December 2021 Insights

What’s Behind the Supply Chain Crisis?

The UK, like the rest of the world, is in the grip of its worst supply chain crisis since the mid-1970s. A recent survey by the Confederation of British Industry (CBI) provided a snapshot of the grim reality: almost two-thirds of businesses surveyed warned that shortages of components would hit factory output in the next three months. That was in mid-October, which suggests the supply chain crunch is likely to get a lot worse after the Christmas holidays.

Feeling the effects

Car makers are unable to meet demand and in some cases are even unable to produce full featured cars due to global chip shortages. Shipping rates are spiking then collapsing due to a lack of containers and truckers at ports. The UK has already suffered brief fuel shortages that evoked painful memories of the winter of discontent. Meanwhile across the Channel the price of electricity this year has doubled, then tripled, and then quadrupled, and is now at its highest level ever, just in time for winter’s arrival.

Retailers are also feeling the effects. In mid-November the Wall Street Journal reported that supermarkets suffering from product shortages are doing whatever it takes to create the illusion there are no physical gaps on shelves, including by using signs and moving products. In a recent Office of National Statistics (ONS) poll, 17 percent of UK consumers said they couldn’t purchase essential food items.

Co-operative Group Limited even stocked refrigerated displays with condiments to ensure customers wouldn’t see empty racks. “We’ve been impacted by some patchy disruption to our deliveries,” a spokesperson for Co-op said. “Our teams are always trying to make sure our stores look as attractive as possible and sometimes managers come up with creative ways of making sure shelves are full.”

Like high inflation, these supply chain issues are unlikely to be transitory. Some industry figures are warning shoppers to expect to see empty shelves until at least 2023. Associated British Ports chief executive Henrik Pedersen said he would be “positively surprised” if the problem was fixed next year. “When you have congested container ports around the world, it takes a very long time to turn it around,” he told Retail Gazette.

Marks & Spencer has cautioned that shortages of clothing and homeware could last until spring. Next and The Entertainer have also hinted that next-day deliveries could be under threat in the lead-up to Christmas, placing the blame on delivery staff shortages, supply chain issues and surging demand.

The supply chain chaos is having a significant impact on factory and retail prices. Consumer price inflation is already well above the Bank of England’s target rate of 2 percent and is on track to reach 5 percent by the end of this year. The cost of living soared by 4.2 percent year over year in October, the fastest rate in almost 10 years. This trend is likely to continue, if not intensify, for the foreseeable future. According to a business survey conducted by Accenture and IHS Markit, almost 60% of U.K. companies are planning to raise their prices to recover rising supply-chain costs and wages.

The global economy is in the grip of a brutal vicious circle: as the supply chain chaos grows, prices surge higher, which in turn is creating even more difficulty for businesses to procure products at prices they – and their consumers – can afford to pay. Consumers are seeing more and more bare shelves and rising prices, which risks causing a rerun of the panic buying we saw at the beginning of the pandemic. The bad news is that governments and central banks have no concrete solutions. On the contrary, much of what they do makes things worse.

But why is all this happening in the first place? Here are five key causes.

 

1) The Global Economy Can’t Be Turned Off and On Without Creating Chaos in the Process

One obvious reason for the supply chain crisis is Covid-19. In 2020, the virus became a global pandemic, and lockdowns ensued: factories, restaurants, shops and ports all closed. Demand for consumer goods – and all the raw materials and labor that go into them – collapsed. Against this backdrop, container carriers had no means of gauging future demand and did the only reasonable thing: cut capacity.

It makes no economic sense to move half-empty ships around the globe; it is prohibitively expensive, especially for a sector operating on the slimmest of margins. The consequence was widespread vessel cancellations, which soared in the first months of 2020. As time went by, more and more trade lines were cut and ports closed as containment measures were enacted globally. In the space of just a few weeks many global supply chains were brought to a virtual standstill.

Factories were also shut down, meaning that when the economy began moving again in the second half 2020 there was a massive shortfall in the basic components global consumer goods manufacturers needed to assemble the products they produce. Raw materials were also in short supply. The world, as the New York Times wrote, “ha[d] run out of everything,” from microchips to lumber to housing to running shoes to specialised resins used in car paint. It isn’t just a problem of supply but of distribution. As we noted in our August newsletter on inflation, there simply aren’t enough trucks, freight trains or ships in the world to transport all the products businesses and consumers need or want to buy.

 

2) Labor Shortages

The UK, like most advanced economies, is suffering an acute shortage of workers, particularly in the manufacturing and logistics sectors. Some of these shortages date back to even before the Covid-19 pandemic. The worst affected sectors include hospitality, construction and transport. According to the Road Haulage Association (RHA), the UK needs 100,000 more HGV drivers if it is to meet demand. If it doesn’t, there will be even more product shortages.

There are three main reasons for the UK’s chronic lack of lorry drivers:

  • Brexit. According to RHA, around 20,000 European drivers have left the UK for “Brexit reasons”. Others left to return to their families after the Covid-19 lockdowns and have decided to stay. But Brexit is not the only or most important reason; if it were other countries in Europe and North America would not also be suffering from similarly severe HGV driver shortages.
  • Pandemic-induced delays in driving tests. Another reason is the huge backlog in HGV driver tests due to the pandemic, which has led to tens of thousands of potential new drivers not being able to join the industry. Last year alone, 40,000 tests were cancelled and 25,000 fewer candidates passed their test than in 2019.
  • No one wants to be a lorry driver these days. Most young people simply don’t want to be lorry drivers while many older drivers are retiring. RHA says around 2,000 drivers are leaving the industry every week, some in pursuit of search of better wages, benefits, and working conditions, others due to retirement, while only 1,000 new recruits were joining over the same period. A similar trend has been reported across Europe as well as the United States. Driving a lorry is a tough, lonely, poorly paid job and most youngsters would rather do something else.

 

3) Decades of Offshoring and “Just in Time” Supply Chain Management.

There are deeper rooted causes behind the supply chain crisis including the growing tendency of multinational corporations to offshore their production processes to countries with significantly lower costs of labor including, of course, China. This trend dates back decades and has enabled companies to amass huge profits, but at the risk of overextending their supply chains, making their operations much more susceptible to a supply chain shock.

To make matters worse, many of the same companies also embraced “Just-in-Time” (JIT) manufacturing processes, which essentially involve holding extremely low inventories of components and instead having the necessary parts delivered “just in time” for a particular assembly process. It is a highly optimized system but one which is extremely vulnerable to disruption. And the world just suffered the mother of all disruptions. When the Covid-induced lockdowns, closed borders and travel restrictions set off a battery of supply chain shocks, many companies had nowhere near enough spare capacity to ride out the storm.

 

4) Global Pandemic Meets Global Geopolitics

Given all that has happened over the past two years or so, it is easy to forget that when the pandemic broke out, the world’s two biggest superpowers, the United States of America and China, were locked in a multiyear trade war. In 2019, U.S. imports from China slumped by $87.3 billion year-on-year – the second largest ever annual decline in U.S. imports from any trade partner (the largest was in 2009, the worst year of the financial crisis). This meant that when the virus crisis began, global supply chains were already tightly coiled.

Since the Covid-19 outbreak, relations between the U.S. and China have continued to sour. In June 2020, China introduced the national security law in response to massive pro-independence protests. Since then, Beijing has unleashed a litany of actions to bring the city-state into political lockstep with the Chinese Communist Party.

For its part, the US has escalated tensions by imposing sanctions on Chinese officials, which in turn have spurred anti-sanctions measures from Beijing. Washington has also entered into a wide-ranging security pact with the UK and Australia, AUKUS, whose ostensible purpose is to counter Chinese influence in the Asia-Pacific region. In other words, the trade war between the world’s two superpowers has morphed into a full-fledged cold war.

These rising geopolitical tensions have done nothing but exacerbate global supply chain issues. The automotive industry is an interesting case in point. In September 2020, the U.S. imposed export restrictions on SMIC, China’s biggest chipmaker, forcing it to buy components from other sources. At the same time, companies procuring their chips from SMIC had to look elsewhere, only to discover that alternative chipmakers were already at full capacity.

America could not rely exclusively on its own production, as US semiconductor giant Intel was grappling with its own production problems. To make matters worse, some firms appear to have been hoarding chips, making the chip crunch even worse. The US has also encouraged its allies to block China from acquiring the technological equipment it needs, making sourcing even harder for the country. China has responded by intensifying its quest for economic self-sufficiency.

As all these moves have played out, Covid-19-induced lockdowns brought semiconductor manufacturing operations to a grinding halt for months in 2020. They also closed some of China’s biggest ports for extended periods in 2021, leading to even more acute shortages of all kinds of electronics as well as sharp spikes in the prices of new and used cars, not just in the U.S. but around the world, including the UK.

 

5) Systems Are Buckling

The latest escalation came in late November with the news that most Chinese container ships had gone dark. Ships around the world, both large and small, are fitted with an Automatic Identification System, or AIS, transceiver. This allows the ships to send information – such as position, speed, course and name – to stations that are based along coastlines using high-frequency radio. If a ship is out of range of those stations, the information can be exchanged via satellite.

This system enabled shipping data companies to track ships worldwide, which is essential for knowing what is happening with maritime trade. But that became a lot more difficult in November when the number of Chinese vessels transmitting their location plunged by nearly 90% in the first three weeks of November, according to data from the global shipping data provider VesselsValue. It is the latest sign that the systems upon which we depend for global trade to function properly are buckling.

Morten Engelstoft, chief executive of Maersk-owned APM Terminals, told the Financial Times in September that surging demand for consumer goods, particularly in the U.S., had created a “vicious circle” that was putting inexorable strain on container groups, suppliers and logistics companies as they struggled to deliver goods.

“We need to work out how we break this vicious circle,” said the boss of APM, the ports and terminal division of the world’s biggest shipping group. “We need lower [consumer demand] growth to give the supply chain time to catch up, or differently spread out growth. Over a long period of time, we will need to recover efficiency.”

Two months later, it seems that Engelstoft’s prayers may have been answered as Europe once again becomes the epicentre of the Covid-19 pandemic. Austria and the Netherlands had already entered full-on lockdown by late November. Germany could soon follow. This is a surefire way of sapping demand from the global economy. But it could also wreak even more havoc on the overstretched supply chains we have grown to depend upon for everything we consume.

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