- What is supply-side inflation?
- How do most businesses respond to supply-side inflation?
- Actionable Tips to handle the challenge of supply-side inflation
Q: How does the supply-side affect inflation?
A: Supply-side inflation makes it more expensive for producers to bring their goods and services to market. As a result, the price they sell these goods and services for also increases. This article explains what supply-side inflation is and what it means for business owners.
Many established remote and online businesses are currently experiencing negative financial and other challenges because of supply-side inflation.
According to the Pew Research Organization, Americans’ overall economic ratings have significantly declined since the beginning of the year. Now, just 13% of Americans describe the economic climate as good or excellent – in contrast to 28% earlier this year.
We can thank supply-side inflation, recession fears, political turmoil, and traditional inflation for the discouraging statistics above.
Let’s find out what supply-side inflation entails for businesses and how your business can be prepared to handle supply-side inflation.
What is supply-side inflation?
You might have overheard recently about supply-side inflation. Before we jump into the specifics, it is first important to clarify the supply-side inflation definition.
Inflation has long been known to be a monetary phenomenon. Inflation is a general price increase across a market such that the value of each unit of currency decreases as a result.
Essentially, if the quantity of money in a country is growing more rapidly than the number of goods and services that the economy can successfully produce, a society experiences inflation.
Between March 2020 and February 2022, the money supply in the U.S. increased by a whopping 40%, while the real gross domestic product (GDP) increased by only 3% over the same period and has since been declining, according to the U.S. Bureau of Economic Affairs (BEA).
When there is such a significant gap between the growth rate of the money supply and the real growth rate of the economy, we can expect to feel the pressure of inflation in our daily lives.
On a more practical level, inflation in the US increases daily living costs, such as gas and groceries, when people are still getting paid the same amount to work.
How did we get here?
You might be wondering how the United States economy ended up in this situation, and you might have even heard about supply chain problems or supply-side inflation. Supply chain problems occur when there are barriers that reduce the production and distribution capacity of worldwide economies.
Initially, these barriers were put into place as a response to the COVID pandemic. These restrictions were intended to be temporary but as we now know, they have lasted much longer than originally anticipated.
Lockdowns, Inflation, and Labor Shortages
After the lockdown and the recession that followed shortly behind, increased government spending helped to restore employment and household income.
There was a plethora of federal relief aid actions that added about $5 trillion in stimulus over two years. Therefore, there was an increase in overall output accompanied by tight labor markets.
If the government had not taken action, inflation would have been higher, and the economy would have recovered more slowly.
The government intended to increase levels of utilization. Utilization is essentially how much the resources in an economy are adequately utilized.
However, high capacity utilization is an incomplete explanation of what is being viewed. Higher levels of utilization have thus produced higher rates of inflation and more varied price movements.
Instead of considering utilization levels in isolation, we need to consider supply-side inflation.
Labor Markets and Rising Costs
Negative supply stocks have played a significant role in raising inflation. Shortages of labor, caused partly by the pandemic and dramatic changes in immigration policy, have restricted labor markets, thus causing disruptions to global and domestic manufacturing supply chains.
Increasing prices are a result of these supply chain shocks. Additionally, the effects of inflation have been magnified as a result of increased consumer demand for goods already in short supply and corporate increases in price margins.
Since the labor market is increasingly restricted, the result has been increased money wage growth, specifically for low-wage workers. While money wages are growing more rapidly than they were before the recession, costs are also rising.
Although the labor market appears to be returning to pre-recession levels, the United States labor force participation has not returned to its value before the 2020 recession.
Changing Immigration Trends
The second significant reason is due to changes in immigration policy.
Immigration reform has restricted the number of working-age individuals adding to the US labor force. According to the American Progress Organization, had immigration continued at the pre-2019 rate, there would be about 2 million additional working-age humans in the United States by the end of 2022, resulting in a 2% difference in the labor force.
Wage Growth and High Employment in Certain Sectors
As a result of labor markets being tight, employment and wage growth have both risen. This is particularly important for minority groups that experience the benefit of these effects most intensely.
This shortfall has resulted in a measurable effect on the ratio of total people unemployed to the number of job vacancies available.
How Supply-Side Inflation Affects the Supply Chain
Supply-side inflation is a subcategory of inflation that occurs in the supply chain.
It makes the cost of raw materials used to produce products and services more expensive and makes the means of attaining those materials, such as freight, more expensive.
The economy experiences a reduction in the supply, like what happened after government-induced lockdowns during the 2020 pandemic.
Since the supply was contracted, it led to an unexpected increase in aggregate demand. Therefore, there was high demand and low supply, resulting in inflation that is exactly equal to the imbalance that exists between them.
Remote Businesses Struggle With Supply-Side Inflation
Supply-side inflation impacts businesses more directly rather than consumers. This often causes a ripple effect that can end up hitting consumers further down the supply chain.
Supply-side inflation can often be referred to as demand-pull inflation. Demand-pull inflation is when the demand for a specific set of goods or services rises faster than the supply of goods and services. When the supply cannot meet the growing demand, the prices for goods and services are pulled higher.
The pandemic disrupted the supply of manufactured goods, and this exacerbated post-recession inflation and volatility. Parts of the United States economy are heavily integrated with the global economic market. Therefore, COVID lockdowns in other countries also play a significant role in the U.S. economy.
Along with the uptick in inflation, many urban areas struggle with increasing office vacancy rates.
The lack of public and private partnerships along with poor urban leadership makes the repurposing of office space an unnecessarily long process. Since property taxes steeply decline in these high-rent districts, city leaders are wondering how to fund essential services for cities like cops, schools, and municipal transit.
Global Supply Chain Disruptions Cause Ripple Effect
Pandemic lockdowns, political turmoil, and other disruptions have reduced the domestic availability of inputs and final goods, thus producing bottlenecks in cross-border transportation.
These supply-side disruptions significantly affect prices and, thus, inflation.
A prime example of this phenomenon in action is the U.S. automotive industry.
Pandemic-related reduction in the supply of essential semiconductors has restricted automakers with essential input. Therefore, there has been a dramatic increase in overall vehicle prices, met with a dramatic decline in supply levels.
Since new cars are scarce on the market, there has been an increased demand for used cars, thus driving up the price of used cars significantly.
Interestingly enough, supply shocks and core consumer price index inflation have fluctuated together throughout the recovery from the 2020 recession.
Changing Consumer Spending Patterns Require Businesses to Adapt
Recent consumer preference changes have also added to the price inflation of common goods. Due to pandemic lockdowns and other behavior-changing factors, the majority of US households have changed their spending patterns.
The shift lies in where consumers choose to spend their money.
According to the Center for American Progress, household consumption has experienced a significant shift from spending on services to spending on commodities following the 2020 recession.
As the number of services available was reduced during the pandemic, the United States experienced a major shift to people spending more of their money on commodities. Thus, this has also resulted in commodity inflation.
Data indicate that these adverse supply shocks have raised inflation, reduced the amount of crucial labor supply, and caused disruptions to global and domestic shortages throughout supply chains. As the economy continues to recover, sudden price hikes for domestic goods create fluctuations in typical consumer spending behavior.
Tech Layoffs and Corporate Remote-First Policies
Businesses are ditching the traditional lease and shifting to a fully remote and globally distributed workforce. With large layoffs in the technology sector, many workers will start business ventures and utilize virtual office plans.
Shaving off the tremendous cost of traditional real estate rentals to house employees, larger businesses erase one of their largest expenditures by shifting to a remote-first posture. Workers can still collaborate face-to-face when needed by utilizing coworking spaces and meeting rooms.
The hybrid workspace model appears to be the best choice for many larger companies, although many enterprise companies are also embracing a remote-first posture. CEOs of these companies can create a regional presence anywhere using virtual office addresses, satellite offices, or flex space.
Entrepreneurs beat supply-side inflation and save money by taking advantage of virtual receptionist services that allow them to focus on the business and have a legitimate business presence virtually anywhere.
Global Events and Supply-Side Inflation
Supply-side inflation affects large amounts of resources necessary to produce goods and services.
The prices of energy and food have both increased significantly since 2021. Increases in energy prices are also driven by worldwide demand, OPEC-coordinated reductions in supply, and disruptions caused by Russia’s invasion of Ukraine.
Food price increases have also been exacerbated by drought, increased input costs, and supply shocks due to the war in Ukraine.
Post-Pandemic Recovery and Remote Business
The post-pandemic recovery in the United States is occurring in a business environment that is experiencing reduced energy and food supply and rising prices.
Climate change, price fluctuations for oil and gas, and war in Europe are all causing strains on the supply change that so many remote and virtual businesses depend on to succeed.
Can the Government Do Anything to Protect Businesses or Consumers?
An increase in the supply of goods and services can reduce the state of inflation.
If we want to produce more, we have to increase the level of productivity in the economy. One can argue that current policy actions have only been taken to demand-driven policies that only end up producing more demand and restricting supply.
The Inflation Reduction Act tried to reduce inflation by increasing corporate taxes, giving subsidies for renewable energy practices, and extending health care subsidies for those who are not in the labor force.
If there is an increase in corporate taxes, there will therefore be a decrease in the number of people saving and investing money since increasing corporate taxes reduces profits for corporations and households. When there is less investment in the economy, naturally, GDP slows.
The Inflation reduction act comes at a similar time as the 1.3 trillion dollar infrastructure bill, the $280 billion CHIPS bill, and the $300 billion student loan forgiveness program. Although the bill was constructed as a counteract to rising inflation, it remains to be seen if it will dramatically reduce inflation.
Listen to: What it Takes to be a Hybrid Leader
There are signs of recovery, but the market remains volatile. This can make it a challenge for remote business owners to plan and grow.
Businesses cannot solely depend on the government to fix all financial market woes.
The weight of reducing inflation also lies in the multinational corporations that monopolize the supply chain. The major players in the supply chain are those who make, buy, ship, and distribute the goods to customers.
You might still be wondering: how will most businesses respond to added inflationary measures?
Corporate Response to Supply-Side Inflation
Big businesses often respond to supply chain inflation by simply buying items in bulk or creating their shipping routes, and factories, or flooding the market with cheap goods.
Because big businesses have immense resources, they can simply cut out much of the supply chain and create their own, allowing them to bypass supply-side inflation to an extent.
Unfortunately, small businesses don’t have this luxury. They are forced to take on the increased costs of supply, and they must remain agile and be able to pivot quickly.
One of the most common ways they do this is by cutting their marketing budgets.
This is a bad idea though, as ultimately it keeps them from reaching new customers and slows their growth. From there, the big businesses often run them out of business.
Another common solution is to raise the price of their goods or services. This can backfire as larger enterprises simply outcompete the small businesses.
During inflation, consumers have less purchasing power. They’ll typically choose the cheaper option – especially if it’s a significant price difference.
The best way to handle supply-side inflation
While the current price inflation that we are witnessing is caused by a combination of multiple sources, the Federal Reserve can only use the tool of demand reduction to deal with it. Since this has not had the intended outcome, it is worthwhile to explore other possible solutions, such as supply-side solutions.
The Federal Reserve and Congress can help supply-side inflation by limiting growth in the money supply and adopting supply-side policies that will remove the barriers that limit productivity in the United States.
The current administration has made strides to induce supply-side policies to combat inflation, including reducing the bottleneck effect at west coast ports and releasing more crude oil from the Strategic Petroleum Reserve. Additionally, they have invested domestically to increase the production of semiconductors for cars.
Encouraging able-bodied individuals to reenter the labor market is one way the government can combat inflation. More consistency with humane immigration regulations and childcare subsidies can help more people rejoin the workforce and reduce inflation.
Intensifying antitrust enforcement to reduce the market power of multinational corporations will create a more level playing field for small and medium-sized businesses to compete.
Stronger antitrust enforcement could increase the ease of entry of new competitors, reduce market power, and reduce the inflationary pressures of future supply shocks. The government could also easily increase the supply of renewable energy to lessen our unsustainable reliance on fossil fuels to limit energy supply shocks.
Tips for Middle-market firms and SMBs to Combat Supply-Side Inflation
Smaller remote businesses and organizations need to recession-proof their businesses by making sure that operations are agile to deal with the impending change that a recession brings.
Small businesses need to cut their losses while maximizing their profits on a small scale.
As a small business, it’s risky to cut your marketing budget or pass on increased costs to the consumer. You also can’t let supply-side inflation ruin your bottom line. How can you do both at once?
Digital Marketing, Remote Business, and a Digital-First Posture
The answer is to shift to a digital-first strategy. Using e-commerce and digital marketing strategies allows you to stay agile and maximize your investments without sacrificing lead generation or your ability to close.
Digital-first strategy is the most cost-effective way to minimize costs and maximize the amount of audience reach for your message or product.
This strategy also helps you cut superfluous business expenses like expensive office rentals and the money you’d spend on commuting. This can save you enough money to offset supply-side inflation without having to raise your prices and make yourself less competitive.
The Shift to Digital and Remote-First Operations
Established remote businesses and virtual offices need to refrain from cutting back on marketing or raising prices to stay competitive. Switching to remote work and digital-first operations is the best way to absorb supply-side inflation while still growing your business.
When you switch to remote work, you may need a virtual receptionist or a physical address to send your mail. Alliance Virtual Offices can help you with these needs and more through their reliable virtual office services.
- Looking for the Best Places to Work Remote? Our Top 5 Locations
- What it Takes to be a Hybrid Leader
- Help the World and Your Wallet with Sustainable Business Practices
Supply-side inflation can challenge solopreneurs and established small and medium-sized remote and online business owners. Grow your business from anywhere with a company address, professional support, and workspace as you need it.
Learn more business tips from the Alliance Virtual Offices blog, and upgrade your remote work style with access to professional office space whenever you need it. Mail forwarding and on-demand workspaces keep your remote work flexible and cost-effective to weather the inflationary challenges ahead.