Do a quick search on the New York Times’ website for the term “Supply Chain” and filter to articles published in 2012, and you will find 190 pieces. Do the same for 2022 (so far) and you will get a list of 1,180 articles, a 521% increase in just 10 years. A topic that received little news coverage outside industry-specific publications has been thrust to center stage in recent years and is often seen as the cause, and sometimes solution, for a litany of challenges facing the business world and population at large.
One of the most prominent and recent examples of the ills caused by supply chains is inflation. The U.S. Bureau of Labor Statistics’ Consumer Price Index year-over-year change peaked in July at 9.1%, the highest rate since 1981. After an arduous two years of pandemic woes, as businesses reopened and people began to venture out into the world again, inflation spiked and made even basic goods and services prohibitively expensive for many consumers.
What caused the 40-year high in one of the most important metrics of our economy? While the reasons are still hotly debated and vary considerably, one thing is certain: supply chain issues played a key role in the state of the United States’, and really the world’s, inflation rates. This article seeks to explain exactly what happened, why it is still stubbornly difficult to get goods delivered on time, and why everything is so expensive.
To understand how the pandemic and supply chains interacted to contribute to the US’s currently high inflation, we need to look back long before Covid-19 existed, to Japan shortly after World War II. Toyota Motor Corporation is currently the second largest automobile manufacturer in the world by revenue, but in the 1940s, the company was on the verge of ruin as a result of World War II and the subsequent collapse of Japan’s economy. As the company emerged from the brink, Toyota’s leadership sought ways to increase their competitiveness and profitability, and that process yielded the related concepts of just-in-time and lean manufacturing. The way in which these concepts are executed can be complex, but the ideas are simple. Carrying physical inventory can be costly and risky, in three main ways:
- First, the inventory a company owns at any given time is accounted for among its assets. One of the many ways to judge a company’s health is to assess how much revenue and profit it can generate, given its level of assets. So, carrying more assets than needed, in this case as inventory, can give investors and the public a perception that the company is inefficient and poorly run, which may discourage investment in the business.
- Second, physical good inventory must be stored somewhere until it is transported or sold. That requires warehouses and staff to move and handle the products.
- Finally, carrying inventory creates risk for companies. The inventory could become obsolete, consumer demand could decrease, or product regulations could change, making the goods unsalable, any of which would cause a financial loss.
That is where lean manufacturing and the just-in-time philosophy come into the picture. Put simply, these ideas hold that carrying less inventory is a sound business decision and companies should seek to do so whenever possible.
As Japan’s economy stormed back during the reconstruction period and began reopening to the world, firms in other countries began to take notice of the efficiency and speed with which Japanese companies, especially Toyota, were able to produce goods and limit their inventory costs and risks. That led to many adopting the principles of just-in-time and lean manufacturing. By the 1990s these had become prevailing business standards, allowing companies to hold minimal levels of stock, along with the mentality that if demand increases, they could simply order more, and the products would arrive soon.
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While efficient manufacturing processes continued their widespread adoption among firms, another underlying trend was reshaping the world.
Cross-border trade has exploded since the end of World War II and has become a key feature of the modern global economy. The value of exported goods as a percentage of total world GDP increased from only 4.2% in 1946 to 31.2% in 2008. Despite a recent trend of protectionism of domestic manufacturing at the detriment of importing, the figure still stood at 28.2% in 2019, just before the pandemic began. Put simply, the world economy and its supporting supply chains are radically different today than 75 years ago. Supply chains are far more interconnected, spread out of thousands of miles and across oceans, and more global than at any prior time. This shift was caused by three primary trends:
- First, as countries emerged from World War II, many of their economies were in desperate need of immediate and sustained high GDP growth to help them recover. In search of economic advancement, many countries turned to global trade.
- Second, a growing acceptance among economists and policy makers of the merits of trade liberalization spread in the years after World War II. Global trade was by no means a new phenomenon at that time. Humans have traded goods and services throughout most of their history, highlighted by trading networks like the Silk Road and companies like the East India Trading Company. But a newfound approval of trade exemplified by agreements like the North American Free Trade Agreement (NAFTA) and global organizations like the World Trade Organization (WTO) meant cross-border trade continued to grow and integrate into the world economy.
- Third, starting in the 1950s and continuing into the 21st century, long distance shipping became drastically less expensive and easier to execute. That trend had been slowly happening for decades with the invention of the internal combustion engine, trains, and infrastructure improvements, but the major paradigm shift happened in 1956 when the standardized, corrugated metal shipping container was introduced. Suddenly it was easier than ever to move goods across the ocean in a box that was uniform in size, easy to move, and could be transferred from boat to train to truck without ever unloading the product inside. The decline of shipping rates in the United States was further accelerated by the Motor Carrier Act of 1980 which deregulated trucking in the country, allowing for increased competition and lower constraints to business activity.
- Finally, national and local government officials have slowly warmed to the idea that cross-border trade is not only an acceptable, but a desirable characteristic of a modern economy. Centuries after economists Adam Smith and later David Ricardo developed the ideas of absolute and comparative advantages, meaning countries should produce the goods they are best capable of producing in relation to others, anti-trade, protectionist ideals began to give way to more liberalized approaches to trade. And powerful examples of trade’s ability to improve a country’s economy helped convince world leaders to follow suit and rely more on trade. For example, China began opening its economy to capitalist ideology and liberalized trade in 1978 and in the 30 years that followed, saw its GDP per capita grow from $229 USD to $9,903 USD, an over 4,000% increase.
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So, when the Covid-19 pandemic began in 2020, it hit a world where global trade was a cornerstone of the economic system and firms’ short-sighted thinking and almost religious adherence to the principles of lean manufacturing, just-in-time, and globalized supply chains meant they carried as little extra inventory on hand as possible and sourced most of their goods from countries thousands of miles away. As pandemic shutdowns spread in March and April 2020, consumers in many countries found themselves largely unable to spend on services, as most restaurants, entertainment, and other in-person activities paused operations. Unemployment jumped sharply from 3.5% to 14.7% in just two months, but that still left 85.3% of the workforce intact. And as pandemic shutdowns wore on, many of those consumers who were no longer able to spend on services pivoted their purchasing habits to physical goods.
Even in normal times, a sudden shift in consumer spending from services to goods would cause a shock to the economy, but these were not normal times. China and many other Asian countries that had become the primary goods manufacturers in the modern, trade-driven, global economy also shut down many workplaces like other counties, but there, many of those were factories supplying goods to the world. That caused a perfect economic storm: a sudden restriction of supply that coincided with an explosion in demand for goods. Add to that, shipping delays and port congestion, and two rounds of federal stimulus checks that gave some consumers excess cash to spend, and supply simply could not keep up with demand.
Anyone that has taken an introductory economics course may be able to predict what happened next. As demand increased and supply decreased, the prices many retailers found they were able to charge skyrocketed. In many countries, pandemic restrictions began to abate in 2021 as the vaccine roll out took effect, but further geopolitical issues added fuel to the fire. The war in Ukraine cut nearly all shipping from the country and sanctions meant most Western governments and companies stopped buying goods from Russia. Ukraine and Russia are both among the world’s largest producers of wheat, Russia is the second largest natural gas producer, and the third largest oil producer. So key sources of several common goods were restricted causing price increases to accelerate further. All of these factors have contributed to the inflationary environment the US economy is now operating in.
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Factories in Asia have mostly resumed production. Shipping delays and port congestion have largely eased. Geopolitical turmoil in Europe continues, but Ukraine and Russia have reached agreements to allow some shipments to depart Ukrainian ports. The Federal Reserve has raised their Federal Funds Rate several times in 2022 in an effort to cool the overheated economy and rein in inflation. All of these developments have had a limited but noticeable impact on US inflation. Since July’s peak rate of 9.1%, inflation has eased slightly, down to 7.7% in October, with November’s figures to be released soon.
Inflation is an inherently difficult metric to measure, much less to attribute to a small set of causes. The Covid-19 pandemic was a challenge to the global economy unlike any in history. The 1919 flu pandemic was even deadlier and more disruptive, but also occurred in a world where global trade made up a small portion of overall economic activity. Inflation did briefly spike in the early 1920s, but quickly fell, and prices remained relatively flat throughout the decade. The inflation we are currently experiencing was likely driven by the pandemic as its initial cause, but its effects are so far reaching and significant because our reliance on long-distance supply chains, lean and just-in-time manufacturing, and a short-sighted belief that our global economy was more resilient than it turned out to be. As the US and the world learn to adjust and deal with these effects, we are sure to see no shortage of continuing news coverage about supply chains.
