Global supply chain disruptions are spreading, and nobody knows what to do about it
The term “global supply chain disruption” has been cited frequently as one of the main consequences of the COVID-19 pandemic. But what exactly does the term mean, and why does it matter?
The origins of supply chain management (SCM) are often traced to the 1980s, when U.S. multinational corporations sought to lower production costs by outsourcing and offshoring manufacturing and research and development (R&D) activities to low-cost countries in Asia. Over time, practices that called for continuous flow processing with low inventory levels, just-in-time production and accurate scheduling of transport became common.
During the early 2000s, multinationals encountered supply problems, and researchers wrote books about how to deal with disruptions. In 2019, the Business Continuity Institute estimated that 56 percent of companies surveyed suffered a supply disruption annually. They were mainly due to information technology (IT) and telecommunications outages and to natural disasters.
Human factors also played a role in the latter part of the decade owing to the U.S.-China trade conflict. In the process, corporations shifted from reactive tactics to mitigate the cost of disruptions to more proactive strategies to improve supply chain resilience.
Meanwhile, the COVID-19 pandemic has posed a much greater challenge to multinational corporations: For the first time, they are contending with complex global disruptions with no end in sight.
When the pandemic first hit in early 2020, shortages of household items such as toilet paper, medical supplies and groceries occurred as people stockpiled items when many businesses and schools were closed. These shortages were alleviated in the summer as the re-opening occurred. Consequently, many people believed the problems had been resolved.
This year, however, attention shifted to soaring prices for lumber, which more than doubled in six months as many homeowners renovated properties or bought new homes. This was accompanied by a surge in prices for used car prices and car rentals that occurred when auto production slowed significantly due to a shortage of computer chips. The chip shortage, in turn, resulted from increased demand for personal electronics such as cellphones and laptops.
As prices of these items surged, Federal Reserve Chairman Jerome PowellJerome PowellBiden selects Sarah Bloom Raskin, two others for Fed board Overnight Energy & Environment — Earth records its hottest years ever On the Money — SCOTUS strikes down Biden vax-or-test rules MORE reassured consumers and investors that the spike in inflation was temporary and that there was no need for the Fed to tighten monetary policy. This view appeared to be validated when lumber prices tumbled in the second quarter and prices for used cars stabilized the following quarter.
More recently, Powell has begun to change his tune by acknowledging that prices have stayed elevated longer than the Fed had originally envisioned. Powell told a conference of European central bankers that, “It’s…frustrating to see the bottlenecks and supply chain problems not getting better, in fact at the margin apparently getting a little bit worse.”
Powell went on to acknowledge that the problems could continue into next year “holding inflation up longer than we thought.” Speaking alongside Powell, European Central Bank Chief Christine Lagarde also discussed global supply shortages, saying, “I’m thinking here about shipping, cargo handling and things like that.”
A Washington Post article by David Lynch highlights what is going on. Lynch notes that the commercial pipeline that brings $1 trillion of toys, clothing, electronics and furniture from Asia to the U.S. is clogged, and no one knows how to unclog it. The median shipping cost for a container from China to the West Coast recently quadrupled to a record $20,586. He observes that “essential freight-handling equipment too often is not where it’s needed, and when it is, there aren’t enough truckers or warehouse workers to operate it.”
The New Yorker’s Amy Davidson Sorkin explains why the ports of Los Angeles and Long Beach reached the point last week where more than 70 container ships were idling offshore. She writes that labor shortages are at the heart of the problem, as there aren’t enough dockworkers to unload cargo or truck drivers to move the contents to distribution centers: “Just in time delivery works only if you can deliver.”
The bottom line is that supply disruptions were initially tied to shutdowns of businesses when the pandemic hit. But since then, they have spread to a much broader spectrum of areas and are proving more difficult to tackle.
This poses a dilemma for the Fed and other central banks about how to deal with prolonged supply shortages. One can make the case that central banks should do nothing and allow price increases to dampen demand. The problem with this tact, however, is that if shortages persist into next year, inflation expectations could become entrenched. According to an August survey by the Federal Reserve Bank of New York, for example, inflation expectations of consumers over the next three years have increased to a median of 4 percent, the highest level since 2013.
Another problem with the strategy of doing nothing is that it downplays the role that expansionary fiscal and monetary policies have played in boosting aggregate demand. By now, a significant component of job losses during the pandemic have been replaced, with the unemployment rate down to 5.2 percent. Moreover, July’s Job Openings and Labor Turnover Survey (JOLTS) indicated that more than four million jobs were available that went unfilled. This is the biggest mismatch on record between jobs that workers sought and what was available.
For the time being, investors have sided with the Fed’s view that higher inflation is temporary. But bondholders may be wavering, as bond yields have increased recently.
Should they come to believe that inflation of 3 percent – 4 percent is here to stay, the bond market vigilantes may return and force the Fed’s hand to raise interest rates sooner than it wants.
Nicholas Sargen, Ph.D., is an economic consultant for Fort Washington Investment Advisors and is affiliated with the University of Virginia’s Darden School of Business. He has published three books including, “JPMorgan's Fall and Revival: How the Wave of Consolidation Changed America's Premier Bank.”