The strains of the Covid-19 pandemic revealed weaknesses that must be addressed—but changing these complex interacting systems is not easy.
When the hundredth cargo ship joined the unprecedented line outside the Los Angeles-Long Beach port complex in October the supply chain crisis that had simmered for months looked to have boiled over. Parents began to worry about the availability of Baby Yoda toys in stores for the holidays. Economists’ warnings of soaring demand, supply shocks, ongoing Covid-19 disruption and potential runaway inflation reached a deafening pitch. Then in late November the Covid omicron variant emerged, threateninig another round of lockdowns and disruptions.
Certainly, the statistics look worrying. Supply chain problems pushed US industrial production 1.3% lower in September, the biggest drop in seven months. While wage rises of 1.5% from the second to the third quarter—the fastest pace since 2001—may seem like great news for workers, their pay bump will be eaten up by October’s year-on-year consumer price growth of 6.2%, a 31-year high. Meanwhile, IHS Markit’s Purchasing Managers’ Index, published in the third week of October, showed that eurozone business activity is weakening. The index fell to a six-month low “amid increasing supply bottlenecks.”
For months, corporates have sought to lower expectations and warn of worse to come. Procter & Gamble announced price increases for nine of its 10 product categories, in the mid-to-high single-digit percentages across most of its portfolio. Nike lowered its sales forecast, with production and shipping delays hampering its ability to meet demand; while home appliance firm Whirlpool said supply chain blockages and the increased price of materials would add almost $1 billion to costs this year. And Amazon predicted that “labor inflation” would add $2 billion to its cost base in the fourth quarter.
What's Going On?
In order to understand how and when the supply chain crisis might resolve itself, it’s important to understand how we got here. According to Gregory Daco, chief US economist at Oxford Economics, the current supply chain crisis has two unique characteristics that differentiate it from those of the past. “First, we live in a highly globalized environment where supply chains span the entire world, and there are an incredible number of financial and capital-based interactions between economies,” he notes. “Second, the Covid-19 crisis, unlike any previous crisis, affected every country in the world.”
While the pandemic affected everyone, supply in different countries is coming back online at different times, leading to pockets of disruption that have cascading effects on downstream industries and have created a “desynchronized global recovery,” according to Daco. This challenge is being exacerbated by the ongoing distortion of the global economy, says Ben Laidler, global markets strategist at investment platform eToro.
In most of the biggest 10 economies, government lockdown actions and restrictions as gauged by Oxford University’s Covid-19 Stringency Index peaked at over 80 (on a scale of 0 to 100) between the beginning of March 2020 and the end of March 2021. Yet restrictions linger and return. “Even in October 2021, it was still around 60,” says Laidler. “Many supply chain distortions are ultimately driven by the fact that we are still, to some extent, locked down.” For instance, there is a labor shortage due to problems in matching laid-off workers to vacancies.
Trade’s complexity and scale means that, “like a supertanker, it takes a long time to turn around,” says Rebecca Harding, trade economist and CEO at data provider Coriolis Technologies. The world is dependent on a limited number of shipping lanes from Asia to Europe and the US, and they can easily get clogged up. As the Suez blockage showed, a single problem can have significant consequences. “The ships that were delayed [then] are still displaced [seven months later], causing knock-on effects for future traffic.”
In other words, many of today’s problems—while serious—are largely short term in nature; the backlog of ships outside the Los Angeles-Long Beach port complex will eventually be cleared, more truckers will enter the workforce and the disruptive impact of the Covid-19 Delta and Omicron variant will (hopefully) dissipate. Equally, it’s important to note that the current supply chain challenges are not universal, according to Madhur Jha, head of thematic research at Standard Chartered. “In Asia, the manufacturing hub of the world, supply remains available,” she says. While pandemic-related shutdowns in Vietnam and China led to some delays in production, restrictions have now been lifted. “Supplier delivery times in the US and Europe are elevated by as much as 17 points; in China, they have risen by perhaps two.”
Uncovering Underlying Problems
Even the best prepared companies might have struggled in recent months, given the pace and nature of the global recovery. But according to Anastasia Kouvela, partner at Boston Consulting Group (BCG), many firms have also found it hard to address underlying or long-term supply chain challenges.
“Transparency across the extended supply chain is critical,” explains Kouvela. Most companies found it difficult to act quickly during the pandemic, as they did not know where their stock was or how resilient their tier-two and -three suppliers were. In addition, many companies had become complacent and failed to proactively manage risk by devising backup plans and strategizing “what if” and “then what” scenarios. Many companies had also concentrated production in a limited number of locations far from their main market of sale, she adds.
Kouvela says that companies are addressing all of these challenges: “In the short term, [they are] relocating inventory and creating buffers. Much of this work [began] during Covid.” Corporations are also “collaborating more extensively with suppliers, including providing training, to improve resilience” and trying to diversify their supplier base, she notes: such efforts will necessarily only bear fruit in the longer term.
The supply chain challenges described above were clearly magnified by the short-term shock of the pandemic. But they have also been steadily intensifying as a result of longer-term political and technological shifts, according to Coriolis Technologies’ Harding.
“Today’s semiconductor crisis, for example, is really the result of the Trump tariffs imposed on semiconductors in 2017,” she explains. “Since then, China has developed its supply chain and focused on domestic production and consumption as part of the Made in China 2025 initiative.” Meanwhile, in the West, there’s been an increased emphasis on nearshoring in order to build resilience. “As a result, global trade in semiconductors has declined and the industry has become less able to respond to the problems we see today,” Harding adds.
Higher energy prices, eToro’s Laidler adds, are largely a result of the breakdown in the relationship between prices and investment (i.e., higher prices usually prompt investment) as the global economy has begun to transition to a low-carbon future.
How Long Will Recovery Take?
Policymakers have limited options available to alleviate current pressures on supply chains. Governments could seek to increase economic capacity through a greater focus on infrastructure investment, capital investment or the labor force. But that will take time. Certainly, today’s problems are outside the scope of monetary policy. “In the current environment, [inflationary] pressure is coming from the supply side, which central banks can do nothing about,” says Oxford Economics’ Daco. “If they tighten monetary policy, that will impact demand and limit growth but do little to increase capacity at ports, bring people into the labor force or alleviate other supply side problems.”
But while today’s problems are significant, it’s helpful to keep a sense of perspective. Many current challenges ultimately reflect good news. Record fiscal stimulus has lessened the blow from the pandemic and spurred a boom in global trade, notes Laidler. “Chinese exports are up 26% year-on-year, Europe 11% and the US 19%. The World Trade Organization says global trade will be up 11% on the year—the best performance in recent memory.” It’s hardly surprising that the world is struggling to meet demand.
Similarly, Daco points out that “the second quarter was the best ever for company profit margins, at around 13% in the US and 11% in Europe.” This is despite the gap between the producer price index (the cost to a company of making something) and consumer prices (which can be seen as a proxy for what can be passed onto the consumer) being enormous by historical standards: at 3% in the US, 9% in China and 10% in Europe, according to Daco. Companies’ strong performance against such an unpromising backdrop is testament to extremely strong demand, which is more than offsetting margin pressure.
Given that the supply chain problems in the West are localized, they are likely to be relatively short term in nature, according to Standard Chartered’s Jha. “The last-mile logistics issues will be sorted out. Clearly there are exceptions, such as chip manufacture. But even here, Taiwan [chip] supplier delivery times are starting to fall. [Likewise,] the Federal Reserve’s recent survey of suppliers in New York, Texas and Philadelphia anticipates an improvement in the next six months.” An absence of Baby Yoda toys on store shelves this Christmas might prompt anguish among parents, but the outlook is bright. Jha believes inflation is temporary and unlikely to become entrenched. Overall, she remains optimistic: “We anticipate GDP growth of 5.8% this year, and we have not revised that downward.”