Economic theory rarely is an interesting topic of discussion at any social outing. Unless, of course, your savings have been depleted; you cannot sell your house; or you have lost your job. Less dramatic but equally important is when long-term changes to the economic Equilibrium impact the very nature of the economy and the way we do our job. The suggestion is that economic theory is quite relevant as we forecast and manage our responsibilities in Supply and Procurement.
Milton Friedman, the Nobel Laureate in Economics, argues that economic Equilibrium can be compared to a String (representing Demand) attached to the underside of the Board (which represents Supply at full or optimum Capacity). When the Board and String are parallel and attached the economy is in economic Equilibrium and the resources are at full utilization. The upward Slope of the parallel Board and String represents upward economic progress. (See Economy A)
If Demand lessens due to recessionary forces, Friedman argues it is a temporary situation and the strain on the String is proportional to the force of a recovery. Soon the Board and String are again parallel and upwardly sloping. (See Economy B)
A recent study from the European Commission raises the specter of an inadequate recovery. Under this situation, the short-term mothballing of Capacity resources produces a new lower level of permanency to both the Board and the String. (See Economy C) More troubling, if the mothballing is combined with a financial recession this may create an increasingly widening gap between Capacity and Demand where both the level and slope decreases. (See Economy D)
I would like to propose that the imagery of the Board and String is inadequate in today's economic environment.
The elasticity of the String is okay, but the solid-state nature of a Board gives a false impression.
Demand is irrational and suffers from the same behavioral patterns of panic. Panic pushes the Equilibrium downward and irrational demand pushes Equilibrium upward. A porous Membrane is more appropriate for Supply and Capacity than a solid Board.
The force that Friedman identifies as propelling the sharp slope of recovery in the String does not stop at the Board, but would actually push through a Board or more appropriately a Membrane creating a serious short-term gap between Demand and Capacity where Demand is higher than Supply and Capacity. This results in an environment of capacity limitations, price escalations, and wide shortages—a traditional seller's marketplace. (See Economy E)
The troubling question is will the hyper growth of the BRIC nations—plus the inevitable world’s recovery and constant surge of emerging nations drive that short-term capacity into a long-term economic environment.
The slower nature of building Capacity resources and assets versus the faster characteristics of building Demand may propel us into a “New Normal,” that is, the next fifty to 100 years of a seller's marketplace.
What does that mean to your roles in Supply and Procurement? It means you will operate in an environment of scarcities, price escalations, and increased supplier power. Are you prepared for the economic disparities of the New Normal? This would really be an economy of Caveat Emptor!