From UPSC perspective, the following things are important :
Prelims level : Upstream and downstream sectors
Mains level : Paper 3-Disruption in supply chains and ways to ensure their recovery.
Disruption of the supply chains lies at the heart of the decline in the output amid lockdown. And the government has announced the fiscal stimulus to revive the economy. How effective will be the fiscal stimulus to streamline the supply chains? The focus of this article is on tackling this question.
Disruption in supply chains and decline in output
- Much of the decline in output is due to supply chain disruptions generated by the lockdown.
- Government spending can do little to alleviate this.
- Putting money in the hands of people can increase the demand for goods but cannot increase the supply of goods and services.
- In modern economies, the production of goods happens through complex supply chains that traverse geographical boundaries.
Let’s understand how supply chains work
- Upstream sectors like ‘mining’ produce metals that are in turn used to produce machines.
- These machines are used to sow seeds, harvest crops, and transport fuel.
- Finally, the harvested crops are used by downstream sectors to produce flour and bread.
- At each step, machines and labour combine to produce goods which are the inputs for sectors further downstream.
So, how lockdown affected the supply chains?
- Under the lockdown, numerous inputs have not moved from their producers to their users.
- These disruptions may not at first generate a reduction in consumer goods like bread.
- However, the availability of consumer goods will begin to decline as bakers run out of flour, and mills exhaust their stocks of wheat.
- And there is no way to guarantee the flow of essential goods while suspending the production of non-essential goods.
- Automotive spare parts may be non-essential in the short run, but become essential as food-carrying trucks begin to break down.(i.e. in the long run)
- How far is the long run? This is difficult to say; there may be some variation across goods.
Impact of labour shortage on supply chains
- The supply chain disruptions are going to be amplified by labour shortage as workers remain at home.
- Countries like India are likely to experience a greater reduction in output on this count than, say, Europe or the U.S.
- This is because of the higher labour intensity of production in India.
- To understand this, think of the difference in unloading of goods in the port at Rotterdam and the port at Kochi.
- Is it viable to substitute labour with capital? Poorer countries are less likely to be able to substitute locked down labour with capital because of the dearth of capital in these nations.
Adapting and Adjusting to the new reality
- As economies emerge out of the lockdown, entrepreneurs, workers, and consumers must adjust to the new reality.
- The world supply chain must adapt.
- Firms may choose to source inputs from suppliers in their geographical proximity to minimise the risk of future disruptions.
- But this involves building productive capacity at new locations, all of which requires investments fuelled by savings.
- Furthermore, the investments must be guided by price signals.
- Within a market economy, the movement of prices provides the incentive and information needed to adapt and grow.
- As economist Ronald Coase put it, prices are bundles of information wrapped in an incentive.
- As the prices of some inputs rise, the buyers of these inputs look for alternate suppliers, and firms which did not hitherto produce the good have an incentive to do so.
- The key to economic recovery lies in millions of such adjustments.
- Through such adjustments, firms locate new providers of inputs, new buyers of their output, and build factories at new locations.
How fiscal stimulus would disrupt the recovery of supply chains?
- Market adjustment processes are likely to be disrupted by government stimulus packages.
- Governments spend by printing money, raising debt, or increasing taxes.
- Irrespective of the way in which the expenditure in funded, resources are transferred from private entrepreneurs to government bureaucrats.
- When governments print money, they draw resources through inflation.
- Bureaucrats tend to be less efficient than profit-motivated firms in allocating scarce resources.
- Bureaucrats have little incentive or information to bring about the granular supply chain adjustments necessary to revive growth.
- As the stimulus package kicks in, economic efficiency is likely to decline and so are the chances of a timely recovery of output.
A lesson from West Germany after WW II
- The experience of West Germany after World War II has a useful lesson for India.
- Beginning mid-1944, Allied bombing disrupted the German supply chain by targeting bottleneck sectors like electric power generation.
- This destruction of the supply chain devastated the German economy.
- Per person food production fell to about half of its pre-war level.
- Two years later, this changed after Chancellor Ludwig Erhard lifted price controls and cut taxes.
- West German entrepreneurs re-established a thriving supply chain through which goods went from upstream sectors to final consumers.
- By 1950, per capita income in West Germany had reached its pre-war level.
Consider the question “Supply chain disruption has been at the core of economic consequences of the corona pandemic. New adjustment in the supply chains would be the norm in the aftermath of the pandemic. What these readjustments would entail? Suggest the measures to help the supply chains recover.”
The recent supply chain disruptions are likely to last long. The path to recovery lies in cutting government expenditure, removing price controls, and opening up trade.