Rethinking of Supply Chains May Be At Hand
Economic theory can be straightforward. It tells us for-profit businesses seek to maximize efficiency by producing the highest quantity of a given good or service at the lowest cost. Over the past few decades, pursuit of the most-for-least objective has led many firms to employ a method of production and supply known as "just-in-time," a concept designed to wring all waste from inventories, production, worker hours, and other elements of the production chain.
But real-world events can thwart accepted theory and practice. So it is that the just-in-time production philosophy has come into question because of rampant disruptions in supply chains set off by unpredictable shocks—first, the global coronavirus pandemic and then the Russian war in Ukraine.
"Any jarring perturbation or disruption has wildly large impacts," Federal Reserve Bank of Atlanta president Raphael Bostic explained at a recent event at the University of Southern California. Global supply chains became so efficient, so taut, that any blip can effectively snap them. So as the pandemic and then war snarled supply chains, many companies apparently have begun to rethink their zealous embrace of just-in-time strategy.
"Businesses are moving away from the lowest-cost model," Bostic said. "So costs are going to go up but with the benefit of not having the same volatility in actual output."
Bostic is not alone in foreseeing strategic realignment of supply chains. In a November essay, former Federal Reserve vice chair Roger Ferguson observed that disruptions caused by the pandemic and other emergencies were made worse by the corporate world’s increased dependence on just-in-time production. "Even after the current crisis passes,” wrote Ferguson, who spoke at the Atlanta Fed’s Financial Markets Conference in May, "companies should rethink this model and keep stockpiles to increase resiliency, even if it is at the cost of short-term profits."
After Russia attacked Ukraine, Adam Posen, president of the Peterson Institute for International Economics, wrote in the journal Foreign Affairs in March that the invasion and resulting economic sanctions would "speed up the corrosion of globalization," with various implications. "Multinational companies, with government encouragement, will rationally insure against problems by building redundant supply chains in safer locations," Posen predicted.
Supply chain disruptions fuel inflation
Hiccups in the elaborate networks that bring all manner of products to consumers have been well chronicled in the past couple of years. Factory shutdowns, particularly in Asia, and widespread lockdowns and mobility restrictions caused disruptions across logistics networks, increases in shipping costs, and longer delivery times. Economists have identified these disruptions as a major culprit in shortages of goods, from couches to microchips to wheat and crude oil. Supercharged demand from consumers flush with cash and cooped up for months by public health measures pushed prices up for consumer goods including staples such as gasoline and food. The war in Ukraine and subsequent economic sanctions heaped on more disruption by slowing or cutting off exports of wheat, fertilizer, oil, and other commodities from Russia and Ukraine. A fundamental tenet of economic theory is thus at work again: many buyers competing for limited goods bid up prices, so inflation has hovered for months at levels not seen since the early 1980s.
One of the reasons Bostic thinks supply chain designs could radically change is because companies have begun attaching a cost to uncertainty, a shift in mentality that probably results at least in part from the extraordinary degree of uncertainty that characterizes today’s global economic and business environment.
Supply chain disruptions are causing many of the Atlanta Fed's hundreds of business contacts to tilt toward the type of shift Bostic has described, according to intelligence gathered by staff of the Reserve Bank's Regional Economic Information Network (REIN). For example, REIN staff learned that a furniture retail chain is shifting much of its upholstery sourcing to the United States from overseas (a move sometimes called "onshoring"). Some port officials in the Southeast expect that import volumes could rise as companies guard against future supply chain disruptions.
Todd Rives, chief commercial officer at the Port of New Orleans, said some apparel manufacturing is migrating from Asia to Latin America to move closer to the American customer base. "We're starting to see some individual movement by companies saying they can't put everything in China or Southeast Asia, so they may need something closer to the US to ensure regular delivery," Rives said in a late 2021 interview with Economy Matters. "I think it's happening today."
Another Atlanta Fed contact had studied moving workers from India to a less-expensive location in Eastern Europe. However, the war in Ukraine forced the company to reconsider—another example of risk outweighing immediate financial cost.
Additional hints suggest that a wider shift in supply chain configurations could be afoot. For instance, in announcing plans for a $17 billion semiconductor plant, Samsung noted that "supply chain resilience of crucial logic chips" was a factor in the decision to build the complex in Texas. In news reports, Toyota officials identified proximity to customers as a significant consideration in the automaker's December 2021 announcement of plans to build a battery factory in North Carolina. And General Motors in January issued a news release detailing $7 billion in investments in Michigan to fashion an electric vehicle supply network that is "expected to be scalable, more resilient, more sustainable and more North American–focused."
A turning point, but globalization is probably not over
It's unclear whether these individual cases herald a sea change in the design of supply networks. Reworking globe-spanning supply chains is no simple undertaking. It can be difficult to terminate long-term relationships with existing suppliers and establish new ones, for example. And measuring resiliency in supply chains is not completely straightforward, particularly if bolstering resilience is costly and done mainly to avoid adverse events that are very rare, according to experts on a webinar from the Conference Board, a business membership and research group.
Even if fundamental change is coming to supply chains, that does not signal the end of globalization, Minneapolis Fed monetary adviser Michael Waugh said in an April article on the Reserve Bank’s website. Waugh pointed out that after the initial economic shocks of the pandemic, cross-border trade rebounded vigorously.
Waugh also discussed the diversification of sourcing as a prudent concern. "And diversifying could mean across countries or it could be across time (building up inventories). Whether I'm diversifying across countries or I'm buying and holding more stuff from abroad, it's going to show up as more trade," Waugh said.
Questions abound. Will we see more onshoring? Will firms mostly diversify their sourcing to presumably safer international locations? Or as the present uncertainties ease, will most firms simply revert to prioritizing cost even at the risk of future disruption? And more broadly, will the relocation of production to costlier locales—along with capital investment required to build new supply infrastructure—raise costs and thus inflation?
It is difficult to forecast the magnitude and effects of a move toward what Bostic and others call "just-in-case" production. For now, in surveys and individual conversations, nearly all Atlanta Fed business contacts—spanning industries and firm sizes—report that they are considering diversifying their supply chains. When the pandemic started, Bostic recalled, most were not pondering those adjustments.
"Businesses are deciding these things today," Bostic added, "so I can’t tell you what the final outcomes will be."
How supply chain adjustments shake out will clarify how those shifts ultimately influence various parts of the economy, Bostic figures. "I do feel like we are at a turning point in how the global economy has functioned," he said. "It’s a very, very interesting time."