Inflationary Pressure Shows Signs of Easing in 2023

We clearly are seeing the impact of inflation as it increases operating costs across supply and labor inputs in 2022. Is there relief coming from this profit-eroding upward pressure? Small-business owners began signaling inflation concerns in the summer of 2021 and now it’s become a major concern. The most recent NFIB’s Small Business Economic Trends survey showed a substantial percentage (77%) of small-business owners reporting “inflation” as their single most important problem.

An inflation challenge is a new experience for most small-business owners. Only those who were in business in the 1970s or early 1980s have any experience with a similar problem. Globally, the inflation issue is about business inputs (supplies, inventory, and materials). Until supply and distribution catch up and start to exceed demand, price pressures will remain elevated worldwide.

A shortage of supplies not only drives prices higher, it also tends to affect business psychology. A poll of more than 600 small businesses commissioned by the Wall Street Journal in Q2 found that 57% expect worsening economic conditions this year, a significant rise from the 42% recorded in Q1. At the same time, expectations of higher revenue in the year ahead fell to 61%, down from 79% last May, despite price increases across the board.

Looking ahead to 2023

What should we expect next year? As I see it, there are two forces at work, one global and one domestic, that provide solid clues. Holding aside the international actions taken purely for political reasons (Russia in particular), most of the global supply input flows were a consequence of Covid, and we are starting to see economic forces bringing stability back to those flows.

Sure, it takes time to convert raw materials into finished goods and ship them across continents, but that balance is coming, albeit slowly. Absent more political or health shocks, 2023 should see a significant rebalancing of most supply flows. But that doesn’t mean inflation will just go away. There also are domestic factors to consider.

In the U.S., we have both labor and government policy influences to deal with as well. Clearly, low unemployment is driving wages higher as labor demand has been robust. And supply is affected by a multitude of factors. Will wage pressures continue? There is pretty good evidence that lower-skilled labor supply/demand will start to rebalance in the coming months as workforce participation rates rise. Skilled labor is likely to experience continued upward wage pressure. It takes time to build those skills and experiences, and we haven’t done a good job of expanding the skilled labor force.

Government policy

In 2020, both monetary policy and fiscal policy were coordinated to get the economy going again. While coordinated in a crisis, general opinion holds that monetary and fiscal policymakers often tend to act at cross purposes in the aftermath. The Fed may tighten, as they are doing now, but what about fiscal programs? Aren’t fiscal programs that stimulate in a downturn hard to reverse when the economy is facing an inflation threat?

This time around, it appears fiscal programs are not going to become part of the inflation problem. The various emergency spending plans put into place in 2020 and 2021 have expired for the most part. Further, taxes are countercyclical because tax revenues increase automatically as the economy grows.

Meanwhile, the GDP drag from this natural fiscal tightening is expected to persist for some time, and at deeper levels than anything we saw after the Great Financial Crisis. It just kind of happens automatically, unless we have some fast-moving discretionary policy changes. Perhaps when confronted with the risk of inflation/stagflation, this time government can get out of the way – if for no other reason than it is having a hard time deciding the best way to get into the way.

It does appear that we will start to see inflation easing in 2023, which is fortunate. Small businesses have few tools available to help them mitigate inflation pressures. The main tool to try to preserve operating margins is to raise prices for goods or services which, of course, exacerbates inflationary pressures and has limits. Relying on continually raising prices is not a strategy that ends well most of the time.

Alternatives mostly focus on efficiencies such as accelerating capital for labor substitutions. These take time, and many businesses have already been emphasizing efficiencies for the past few years out of necessity. I think we can anticipate less margin pressure from inflation as we roll into the next year or two. (I’ll save for another article a discussion of the Fed overshooting and triggering a recession.)

Darrell Johnson is CEO of FRANdata, an independent research company supplying information and analysis for the franchising sector since 1989. He can be reached at 703-740-4700 or djohnson@frandata.com.