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Labor and materials: Shortages drive costs higher

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Labor and materials: Shortages drive costs higher

Businesses in 2022 will be forced to pay more for labor, especially to service workers who were some of the lowest paid workers and most in danger of getting COVID, and have been most hesitant to return come to work.

Labor has been a major problem as the economy started recovering from the worst of the COVID lockdown in the second quarter of 2020. In the US, labor force participation collapsed during the pandemic and has had a hard time recovering. The US labor force remains 4 million workers below pre-pandemic levels. In Europe, wage subsidy schemes helped maintain the pre-pandemic labor force. However, COVID-19 disrupted migrant labor flows, which is starting to show up in job vacancy rates, especially in Western European countries. Even Southeast Asia is struggling with availability due to new waves of COVID-19 restrictions, and a zero-COVID policy in China is leading to lockdowns of entire cities, adding to supply chain disruptions.

Tight labor supply is shifting negotiating power away from employers toward employees. The bottom line is if you are a business, you are going to pay more for labor in 2022. It’s that simple. Labor supply issues are hitting as demand for goods remains elevated. In the US, consumer spending on goods was up 17% in the fourth quarter of 2021 compared with the fourth quarter of 2019. Spending on durables was up 23%. Strong demand is putting a strain on the logistics sector, with a rapid acceleration ine-commerce boosting demand for truck drivers and warehouse workers. Even in normal conditions employers would have to hire a lot more workers to meet demand, and with tight labor market conditions employers are finding they need to pay more to attract and retain workers.

Worker availability is not limited to the goods producing sector. In Europe, China, and the US, those most exposed to COVID are service workers, who were some of the lowest paid and most in danger of getting COVID. These workers have been hesitant to come back to work and have been able to find jobs in other industries. In the US, low-paid workers in the hospitality and food service industries are seeing some of the strongest wage increases.

Higher wages should help bring more workers into the labor force. However, continuing COVID complications, especially in light of the Omicron variant, may slow the supply response. Another thing to consider in 2022 is inflation. Higher inflation rates are no longer transitory, nor are they limited to the United States. Rising inflation rates in the Americas and Europe will add to wage pressure. Workers are looking for an increased base to keep up with inflation, which can lead to a self- fulfilling spiral on the way up. If workers anticipate inflation, they ask for raises based on it, which makes inflation worse.

The mismatch between supply and demand is not limited to labor markets. Demand came roaring back in the second half of 2020 but capacity utilization came back slowly. Some of this is attributed to labor shortages, but some of it can be explained by other factors, such as logistic disruption and energy availability, which is keeping capacity idle. The recovery in utilization rates has been slow for multiple categories: steel, plastics, services. And demand is very strong but capacity utilization has been poor.

A good example of the problem is electrical steel, which was mentioned earlier for automotive. Electrical machinery is going to be a smaller version of 2021’s story on microprocessors. Historically, electrical steel was used to make electric motors that go into generators and transformers. Now, it has to make all of that plus battery vehicles, and there’s not enough capacity to serve that new demand sector. While there was ample idle capacity before, going forward it will be stretched too thin.

Steel mills have told battery vehicle makers that for 2022 they will get all the electrical steel they need. But if you make electrical machinery, you’re only going to get about 80%, at best 90%, of your requirements. We’ve heard this from the major electrical machinery makers around the world.

All have been told the same thing by the mills: “You will get the remainder after we serve electric vehicles and it will not be all the steel you need.” Therefore, there will not be enough electric motors, nor generators or transformers. It’s going to hurt everything from expanding the power grid, to maintenance at factories where you need to replace a machine, possibly even down to vacuum cleaners and hair dryers.

The other major thing we worry about is chemicals. Many chemicals are made from natural gas. Natural gas is stretched thin, particularly in China and in Europe. If it’s a cold winter and more natural gas goes for heating, you won’t be able to make chemicals from it. Right now, inventory levels are sufficient to meet near term demand so chemicals should be okay. But if demand surges, supply chains will come under immense strain. We could then have a price spike and a supply shortage.

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