Profits Come Before Growth in a Post-Pandemic Economy

(Bloomberg Opinion) -- It should be a great year for economic growth. The mass distribution of vaccines combined with multiple rounds of fiscal stimulus and pent-up demand for in-person activity provide plenty of reason for optimism in 2021. But if you're looking for a potential stumbling block for the economy, consider the container shipping market, where prices have surged in response to rising U.S. consumer demand for imported goods.

Demand for goods has gone up during the pandemic as consumers spend money on physical items rather than activities like travel and dining, leaving the container shipping market supply-constrained and unable to keep up with demand. And while ordinarily the response to rising demand would be to increase supply accordingly, the dynamics are different in a consolidated industry where a handful of players control how much supply to produce — as now exists in the container shipping market.

The same is increasingly true in the homebuilding industry, where inventories remain at historically-low levels. And we saw similar dynamics at work among airlines prior to the pandemic: the consolidated industry was punished by investors whenever it got too ambitious in increasing capacity.

Now the question is how many industries are caught in this pattern, and how will they respond to the possibility of bigger gains in economic demand in 2021?

There was nothing nefarious in the evolution of the container shipping industry to its current oligopolistic state. A generation ago the industry found that it would be more efficient if it acted more like a commodity, where ships and containers were interchangeable, allowing for global carriers operating regularly-scheduled service. Then, when demand fell after the economic downturn in 2008 reduced global trade, cost-cutting and consolidation was an understandable approach to maintain or grow profits, rather than investing to add uneconomic capacity. 

It's the life cycle in the maturation of an industry, where an increase in demand leads to multiple players fighting for market share, just like we see in cloud software today. At first the biggest risk is a competitor growing faster than you and edging you out of the market. But then slowing industry growth leads to cost-cutting and consolidation, and  companies are more focused on the risk of economic downturns.

Homebuilders and airlines are industries that are more consolidated today than they were a generation ago after weathering financial crises over the past 20 years. The housing downturn in the late 2000's led to the bankruptcy of many smaller homebuilders while larger publicly-traded builders gained market share, with large and strong balance sheets becoming a competitive advantage. Airlines went through travel downturns after the Sept. 11 terrorist attacks and the 2008 financial crisis, resulting in bankruptcies, mergers and the reduced number of carriers that we have today.

So what happens when fiscal stimulus is deployed to engineer robust growth in an economy that's been transformed by crises and years of slow growth? Over time, if there's more money to be made, even consolidated industries will expand capacity to meet the additional demand — technology companies like Amazon.com Inc., Alphabet Inc.'s Google, and Microsoft Corp. that exist in growing industries have shown that. If the container shipping, homebuilding and airline industries believe that growth is sustainable, they'll increase capacity over time on their own terms to serve that growth profitably.

But that might not happen in 2021. Capacity expansion plans, particularly when they involve the bulky, physical world of goods and infrastructure, are expensive and take years to implement. Corporate executives may struggle to shake off the trauma of last spring when they went into survival mode, unsure about when or if demand would recover and if they'd have the financial runway to make it to that point before having to worry about insolvency.

What we might get for a few quarters is a period of windfall profits for the consolidated, capacity-constrained industries experiencing a surge in demand. Maybe that means record profit margins for the container shipping industry now, for homebuilders in the middle of the year, and for airlines when consumers decide it's safe to travel and are anxious to get on planes to go on vacation and see families and friends.

Policymakers should look at this as the cost of doing business as growth recovers, while using what levers they can to encourage companies to increase investment and jobs in response to the better growth environment, rather than just banking the profits.

If that ends up being what we get this year — a little more inflation and a little less real economic growth than expected, with profits outpacing hiring yet again — we should see it as a transitory phase as companies adjust to an environment of increased economic demand. The key is making sure that government policy continues to sustain an environment of faster growth rather than viewing any pockets of inflation as something that needs to be curtailed.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.

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