Home / Opinion / Columns /  What severe disruptions taught us about supply chain resilience

A lot of the popular discourse on international trade is about the consumer goods that we buy. The political rhetoric naturally goes along the same path. These arguments miss the fact that most consumer goods produced in one country use inputs sourced from other countries, through complex global supply chains. The production structure of the modern economy is like an iceberg—the small tip above the water level does not give the seafarer an idea of the vast volume that is out of sight.

The extraordinary events of the past two years have highlighted the fact that the supply of components, or more generally what economists call intermediate goods, is the more important issue when thinking about economic resilience. What has happened in the global automobile industry is a good example. A persistent shortage of semiconductors has upset production schedules of automobile companies across the world over the past two years. There are long waiting lines for the delivery of cars right now.

The International Monetary Fund (IMF) has shone a light on global supply chains in the latest edition of its World Economic Outlook, released in April. Economists at the multilateral lender have cited three interesting examples from the global automobile industry. General Motors has announced that it would bring its use of unique semiconductor chips down to just three types of microcontrollers, which can easily be substituted for each other. Tesla rewrote the software used by its cars so that they could run on semiconductors that were available at the time, rather than stopping its assembly lines. The first is an exercise in standardization of inputs, while the second is an example of building more flexibility into the production system.

The third example is how Toyota responded to disruptions following the 2011 earthquake in Japan. It standardized components across models so that different units could share inventory across various factories. A database was created to track suppliers as well as inventory availability across the Toyota system. The car-maker regionalised its supply chain to reduce dependence on any one location. Toyota told its single-source suppliers to either produce in several locations or hold excess inventory. Such lessons will resonate with manufacturing companies as they learn from the multiple supply shocks that have hit the global economy since early 2020.

What about national policy? Policymakers in India have already built some macroeconomic buffers after the experience from other shocks, and these have generally served the country well. Food shortages in the early decades after independence as well as foreign exchange shortages that led to frequent balance of payments crises before 1991 have led the Indian government to hold excess stocks to deal with unexpected shocks. However, maintaining resilience through excess stocks has fiscal costs for the government. This strategy cannot be used in all areas; it would be akin to building two bridges across a river just in case one falls at any point of time.

Nor is protectionism the answer. The idea that a country can produce everything it needs within its borders is impractical. Global production networks are far too complex for such a strategy to succeed. What the American astrophysicist Carl Sagan said in another context also holds true when it comes to economic exchange: “If you want to make an apple pie from scratch, you must first invent the universe." Import tariffs increase domestic costs. An old insight from trade economics still holds: An import tax is in effect a tax on exports.

The question then is how international trade policy can be adapted to absorb the lessons of the past two years so that global supply chains are more resilient. One starting point is to think of not individual goods, but sets of consumer and intermediate goods. The best way to do this is through the square matrix of an input-output table. Such a table will help map how specific components go into the production of each other and eventually the consumer goods we buy.

The International Monetary Fund has provided two useful principles for making supply chains more resilient when there are supply shocks. First, supply chains must be diversified geographically. Second, there should be greater ease of substitution so that a company can quickly switch input sourcing from one country to another.

The series of supply shocks over the past two years—from lockdowns and clogged ports to the war in Europe—have tested the resilience of global supply chains. Most global supply chains have adapted, and the proof of the pudding is in our individual experiences as consumers. The shortages we saw during the first lockdown have generally not been experienced again, though the diminishing severity of subsequent restrictions also played a part. However, there is little doubt that what has happened underlines the need for more resilience to deal with large shocks.

The overall lessons that supply chains should not be concentrated in any one country, that intermediate goods production has a risky home bias in several sectors, and the more general global move to contain China should all work to India’s advantage, as long as it remains a trading nation rather than a protectionist one.

Niranjan Rajadhyaksha is CEO and senior fellow at Artha India Research Advisors, and a member of the academic advisory board of the Meghnad Desai Academy of Economics.

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