The writer is the executive director of the LSE Economic Diplomacy Commission
Recent months have shown that supply chains carry not only the world’s goods, but also its inflation anxieties, geopolitical divisions, climate challenges and health risks.
Semiconductor shortages are weighing down the industrial recovery as droughts have hit Taiwanese producers and geopolitics have split the market. At the same time, a squeeze on the supply of building materials has led to rising costs for contractors, adding to concerns about inflationary pressures across the world economy. And as medical supplies have run low and vaccine production fallen short, the Covid pandemic has continued to rage.
It was welcome, therefore, that the final communiqué of last weekend’s G7 summit should contain an acknowledgment of the threats faced by global supply chains and a proposal for establishing a common framework for stress-testing them.
Consider the alternatives. Demand is surging as upper-income countries emerge from the coronavirus pandemic. And Covid-induced supply chain disruptions are putting upward pressure on a variety of prices. No matter how transitory these price rises may be, inflation anxieties have returned and calls for conventional remedies — cutting spending and raising interest rates — have, too. But bluntly suppressing demand would be counterproductive.
The problem is compounded when inflationary disruptions are driven by geopolitics. If semiconductors are in dangerously short supply as a result of G7 countries’ unwillingness to work with military-affiliated Chinese hardware companies, must the domestic economy be punished with lower spending and higher rates? Would those worried about inflation have these countries drop their sanctions and dismiss their security concerns in the name of price level stability?
The question for the G7 is how to adapt to changing economic and geopolitical conditions. In the long run, the answer will be approximated through rough-and-tumble market adjustments.
But in the meantime, by stress-testing supply chains, governments can simulate and prepare for sudden shocks and changing conditions. Adverse scenario analyses would allow them to model the resilience of critical supply chains in the face of both familiar financial events and emergent non-financial risks.
How might supply chains endure tariffs and cyber attacks, droughts and storms, or the outbreak of disease and need for certain medical goods? The key calculation is the difference between a supply chain’s “time to survive” — how long it can meet demand after a disruption — and its “time to recovery” — how long it takes to mitigate or adapt to the disruption. If the time to recover is greater than the time to survive, companies and authorities will see that the supply chain needs strengthening.
In turn, G7 countries should work together much as they did after the financial crisis, when stress tests of financial institutions were taken up with vigour. Implementing microprudential stress tests for supply chains would reduce the likelihood of debilitating disruptions by informing better private sector practices and guiding smarter investment and regulation.
The “forum on supply chain resilience” proposed by the US would likewise provide the setting for regulators to co-ordinate macroprudential policies that anticipate broader contagion risks and systemic threats.
Tucked away in another G7 communiqué was the announcement of a new doctrine of interventionist economic policy. It was called the “Cornwall Consensus”.
If it is to succeed, where its predecessor, the laissez-faire Washington Consensus failed, the Cornwall Consensus will have to take a more serious look at the supply chains that underlie the world’s most significant challenges.