Photo by AFP via Getty Images

Do you remember the days when the world already knew that there was a Covid-19 outbreak in Wuhan and that it was spreading rapidly, but you were not under lockdown yet? An in-between moment when it was clear a catastrophe was coming, but not what it meant. This stage of the US and Israel’s illegal attack on Iran is another such moment. The shock is here. The shockwaves are on their way.

One fifth, one third, one third, two fifth, nearly one half – these are the respective shares of global exports of liquefied natural gas, crude oil, fertilisers, helium and sulphur normally passing through the Strait of Hormuz. Our research shows that these are essentials the world economy depends on. Fossil fuels are by far the most systemically significant inputs in (as yet) predominantly fossil fuel-powered capitalism. Food production depends on fertilisers. Helium and sulphur are necessary for microchips production, in turn needed for everything from lawn mowers to data centres sustaining the AI boom. The passage through the strait of these raw materials – key for making everything else – has been effectively suspended since the beginning of the war.

One of the lessons of the Covid supply crisis was that even a momentary blockage of trade’s flow provokes massive disruptions. Remember the images of traffic jams off major ports? Now add the production side to this. Since local storage facilities for oil and gas have filled up behind the Strait of Hormuz, several production sites have had to stop production – they are “shut in”. Supply is not just slowed but simply not there. And you cannot switch oil fields or refineries back on overnight, it can take weeks or months to do so. Moreover, production and transport infrastructure has been damaged. And as fertiliser is produced with gas, and sulphur and helium are by-products of oil and gas production, these chemicals are no longer produced either.

At time of writing, the war is escalating with attacks on oil and gas production after Israeli attacks hit the Iranian South Pars gas field, the world’s largest, and Iran retaliated with attacks on the liquefied natural gas plant in Ras Laffan, wiping out 3.5 per cent of global LNG production for the next 3-5 years. 

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It is unclear when the Strait of Hormuz might fully reopen to ship traffic, but one thing is certain – there is a blow coming for the global economy through the supply chain, no matter how soon the war ends.

European and US consumers are still, for the movement, relatively insulated, even if they already see elevated gasoline prices that bring a major cost burden to households. The full scale of the effects to come remain hidden in the complexity of the global supply network. Here is a sketch of what might be coming: inflation, redistribution shocks, shortages, stagflation and global financial instability.

So far only the prices of essential commodities – oil, gas, fertiliser etc – have shot up. Firms buying these inputs that can’t influence the price of their product must absorb the cost or stop producing, as many small-scale producers have done, like fishermen in the Philippines that can’t afford the twice as expensive fuel anymore.

However, most of today’s global economy is run by giant corporations that set their own prices, and our research shows that cost shocks helped them coordinate price hikes. They did not swallow the cost of pandemic and war but pushed it on to consumers, protecting their margins and lifting their bottom line in the process. This is sellers’ inflation. Corporations transmit price explosions in essential inputs across the whole economy through their own price setting, ultimately causing inflation.

Such corporate price hikes become even easier when inputs are not just more expensive but in short supply. This grants companies a temporary monopoly. During the Covid-era computer chip shortage, each car company could only produce as many cars as they had chips for, so customers waiting months for new cars could not escape high prices and waits by switching to another company, and the car companies reaped extraordinary profits. Furthermore, when input prices fall, consumer prices tend to stay up, or to fall by less, generating yet another round of windfalls.

Next, sellers’ inflation means redistribution from labour to capital and ultimately to the richest of the rich. Even if workers eventually manage to push up wages to compensate for inflation, they take a hit in the first place. In the UK, real wages are only just returning to their pre-energy crisis level now – after four years of lower incomes. German real wages have still not regained their pre-pandemic level, after seeing the largest collapse since the end of the Second World War. Even in the US, which experienced faster wage recovery, the share of profits in income is at a record high, and the share of wages at a historic low. Profit margins in several sectors spiked in the last round of sellers’ inflation, are already near a historic high for the economy as a whole, and will now start to rise even more in response to the Strait of Hormuz blockages.

Profits do not distribute equally across the population. In the US, the richest 10 per cent of households own 87 per cent of US equities. Stock market valuations for fossil fuel and fertiliser producers, for example, are shooting up and are being celebrated by market commentators as a wonderful investment opportunity. The current price spikes in oil, gas, fertilizer and other inputs are poised to deliver massive windfall profits for shareholders of companies not affected by the blockage – their costs of production haven’t increased but the prices of the stuff they produce are through the roof.

Our research shows that the hundreds of billions of excess profits reaped by oil and gas companies in 2022 compensated the richest 1 per cent of US Americans on average for several percentage points of inflation that year through their shareholdings in these companies. Meanwhile, the least wealthy half of Americans, and most of the rest of the world, saw nearly none of these benefits while carrying much higher inflation burdens. Newspapers already calculate billions of excess profits for the energy industry this year – risking even higher inequality if left unchecked by excess profit taxes.

There is a real threat that many consumers will not only have to pay more but will be priced out of the market for goods altogether. Shortages will rip apart societies and run along international fault lines. They are already a reality in the most exposed fuel importers in Asia. And affluent economies buying up what remains of supplies will leave people in developing countries without the physical product. Average European Union per capita purchasing power in current dollars (the relevant metric for buying imports), is 15 times higher than that in South Asia (that of the UK is 18 times higher). While gasoline will become more expensive in Europe, which is bad enough in itself, the ability to actually transport people and things in many parts of Asia is eroding fast. Sri Lanka just declared a four-day work week to conserve fuel.

Most worrying are food shortages. The disruptions from Covid, the war on Ukraine, all exacerbated by climate change erased more than a decade of progress on combating global hunger. But that was a world food price crisis – there were no physical shortages globally. Now, with some 40 per cent of fertiliser exports at risk at the time when key markets from the US to India have a planting season, food output decline during the next harvest is a real risk. What would manifest as a price shock in the Global North, would devolve into a food shortage crisis in import-dependent regions in the Global South.

To what extent all of this occurs is of course a function of how long the disruptions last. But measures like those taken in Sri Lanka, that effectively shrink the economy to match lower supply, should ring alarm bells around the world.

Sellers’ inflation only benefits business so long as the output destruction is not too large. If a prolonged strait closure exacerbates shortages and too much production ends up going offline due to shortages, the recession that follows could also hit profits. It would definitely lead to unemployment, which in turn would make it very hard for labour to have wages keep up with inflation. So, the worst case scenario from a macroeconomic perspective is stagflation. While some stocks are booming on war profits, the stock market as a whole could lose much value, and credit default rates go up, with risks for financial stability.  All of this will lead to major political fallouts. Judging from the last crisis, the far right is the likely winner. But defeatism should not rule the day. The time to act is now. The obvious, necessary thing to do is to end this illegal war and not be complicit. The fallout that is already in the pipeline needs to be addressed as quickly as possible. Preparedness was the lesson of the last crisis. But governments failed to act. Now their backs are against the wall, and they must intervene as quickly as possible with all levers available to contain the shocks rather than letting them ripple through our economies and rip apart our societies. The toolkit involves everything from releases from reserves (already implemented) and wholesale price caps in commodity markets – both multilaterally coordinated, to margins caps along the supply chain to contain sellers’ inflation and retail price caps on essential consumption with market prices for the rest (nonlinear pricing). To address the risk of physical shortages, fair rationing protocols have to be drawn up. If none of this is needed, we should be relieved. But if it is, we better have it in place.

[Further reading: How ready is Britain for fuel shortages?]

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