Supply shortages to cost the German economy €25 billion

As the global economy has begun rapidly reopening this past spring and summer following Coronavirus-related lockdowns, the business press has been awash in stories about bottlenecks and supply shortages (think semiconductors, lumber, houses) and their effect on the overall economy. Demand has been running well ahead of supply in many markets and balancing this out has become a major challenge in many parts of the world. A new study from the Institute for the World Economy (IfW) based in Kiel, Germany quantifies the effect supply shortages are having on the German economy.

[You can read the press release from June 29, 2021 here, and details of the study here (both in German).]

[Text in blue below has been translated from German by Randal Gernaat.]

As vaccination campaigns began picking up in North America and Europe over the spring and early summer, a new topic began appearing in the press: supply shortages. Restless consumers, who were newly vaccinated and flush with a year of forced pandemic savings, emerged from their homes ready to spend. With infection rates dropping and vaccination rates accelerating, consumer and business confidence rose and demand for goods and services soared.

What should normally be a good news story for businesses and the overall economy (what business wouldn’t welcome news of an uptick in demand for their goods or services?), was tempered by the fact that this sudden rise in demand could not immediately be met with increased supply. Ramping up production on short notice was a challenge, especially when so many factories had been idled and global supply chains disrupted over the previous year.

Service providers in the leisure industry (restaurants, hotels, bars) who had been hit particularly hard over the past year, found themselves caught between rapidly changing local and national regulations and the struggle to onboard workers fast enough to keep up with rising consumer demand.

As shortages proliferated, prices rose -- sometimes dramatically. Policymakers on both sides of the Atlantic were quick to stress their views that the imbalances in the economy along with sharply rising inflation would be temporary phenomena. And indeed, as the summer has progressed, some of these imbalances have begun to correct themselves.

A new study from the Institute for the World Economy (IfW) in Kiel, Germany attempts to quantify the effect that supply shortages have had on production in the German economy. To measure this effect, the study looked at the cointegration relationship between industrial production and manufacturing orders since German reunification, with a focus on recently observed deviation from the expected norm. (To simplify: orders that a manufacturing company receives get translated into output or industrial production, with a certain time lag. These two series, manufacturing orders and industrial production, tend to move together over the long-term in a stable manner).

And the results? There have been larger than normal deviations over the past year and a half, with industrial production struggling to keep up with manufacturing orders. According to IfW analysts, “in August 2020, industrial production was around 10% lower than expected as a result of the pandemic, but by the end of the year the backlog of orders had been reduced by about half.” However, as the pandemic in Germany flared up again last winter, the gap between industrial production and new manufacturing orders started growing again so that by “April 2021, industrial production was nearly 11% below the level that would be expected based on new orders.”

The authors of the study hypothesize that the lack of raw materials and intermediate products are primarily driving this deviation. “According to business surveys [this situation] is mainly due to supply shortages that can in part be traced back to disruptions in the operations of the container shipping industry.”

Klaus-Jürgen Gern, Director of International Economic Analysis at IfW, laid out the extent to which this is affecting the German economy in a concrete way. “The estimates suggest that German industrial production could be at least 5% higher if sufficient raw materials and intermediate goods were available. Supply shortages are expected to continue to weigh on industrial production until well into the third quarter, with significant improvements coming only after that period. In 2021 as a whole, losses to the German economy could amount to approximately 25 billion euros.”

But as with most imbalances in a market economy, they will eventually correct themselves. As supply shortages and bottlenecks begin to subside, industrial production is expected to pick up in order to work through the backlog of orders. Manufacturers will then be able to “eliminate a large part of the current production gap through future increases in output, thereby providing support for economic activity in the coming year.”