Identify different forces that lead to the shortage economy in the article. Explain these effects on SRAS and AD curves. Draw an AS-AD diagram to illustrate these effects.  

For a decade after the financial crisis the world economy’s problem was a lack of spending. Worried households paid down their debts, governments imposed austerity and wary firms held back investment, especially in physical capacity, while hiring from a seemingly infinite pool of workers. Now spending has come roaring back, as governments have stimulated the economy and consumers let rip. The surge in demand is so powerful that supply is struggling to keep up. Lorry drivers are getting signing bonuses, an armada of container ships is anchored off California waiting for ports to clear and energy prices are spiralling upwards. As rising inflation spooks investors, the gluts of the 2010s have given way to a shortage economy.

The immediate cause is covid-19. Some $10.4trn of global stimulus has unleashed a furious but lopsided rebound in which consumers are spending more on goods than normal, stretching global supply chains that have been starved of investment. Demand for electronic goods has boomed during the pandemic but a shortage of the microchips inside them has struck industrial production in some exporting economies, such as Taiwan. The spread of the Delta variant has shut down clothing factories in parts of Asia. In the rich world migration is down, stimulus has filled bank accounts and not enough workers fancy shifting from out-of-favour jobs like selling sandwiches in cities to in-demand ones such as warehousing. From Brooklyn to Brisbane, employers are in a mad scramble for extra hands.

Yet the shortage economy is also the product of two deeper forces. First, decarbonisation. The switch from coal to renewable energy has left Europe, and especially Britain, vulnerable to a natural-gas supply panic that at one point this week had sent spot prices up by over 60%. A rising carbon price in the European Union’s emissions-trading scheme has made it hard to switch to other dirty forms of energy. Swathes of China have faced power cuts as some of its provinces scramble to meet strict environmental targets. High prices for shipping and tech components are now triggering increased capital expenditure to expand capacity. But when the world is trying to wean itself off dirty forms of energy, the incentive to make long-lived investments in the fossil-fuel industry is weak.

The second force is protectionism. As our special report explains, trade policy is no longer written with economic efficiency in mind, but in the pursuit of an array of goals, from imposing labour and environmental standards abroad to punishing geopolitical opponents.

This week Joe Biden’s administration confirmed that it would keep Donald Trump’s tariffs on China, which average 19%, promising only that firms could apply for exemptions (good luck battling the federal bureaucracy). Around the world, economic nationalism is contributing to the shortage economy. Britain’s lack of lorry drivers has been exacerbated by Brexit. India has a coal shortage in part because of a misguided attempt to cut imports of fuel. After years of trade tensions, the flow of cross-border investment by companies has fallen by more than half relative to world gdp since 2015.

All this might seem eerily reminiscent of the 1970s, when many places faced petrol-pump queues, double-digit price rises and sluggish growth. But the comparison gets you only so far. Half a century ago politicians got economic policy badly wrong, fighting inflation with futile measures like price controls and Gerald Ford’s “whip inflation now” campaign, which urged people to grow their own vegetables. Today the Federal Reserve is debating how to forecast inflation, but there is a consensus that central banks have the power and the duty to keep it in check.

For now, out-of-control inflation seems unlikely. Energy prices should ease after the winter. In the next year the spread of vaccines and new treatments for covid-19 should reduce disruptions. Consumers may spend more on services. Fiscal stimulus will wind down in 2022: Mr Biden is struggling to get his jumbo spending bills through Congress and Britain plans to raise taxes. The risk of a housing bust in China means that demand could even fall, restoring the sluggish conditions of the 2010s. And an investment boost in some industries will eventually translate into more capacity and higher productivity.

But make no mistake, the deeper forces behind the shortage economy are not going away and politicians could easily end up with dangerously wrong-headed policies. One day, technologies such as hydrogen should help make green power more reliable. But that will not plug shortages right now. As fuel and electricity costs rise, there could be a backlash. If governments do not ensure that there are adequate green alternatives to fossil fuels, they may have to meet shortages by relaxing emissions targets and lurching back to dirtier sources of energy. Governments will therefore have to plan carefully to cope with the higher energy costs and slower growth that will result from eliminating emissions. Pretending that decarbonisation will result in a miraculous economic boom is bound to lead to disappointment.

The shortage economy could also reinforce the appeal of protectionism and state intervention. Many voters blame empty shelves and energy crises on the government. Politicians can escape responsibility by excoriating fickle foreigners and fragile supply chains, and by talking up the false promise of boosting self-reliance. Britain has already bailed out a fertiliser plant to maintain the supply of carbon dioxide, an input for the food industry. The government is trying to claim that labour shortages are good, because they will raise economy-wide wages and productivity. In reality, putting up barriers to migration and trade will, on average, cause both to fall.

Disruptions often lead people to question economic orthodoxies. The trauma of the 1970s led to a welcome rejection of big government and crude Keynesianism. The risk now is that strains in the economy lead to a repudiation of decarbonisation and globalisation, with devastating long-term consequences. That is the real threat posed by the shortage economy.

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The forces that lead to the shortage economy in the article include the Covid19 pandemic government stimulus consumer spending and a lack of investmen... View the full answer