lower level of labor force participation will not be permanent, but we can expect improvements to be more protracted.   This will have implications for hiring, and overall labor scarcity.

While goods spending has climbed to record heights, auto sales remain depressed.   Auto sales are now at the lowest levels since the 1960s, except for April 2020. The inventory to sales ratio for automobiles is at the lowest since at least 1992.  The depressed sales in automobiles are not due to a lack of demand, but one of supply.   Inventories are simply too lean, as evident by the inventory to sales ratio.  As inventories remain scarce, demand is simply delayed.  Some consumers are postponing auto purchases today, logging additional miles, and will enter the market when inventories are replenished. This should serve as a boost to Louisville area manufacturing, and the broader economy.

Sources:  FactSet, BLS Employment Situation, BEA Personal Consumption and Expenditures, Census Manufacturing and Trade Inventories, Census Advance Retail Sales.

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