Wednesday , December 1 2021

The Bottleneck Story

Summary:
Economies around the world are afflicted by supply chain bottlenecks. Daniel Rees and Phurichai Rungcharoenkitkul dig into the topic in “Bottlenecks: causes and macroeconomic implications” (Bank of International Settlements, BIS Bulletin #48, November 11, 2021). The authors point out several factors behind the bottlenecks. One, of course, is disruptions to work and schedules caused by the COVID pandemic. Pandemic-induced supply disruptions have clearly been a major cause of bottlenecks, especially in the early stages of the global recovery. Producers who had severed relationships with suppliers early in the pandemic found it hard to re-establish them when demand picked up. Asynchronous lockdowns disrupted shipping, while sporadic virus outbreaks led to further dislocations. But

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Economies around the world are afflicted by supply chain bottlenecks. Daniel Rees and Phurichai Rungcharoenkitkul dig into the topic in “Bottlenecks: causes and macroeconomic implications” (Bank of International Settlements, BIS Bulletin #48, November 11, 2021).

The authors point out several factors behind the bottlenecks. One, of course, is disruptions to work and schedules caused by the COVID pandemic.

Pandemic-induced supply disruptions have clearly been a major cause of bottlenecks, especially in the early stages of the global recovery. Producers who had severed relationships with suppliers early in the pandemic found it hard to re-establish them when demand picked up. Asynchronous lockdowns disrupted shipping, while sporadic virus outbreaks led to further dislocations. But there are also other causes. Unexpected natural events have intensified supply pressures. A lack of investment in the years leading up to the pandemic left some industries with little spare capacity. The investment shortfall was particularly severe for oil and resource commodities, due in part to the transition away from fossil fuel energy.

But the pandemic has now been with us since February 2020, more than 18 months ago. Why are the bottlenecks becoming so salient now? The authors write (footnotes and references to graphs omitted:

Several factors have amplified the economic severity of bottlenecks. One is the shift in the composition of demand towards manufactured goods during the Covid recession and recovery. These goods are heavily reliant on inputs from other industries, leading to larger demand spillovers than from a services-led recovery. Manufactured goods (and their inputs) also tend to be relatively capital-intensive, making their short-run supply elasticity low as it takes time to expand productive capacity. As a result, sudden increases in manufactured goods demand can translate quickly into bottlenecks, leading to higher inflation.

As I have noted in an earlier post, the patterns of consumption of goods and services have been unusual in the pandemic recession. Usually in a recession, consumption of goods drops (as people put off purchasing new items) but consumption of services remains about the same. In the pandemic recession, consumption of many services was sharply constrained, with a combination of public lockdowns and many people who stepped back from public spaces on their own. However, the federal government at the same time was paying out substantial support packages: checks to families, higher unemployment payments, payroll protection to small businesses, and so on. Overall, demand in the economy remained reasonably high (the actual recession was only two months long), but with many services shut down or unattractive, the money went into buying goods instead. The BIS report continues:

A second factor is behavioural change on the part of supply chain participants. Anticipation of product shortages and precautionary hoarding at different stages of supply chain have aggravated initial shortages (the “bullwhip effect”), leading to further incentives to build buffers. These behavioural changes have the potential to lead to feedback effects that exacerbate bottlenecks.

In short, shortages lead to hoarding, and hoarding makes the shortages worse. It’s like the Great Toilet Paper Shortage of 2020 all over again, but this time at a more widespread and macroeconomic level. More from BIS:

A third important background element is the lean structure of supply chains, which have prioritised efficiency over resilience in recent decades. These intricate networks of production and logistics were a virtue in normal times, but have become a shock propagator during the pandemic. Once dislocations emerged, the complexity of supply chains made them hard to repair, leading to persistent mismatches between demand and supply.

Here are a few figures to illustrate the patterns. The first set of figures shows rising shipping costs, rising delivery times, and drops in inventories of goods.

The Bottleneck Story

But the BIS also points out that while these bottlenecks are very real, the amount of goods being actually moved has been rising and is at high levels. Thus, the bottlenecks have arisen because demand is trying to pull so many goods and services through the pre-existing and disrupted supply chains. The figures show levels of shipping of some key raw materials, semiconductors, and overall container volumes.

The Bottleneck Story

In the short run, a combination of high demand and bottlenecks will push up prices and cause inflation. The BIS economists estimate that if you take out price increases for bottleneck-affected items like energy and motor vehicles, the US inflation rate would have be 2.8 percentage points lower. The question of whether this inflation will last remains unsettled. On one side, if the inflationary pressures become incorporated into an expectation by firms that they need to keep raising prices substantially and an expectation by workers that they need to see wages keep rising substantially, then inflation can become self-sustaining. In the decades since World War II, this kind of inflation has been ended by the Federal Reserve raising interest rates and causing a recession.

On the other side, there is some possibility for the bottlenecks to resolve themselves. The BIS report notes:

Nevertheless, persistent bottlenecks could also prompt corrective behavioural changes over time, eg by providing incentives for investment to expand capacity. Once bottlenecks begin to ease, the feedback loops could operate as a virtuous circle to mitigate the bullwhip effects. In this way, just as bottlenecks have persisted longer than initially expected, their resolution could also follow more swiftly than currently feared.

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