Why are we having an infant formula shortage?

By design, the US has a massive dairy surplus every year.  Yet we saw in late 2021 a shortage of cream cheese and now we see parents at wits end searching for infant formula.  How can this happen in a country awash in dairy products?  

From the research I have done so far, there seem to be three main drivers:

1) Corporate failure: Abbott Nutrition had to recall three different types of formula manufactured in its Sturgis MI factory in February.  Four babies were hospitalized after consuming formula made in that plant; two of them died.  The plant remains closed until it resolves all the issues raised by recent FDA inspections.  So far a whistleblower at the plant has been fired (who gave the FDA a heads up about food safety issues last October), but I am not aware of any other dismissals.  

2) Market concentration: Two firms, Abbott and Mead Johnson, account for 80% of the baby formula market in the US.  So losing Abbott's throughput for three months is going to be noticed.  

3) Government failure: Baby formula is subject to a 17.5% tariff.  This helps explain why almost all baby formula sold in the US is produced in the US. 

Add panic buying to the situation and, voila, empty shelves and very concerned parents.  Abbott claims it can resume production in two weeks, once they get the go-ahead from the FTC.  It will take another 6 to 8 weeks for new product to get to retail.  In the meanwhile, Abbott and other manufacturers are doing their best to expand capacity.  

Price-cost margins have been growing

A new study by Harvard Business School economist Alexander MacKay shows that profit margins rose by 25 percent between 2006 and 2019.  They find profits are rising because of cost reductions, not rising prices.   

Textbook economic models predict that firms should lower their prices when costs go down.  By doing so they can increase profits by selling the cheaper goods to more price sensitive customers.  But prices would stay the same, or even increase, if customers become less price-sensitive.  MacKay's study shows consumers have become more brand-loyal and less likely to use coupons.  

This could have implications for the high inflation rates we see today.  We know that costs are rising because of supply chain issues and labor shortages.  If consumers continue to become less resistant to price increases, then we could expect firms to respond accordingly.  

Was it smart for states to cut UI benefits?

Last year about half of the states eliminated the supplemental unemployment benefit program that was launched in reaction to the pandemic.  The logic in these states, most of which had Republican governors or legislatures, was that the extra UI benefits discouraged job search.  

New research by a team of economists, including a Harvard Business School professor, indicates that only 20 percent of the unemployed workers were employed three months later.  More alarmingly, the cuts in UI benefits led to reduced spending in these states.  The math is pretty simple.  There were 1.1m newly employed workers who collectively made $900m in the states that cut benefits.  At the same time there were 3m unemployed workers who did not get to collect $7.6b in benefits.  The overall result is less spending in those states, which in turn no doubt led to reduced employment.  

So much for stakeholder capitalism?

It is one thing for CEOs to give speeches saying that employees are critical stakeholders in XYZ, Inc.  But what do large corporations do when the company gets sold?  WSJ reports that three law professors examined 116 takeovers worth $1b+ since April 2020 and examined how the proceeds of the sales were distributed.  

As you might imagine, shareholders and executives made out fine across the board.

Guess how many provided job guarantees after the sale.  Guess how many guaranteed severance payments to those laid off.  

The answer in each case: zero.  

Which corporations are really socially responsible?

Yale b-school prof and former dean Jeff Sonnenfeld has composed a spreadsheet listing the American companies that are still doing business in Russia.  That got me wondering how many of those companies signed the Business Roundtable's manifesto on the Purpose of the Corporation, a document in which 181 CEOs pledged that they would lead their companies for the benefit of all stakeholders.  These companies showed up on both lists:

• AmerisourceBergen
• Caterpillar
• Citi
• Coca-Cola
• Deere
• Honeywell
• Marriott
• McDonalds
• Pepsico
• Starbucks
• Yum! Brands

I expect they will start getting pressure from their US customers soon if they do not pull out of Russia.  Choices have consequences.  

How long should we expect high inflation?

There was bad news on the inflation front this week, with the CPI rising 6% over a year ago.  We have not seen 6% inflation in 30 years.  This is a worrisome development for those on fixed incomes, as well as for those whose income growth fails to keep pace with inflation.  

The consensus among economists is that the current inflation is a classic case of too much money chasing too few goods.  Compounding the problem is the covid-induced shift in demand from services to goods.  

Economic history suggests one of two alternative scenarios will play out.  One possibility is that the inflation will prove to be temporary, just like it was in the aftermath of World War II.  In that case there was pent-up demand for everything (many goods were rationed during the war) along with the need to shift the economy away from tanks and aircraft carriers toward housing and education.  Option B: a replay of the 1960s and 1970s, when a vicious circle developed with rising prices feeding into higher wages, which in turn increased costs even more requiring even higher prices.  

Jerome Powell, Janet Yellen and other White House and Fed economists say inflation will be temporary.  Companies will need a few more months to ramp up supply, but once that happens we will be down to 2-3% annual rates.  But not everyone is buying this!

Two clues about the future direction of inflation can be found in the bond market.  First look at the actual yields for five-year and ten-year bonds, which are 3.1% and 2.7%.  Interest rates adjust upward in response to expected inflation, so these rates indicate that the bond market does not expect inflation above 3% over the next five years.  

The second clue: the Treasury sells two types of bonds: those with a fixed yield and those where the yield is indexed for inflation.  Adjusting for maturity, a comparison of the yields tells us what financial markets expect.  So take a look at this chart from the St Louis Fed.  At the beginning of the year, the yields implied an expected inflation rate of 2%.  From March through September, the expected inflation rate increased to 2.5%.  Now it is up to 3%.  

My advice: keep an eye on the bond markets in the months ahead.  

Is automated resume screening gumming up the labor market?

We have a genuine puzzle in today's labor market: large numbers of unemployed workers and even larger numbers of vacant positions.   As MIT labor economist David Autor noted in NYT:

Let’s start with the causes of the current labor shortage. Research on this question is unambiguous: We don’t know what’s going on. 

Saturday's WSJ offered one possible culprit, based on a recent Harvard Business School survey: the software designed to match resumes with vacant positions.   

Large companies cannot spend all of their time reviewing each and every job applicant, so they buy software systems and set up parameters to decide who are the lucky few who get interviewed.  Many companies are screening out applicants based on skills that are not needed for the job.  For instance one hospital insisted on computer programming skills for nurses who simply had to perform data entry.  Similar issues arise in setting minimum education and experience requirements.  For instance, how many open jobs really require a college degree?  

If a critical mass of companies have not adjusted their job specs in light of today's labor shortage, then they are guaranteeing themselves problems in filling open positions.  Many companies refuse to look at applicants with gap years in their employment history or who have been incarcerated.  WSJ reports that some companies, including IBM, are starting to re-evaluate their hiring process.  

The pandemic productivity boost

The good news: GDP is now slightly higher than before the pandemic.  The not-so-good news: Employment remains 4.4 percent lower.  The intriguing news: labor productivity (which is simply the ratio of GDP to employment) has increased at the fastest rate in 20 years.  If this productivity spurt can be maintained, this would mean rising living standards for all of us.  

I must admit that I was at first surprised by these data.  Covid forced companies to invest more in cleanliness, which means more inputs to get the same output.  They also had to make massive adjustments in operations, and I expected that to be a mixed bag at best.

This recent NYT article provides some insight into why productivity has increased.  A key factor is that the pandemic accelerated the adaptation of some labor-saving technologies.  We see this in the food service business where more orders are placed online (even among customers sitting inside restaurants).  Also, people shifted more of their shopping from in person to online.  Amazon can deliver any consumer good to your door without having a bunch of people standing around to wait on customers.  

Another driver has been work from home.  It seems that workers and bosses have struck an implicit bargain in many workplaces to split the difference on saved commuting time: working more hours AND having more free time at home.  

How much should graduate students be allowed to borrow?

Last month WSJ did a study of the earnings of those who earned masters degrees at selective universities.  Those who studied business or engineering did extremely well, with annual earnings above student loan debt by a sizable margin.  

Labor market outcomes were less positive in other areas, especially degrees from elite universities in areas such as drama, education, film studies, and publishing.  Half of the graduates of Columbia's program in film studies earned less than $30k after two years in the job market.  Their median debt was $181k.  

Although this is an extreme case, borrowing for graduate programs has been growing and now represents half of student loan debt.  WP columnist Charles Lane pointed out that there are no limits on annual borrowing on Sallie Mae Grad Plus loans, whereas undergraduates cannot borrow more than $12.5k per year and $57.5k total.   It is quite possible that demand for graduate degrees would become more price sensitive if this issue were reexamined.  

Some have called for student loan relief.  For instance Sen. Warren of Massachusetts wants to forgive up to $50k of debt for all borrowers.  However a Brooking Institution study found that the bottom 60% of households would only receive 34% of the relief.  Why should MBAs earning over $100k get this form of relief?

I think there are two areas where borrowers could be better served.  First, one way to provide debt relief that makes economic sense as well is to reduce interest rates.  Currently the US government borrows money at close to a zero interest rate, but this year the Grad Plus interest rate is 6.25%.  Second, universities that participate in Grad Plus should be required to divulge to student borrowers data on labor market outcomes for graduates.  How many students would sign up for film studies at Columbia if they knew the likely prospects for graduates?

A new tool for investigating employer discrimination

Blacks earn less than whites and have higher unemployment rates.  This suggests that a critical mass of employers could be discriminating against Blacks, but how do you prove that?  

One way is to conduct research studies where employers are sent resumes of persons who are identical except for their names.  Studies have shown that there are some names where 90 percent or more of those with that name identify as Black (Darnell or Precious) or white (Brad or Claire).  If an employer tends to call back applicants at a vastly different rate based on the race-identification of their name, that would signal discrimination by race.  The same approach can be used for gender discrimination as well.  

A team of economists at Cal-Berkeley and Chicago used a brigade of undergraduate volunteers to apply to 108 of the largest employers in the US.  The odds of a callback were two percentage points lower for resumes with Black-sounding names as opposed to those with white-sounding names.  Overall the callback rate was around 25 percent, so this means that if 1000 Blacks applied they would get 240 callbacks and if 1000 whites applied they would get 240 callbacks.  This difference by itself is not likely to explain the gaps in wages and employment that we observe in the labor market, but it certainly can be a contributing factor.  

This finding was not uniform across all of the companies in the study; in fact it was concentrated among 23 of them.  The authors question whether these companies have intended to discriminate against Blacks; they may very well lack internal controls to ensure equal treatment.  

Did cutting unemployment benefits lead to more employment?

Under the covid relief bill passed last March, unemployment benefits were increased by $300 per week.  Although this improves the living standard for the unemployed, it does create an incentive to delay returning to work, especially for those who earn more from unemployment benefits than they would from working.  

Employers in many sectors of the economy faced labor shortages, so the supplemental benefits became a political hot potato.  In June 22 states dropped the $300 supplement. 

A new study by economists at four universities were able to get detailed data on 19 of those 22 states.  They found that 1.1m people had their benefits reduced and that by early August only 13% of them had found jobs.  Other recent studies cited in this NYT piece find similar conclusions.  

The $300 supplement ends on September 6.  Based on these studies, we should not expect a big drop in the number of vacant positions or a big increase in employment.  

Iceland tries a four day work week

Iceland is known for the Northern Lights, glaciers and volcanoes, and Bjork.  Attention is now being paid to the Icelandic experiment with a shorter workweek.  Five years ago trade unions were able to persuade city management in Reykjavik to cut weekly work hours to 36 and work days to 4 for 2500 municipal workers.  Later the national government followed with its own trial run.  

Two things happened: (1) productivity increased enough that there was no overall loss in services and (2) workers reported reduced stress and higher overall satisfaction with life.  Now the experiment has been expanded to 86% of the Icelandic work force.  

Guidelines for reducing work time included fewer and shorter meetings, more effective prioritization and delegation, and less time spent on personal errands and breaks.   Click here for the full details. Covid has already led to unprecedented changes in work schedules; perhaps the time has come to take even further steps!

Market challenges posed by Covid-19

Politicians and epidemiologists get most of the headlines in the battle against Covid-19 and deservedly so on the public health front.   Fear and shutdowns have plunged the economy into unimaginable depths.  Although some macroeconomists have received attention regarding advice on fiscal and monetary policy, two basic concepts from MBA-level microeconomics are probably even more critical as we plan our path toward recovery.

Concept #1: testing and contact tracing are public goods.  There will need to be testing at large scale and frequent intervals to be able to build confidence and contain future outbreaks.  Right now we have 50 states each developing their own protocols and numerous firms selling tests, many of which are of dubious effectiveness.  No private sector firm on its own would have the resources or the credibility to carry this out.  There are two ways out: (a) Congress and the President provide one of the large tech firms with a monopoly license to devise and implement a plan or (b) federal agencies such as FDA and CDC take on the task.  Yale economist Zack Cooper's WP op-ed provides further insights about what we need to do to correct this market and government failure.

Concept #2: economies of scale for vaccine manufacturing.  You may think this is putting the cart before the horse or that I am just taking vaccine discovery for granted.  Consider, however, what will happen once a viable vaccine has been discovered.  How much slack capacity does Big Pharma have?  Who is going to produce vaccines on a scale that will allow worldwide, equitable distribution?  Stanford b-school economist Susan Athey and three co-authors argue in an NYT op-ed that the federal government needs to invest $70b now to build the capacity we will eventually need.  You might say, why not let the firm that develops the vaccine create the capacity?  Problem is there are dozens of firms worldwide doing vaccine research and only a handful will achieve breakthroughs.  What CFO would ever approve a massive expansion of capacity without knowing whether it will be needed?

Most of the spending from the three pandemic spending bills passed and signed so far has focused on support payments to businesses and individuals.  There are genuine investments that need to be made as well.

Giving away oil

Tuesday oil producers had to pay other parties to take their oil off their hands.  Well, not exactly.  What did happen is the price for May delivery of West Texas crude fell to -$38 per barrel.

So what gives?  Keep in mind these are futures contracts that are used for risk management; these are options to sell.  Oil companies purchase these futures to hedge against the risk of price drops.  For instance if the price of oil today was $30 per barrel and you were worried about the price dropping below $25, you might want to buy an option that lets you sell at a price of $28.  Most options are never exercised; they either expire or are traded.

On Tuesday there were not any buyers for May delivery at prices above zero.  This is happening because (1) global demand for oil has collapsed as people shelter at home to avoid COVID-19, (2) major producers such as Russia and Saudi Arabia have yet to cut back on production despite the demand situation, (3) it is costly to shut down a well so many producers have procrastinated, and (4) we are about to run out of storage space.

In a nutshell, a simple supply and demand story.  Looking ahead, expect prices at the pump to drop in the coming weeks, perhaps falling below $1 per gallon.  For more insight, see this video clip of my interview with local news channel WRAL.

Maybe you should stock up on toilet paper

Shortages of certain goods were easy to anticipate as a result of COVID 19, including hand sanitizer and disinfecting wipes.  An early run on "critical" household supplies is also no surprise; in North Carolina eggs, bread, orange juice and milk vanish from the shelves whenever the local weatherman hints at snow or ice.  

But toilet paper?  Initially many experts assured us that this was a simple inventory management issue and that more product would be rolling out soon.  Now I am less sure, for two reasons brought up in this WP article.  

First, people are spending less time away from home working, traveling, or socializing.  This means a shift in demand from using other people's paper to using your own.  Second, TP away from home is not a perfect substitute for TP at home.  Think about it -- the rolls at work, restaurants and airports are often a foot in diameter.  Even more critical, they are usually single ply.  In other words, there is a mismatch in the specs of much of the TP being produced and the specs of what people want to buy for home use.  

In time I am sure that the makers of Charmin and Cottonelle will figure out how to expand capacity.  But the makers of away-from-home TP will need some time to reconfigure their production lines and distribution channels so that they can sell directly to consumers.  This may take almost as long as it is taking GM and Ford to switch from cars to ventilators.  

This same phenomenon is happening in food production.  Companies that make ten pound bags of shredded mozzarella for Sysco are not going to be able to turn on a dime to make smaller bags for consumers.  

My advice: don't wait until you are down to your last roll before restocking.  

Robots did not overtake the world. But what about artificial intelligence?

Labor markets have been upended over the centuries by technological change.  Only John Henry could compete with the steam-powered drill, and he paid dearly.  In the not too distant past, there have been concerns about the impact of software and robots on wages and employment.  Now the big worry is artificial intelligence.

Stanford economics PhD student Michael Webb has developed a framework that can evaluate the impact of new technologies on different occupations by matching words between patents and job descriptions.  Looking at data between 1980 and 2010, he found wages and employment declined the most in jobs that were most exposed to competition from software (broadcast equipment operators) and robots (forklift drivers).  These are jobs that do not require a college degree.

Based upon patents related to AI, Webb finds that the occupations most likely to be endangered include clinical laboratory technicians, chemical engineers, and optometrists.  All of these jobs require post-secondary education.  Overall, the risk of displacement from AI is greatest for those with college and graduate degrees.

Technical change and globalization have resulted in the loss of a number of middle class jobs.  AI could be coming after the upper income brackets.

Economic actions to fight the coronavirus

The expected economic damage from the coronavirus is starting to become apparent.  Many sectors of the economy have shut down or will do so soon.  Within 48 hours of Governor Cooper’s announcement that closed bars and restaurants in North Carolina, 18,000 people filed for unemployment benefits.  This is more than the number that filed in all of February.  These numbers will only accelerate in the coming weeks.  

The need for economic action is now, but what actions will best serve our citizens?  Many in Washington are calling for a replay of the actions that were effective in past recessions, including cuts in payroll taxes, direct payments of $1000 to all citizens, bailouts to specific companies, and lower interest rates.  

The generals of our economy are fighting the last war.  Although everyone no doubt will like having Washington send them an extra $1000 to $2000, most of those checks will be saved, not spent because most of the service economy is shut down.  Payroll tax cuts will help those with jobs to a small extent but will do nothing for those out of the labor force.  A further problem with these approaches is that they are not targeted toward those who will have the greatest need, especially those unable to work and without savings to tide them over.  Owners of small and medium size businesses are at risk as well.  

From an economic perspective, I see three challenges that can be addressed through wise policies: public health, income maintenance and financial stability.  On the public health front, Congress needs to make sure that Dr. Anthony Fauci and his colleagues get whatever they say they need, including test kits and vaccine research support.  The bill passed last week is a good start.  

Income maintenance can be achieved through a variety of actions, but the primary focus should be on expanding the eligibility and generosity of unemployment benefits and making paid sick leave more widely available.  The average unemployment benefits check in North Carolina is $250 per week and they run out after 20 weeks.  Thanks to actions taken by the NC General Assembly to reduce benefit generosity in 2013, the state system has $4 billion in the bank.  It is time to put that surplus to work.  

The Federal Reserve will need to think outside the box on financial stability.  Job one will be to maintain liquidity in financial markets, just as it did in the Great Recession.  But the virus poses an additional challenge.  Businesses such as airlines and hotels were healthy a month ago and will be healthy again in six to 12 months.  Owners of hair salons and local restaurants operate on thin margins and many have little in the way of savings to fall back on.  What can we do to keep them going in the interim?  

Some politicians are calling for direct payments to the companies.  A better idea would be to loan Delta Airlines and Marriott Hotels the funds needed to pay off loans and roll over bonds over the coming months, with the Fed or Treasury accepting planes and buildings as collateral.  The Fed ended up in the mortgage market in the Great Recession; it may need to provide bridge funding to some cruise ships and casinos this time around.  Special programs for small to medium size businesses will be needed as well.  

Whisky business: tariffs and their consequences

In March 2018 the US imposed tariffs on steel and aluminum imports.  In reaction the European Union imposed tariffs on American goods to maximize political damage to Republicans, including tariffs on bourbon made in my home state of Kentucky.  In response the US announced in October new tariffs on Scotch whisky and French wine.

In a recent WP column, Catherine Rampell examined the consequences of this escalating tariff war.  Overall US whisky exports dropped 16 percent while EU exports fell 27 percent.  There also are domestic losses associated with declining wine and Scotch imports -- namely fewer jobs and lower profits for the firms that import, transport, and retail the goods in question.  

In the meantime employment in primary metals manufacturing is actually down since the US started this escalating tariff war, which is proving not so easy to win.

Powell on labor force trends

Today's WP summarizes FRB chair Jerome Powell's analysis of why the labor force participation rate of prime age adults has (1) declined over the last 60 years and (2) become lower than the rate in most other well-to-do nations.  This is an important issue for the prospects for continued economic growth.    With the unemployment rate at all time lows and job vacancies exceeding the number of job seekers, future gains in GDP are contingent on more people entering the labor force.

In the 1960s, virtually all men between the ages of 25 and 54 worked or were looking for work.  Today that rate has gone down to 89 percent.  Labor force participation hinges on the rewards for working versus the value of not working.  One might argue that the rewards for not working have risen, leading to more labor force dropouts.  But single men do not qualify for many income maintenance programs and the inflation-adjusted payout from these programs has declined over the last 40 years.  Also, income maintenance programs are far more generous in Western Europe than the US.

Powell points to two trends that have driven more men to drop out of the labor force: education and opioids.  Today's jobs require more skills than those one or two generations ago, but education levels have not kept up.  Research on the impact of  opioids is just getting geared up.  To date it shows a correlation between low (high) labor force participation with high (low) opioid use across communities.  This begs the question of which came first.

To this list I would add two more items: a declining marriage rate and video games.  Married men are more economically active and make higher wages than unmarried men, although again establishing cause and effect here is challenging as women are less likely to marry men who are unlikely to contribute to a household's economic well-being.  As for video games, research shows they provide a low cost mechanism for passing time with some social interaction that increases the payoff for not working.  

Saving NCAA men's basketball

This has been anything but a great season.  There is no Zion Williamson or Anthony Davis on the court.  The ACC has three good (not great) teams and then a lot of mediocrity.  Most other conferences are the same way.  Lots of fouls getting called and lord help us when the officials have to visit the monitor to review a play.

Mark Story, a sports columnist for the Lexington Herald-Leader (which along with the Kentucky Sports Radio blog are your go-to sources for the winningest team of all time) has some great suggestions on how to improve the game:

1) Let players who enter the NBA draft and are not selected return to college.  This would shift some talent back to the college game that will otherwise play overseas or in the NBA G League.

2) Let players make endorsement deals.  It's their name and number on the t-shirt; give them a cut of the action.  Again this will make a difference for the stay-in-school versus bolt-for-overseas decision.

3) Reduce the use of video replays.  Story recommends giving each coach the right to request two replays per game.  I would add this -- require replays to be complete in two minutes.  If there is not a clear case for overturning a call by then, the call should stand.