Covid-related supply-chain disruptions and the inflation they brought about in the U.S. are starting to go back to normal, but some of the reaction to that disruption—in the form of new trade policies and reshoring efforts—could cause inflationary pressures of their own, according to a report from Goldman Sachs Research.
Amid these two potentially opposing impulses in the inflation fight, it’s important to note that supply chain normalization is allowing inventories to rebuild. When demand rebounded after the initial impact of the pandemic and supply constraints deepened, inventories didn’t keep up with sales. “The economywide inventory-to-sales ratio has now closed 40% of the gap vs. pre-pandemic levels,” says GS Research.
The recovery in inventories, in turn, is slowing inflation. Inventory improvement has been sharp in the core goods categories—including new cars, used cars and household appliances—that had acute shortages and large price run-ups in recent years.
These supply-constrained categories are still adding to inflation today, but the trend is in the right direction. They accounted for 60 basis points of U.S. core inflation in September as measured by the personal consumption expenditures (PCE) index, according to an updated GS Research inflation model. By the end of 2023, they will be deflationary, subtracting 45 basis points from core PCE, the model shows.
With supply chain improvements helping slow inflation, what might have the opposite effect? Companies are reassessing supply chain strategies in light of their experiences during the pandemic, and some are ready to overstock inventory, diversify supply chains, and move production back to the U.S. (“reshoring”).
Reshoring poses the biggest risk of boosting prices, though any impact so far has been limited. Imports of foreign intermediate and final-manufactured goods have continued to grow faster than domestic manufacturing output. This is “the clearest evidence that there has not yet been meaningful aggregate reshoring—or at least that any reshoring has been outweighed by increases in offshoring,” the report states.
The construction of new domestic manufacturing facilities remains below pre-pandemic levels. While there has been an increase in manufacturing facilities in the planning phase, the magnitude of the uptick in planned factories so far falls short of anything that would indicate a turning of the tide in this direction.
One industry to watch is semiconductors, where reshoring would appear to be well underway. Construction of computer-related manufacturing facilities is now almost triple the pre-pandemic pace. Employment in U.S. semiconductor facilities has increased 5% over the past year. “The recently passed CHIPS Act and new export controls should further encourage domestic semiconductor investment.”
Sourcing semiconductors in the U.S. raises costs, but the inflationary effect would be muted. GS analysts estimate that production of advanced semiconductors is 44% more expensive in the U.S. than it is in Taiwan (excluding incentives). “The aggregate price level impact of higher production costs from producing semiconductors domestically instead of importing them would likely be extremely limited,” says the report. This is because semiconductors represent just 0.3% of the final value of consumer prices.
There are two additional channels through which supply chain onshoring might have inflationary repercussions. First, if domestic chip production was unable to ramp up quickly enough to offset declines in imports, this could weigh on domestic production of goods and temporarily boost prices.
Additionally, an escalation of trade tensions that leads to broader reductions in imports, not just semiconductors, could have a more significant inflationary effect.