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28 September 2014

No 'Shortages' in Market Economies

Richard L. Aboulafia, Vice President, Analysis

"It's a beautiful thing, the destruction of words." That chilling quote is from a character in George Orwell's 1984. As someone who likes to write, I usually disagree with that sentiment. But every so often, a word merits destruction. It's time to destroy (or at least avoid) the word "shortage."

Shortages are a serious problem...if you are living in the old Soviet Union. "Comrades," they'd say, "the minister in charge of APU factories has failed to meet his quota. Due to the shortage of APUs, aircraft production is off by 25%. We will airbrush him out of all Politburo photos, and send his widow a bill for the bullet."

But most of us today live in a market economy. Markets are just a dialog between people who have something and people who want something. This dialog determines the price of that something. There may be disruptions in supply – aerospace companies are now wisely stockpiling titanium in case Russian sanctions worsen – but for the most part the idea of a shortage is complete nonsense. There are upward and downward pressures on price, based on supply and demand. That is all.

Many aviation industry executives, however, believe otherwise. In its second quarter results, Skywest cited a "pilot shortage" as a major cause of its $14.7 million loss. Skywest new hires earn $22,000-25,000 annually (average pay for an interstate trucker is around $50,000). A recent Government Accountability Office report put it well: "Data indicate that a large pool of qualified pilots exists relative to the projected demand, but whether such pilots are willing or available to work at wages being offered is unknown."

Similarly, in February 2010 Boeing's then-HR VP Rick Stephens told the House Science and Technology Committee that the STEM (Science, Technology, Engineering, Math) "skills shortage is a global concern across the board in all high-tech sectors – public as well as private." This "shortage" might just be related to the frequent engineer firing binges at Boeing and other aerospace companies. Even in a great year like this one, Boeing informed 2,000 engineers that half of them would be fired soon (the other half, of course, was given every good reason to leave too).

We can use The Google to calculate the extent of this foolishness. The phrase "pilot shortage" produces 118,000 hits; "STEM shortage" produces 15,300 hits. Strangest of all, executives have been known to use "shortage" about commodity metals, fasteners, and other products that fluctuate in price. And years ago, during the rise of the low cost carriers, an executive at a major airline (my memory of this is hazy) said something like, "we have a shortage of seven cent per seat mile capacity and a surplus of fourteen cent per seat mile capacity." I can't decide if that executive was a genius or an idiot.

Executives who think we live in a Soviet economy draw bad conclusions. "We can't seem to get any more $22,000 a year pilots to meet our needs! Our competitors are paying $26,000 per year, and they're winning. There's a pilot shortage!" Or, even stranger, "People aren't willing to get an engineering degree to start a career in aerospace with the constant risk of being fired. There is an engineer shortage!" Or strangest of all, "We were paying $5 per pound for Material X. We're now paying $6. There's a shortage of Material X!"

Most of these executives aren't idiots. Sure, by whining about a "shortage," they're being incredibly passive about their business, but most are just looking for a handout. They've done the math, and even though more experienced pilots, engineers, and machinists are more capable, it's more profitable to employ lower paid new starts. Yet working conditions and wages often aren't good enough to get these. That's where government comes in. Training subsidies are a popular way for state and local politicians to support industry. Even at the national level, President Obama has proposed a government/industry scheme to train 10,000 new US engineers each year. As a 51-year old mid-career market analyst, I'm deeply grateful that nobody is thinking of a government program to train hundreds of new market analysts every year.

This isn't just an academic debate about words. If we banish "shortage," we also weaken its idiot cousin, "crisis." This word is thrown around to indicate a near-insurmountable problem that needs to be urgently dealt with (the phrase "Pilot Crisis" yields over 39,000 Google hits; STEM crisis yields 37,500). People ask forecasters (including me) questions like "could the STEM crisis (or the 'fuel shortage') de-rail industry growth?" Think in terms of inflationary (and deflationary) cost pressures rather than shortages and crises, and then look at the total impact of those pressures on the cost structures of companies that build and fly planes. You quickly realize that there are no show stoppers. It's merely a question of just paying a bit more for something. Or, a question of profit margins.

Finally, not only can companies pay their workers more, there's a strong reason that they should. American capitalism, as pioneered by Henry Ford, is based on the great idea that companies can learn to build things cheaper while paying workers enough to become consumers. In the case of Ford, that meant building Model Ts cheaper and paying line workers enough to save and one day buy a Model T. That virtuous cycle has been repeating itself in China over the past few decades.

By treating workers as a cheap commodity (and crying "shortage" when they can't get them cheap) companies are reducing aggregate demand for their goods and services. In other words, reducing wages for engineers, machinists, pilots, and everyone else means less demand for air travel. Stagnant wages certainly help explain stagnant travel demand in the US over the past decade or two. Yet very few individual airlines or aircraft companies care enough about the greater good to start stimulating demand with better wages.

But let's do our part. Let's abolish the word "shortage." The industry, and the world, will be better for it.

About the Author

Richard L. Aboulafia

Richard L. Aboulafia

Richard is Vice President of Analysis at Teal Group. He manages consulting projects in the commercial and military aircraft field and analyzes broader defense and aerospace trends. He has advised numerous aerospace companies, including most prime and many second- and third-tier contractors in the US, Europe and Asia. He also advises numerous financial institutions on aerospace market conditions.

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