Suez Crisis: the fragility of global supply chains

Last week, a container ship almost as long as the Empire State Building ran aground while navigating through the southern entrance of the Suez Canal, blocking approximately 12 percent of the global seaborne trade and about 9 percent of total seaborne traded petroleum (according to EIA estimates), causing the stalemate of an estimated US$ 9.6 billion of goods a day, according to Lloyd’s List. After many failed attempts, local authorities just managed to move the 220 000-tonne ship “Evergiven” in the last hours, liberating the passage for 30% of the global container ship traffic and 13 million barrels of oil every day (Source: Suez Canal authority). However, this event is just the icing on the cake when it comes to recent global supply chain disruptions, as the 2020 pandemic provided many challenges to international trade. Many consumers around the world may have started to notice that it has become more and more difficult to find some items in stores, especially technological devices, and while in the first months of 2020 this could be seen as the result of covid-19, we can’t say the same after many months from the beginning of the emergency. In fact, according to basic economics, instead of running out of stock, companies should raise prices in order to match demand while maximizing profits. So, why are we seeing so many retail companies still running out of stock?


Image captured by the Copernicus Sentinel-1 mission on Thursday © European Space Agency


An important function

Global supply chains have become more complex over the years because of the relocation of companies around the world and the use of contractors to maximize profits. This is especially true with complex products (like electronics), that need a large number of suppliers often distributed across multiple nations. This means that if even one country shuts down its factories or restricts shipping, the whole product cannot be manufactured. The chance of a final product not being manufactured can be illustrated through a simple function: The probability of supply being halted is equal to the inverse of the chance of a component supplier shutting down, to the power of the number of suppliers necessary to make the product; which means that even with a very low probability of a component supplier being shut down (let’s say 1%), the probability of supply disruption for a product with 40 suppliers is equal to 33% at any given moment. By looking at these numbers, we should realize that the global supply chain has actually done an impressive job at keeping up production the way it did: Ngozi Okonjo-Iweala, general director of the World Trade Organization told the Financial Times that “If you really look at what is happening objectively, you will see that supply chains have been pretty resilient.”


Probability of disrupted stock= 1-(1-Probability of component supplier shutdown)^Number of suppliers


Demand

The second most important factor when it comes to the amount of goods available in the economy is, of course, demand. It might seem logical that during a period of economic downturn caused by a pandemic, demand falls as a consequence of reduced income, but because of the huge amount of government subsidies and the type of jobs that were lost, statistics show that household incomes have grown, as total employee compensation rose 2.5% in 2020, according to the US Bureau of Labor Statistics. In fact, the ones that suffered the most during the pandemic are unskilled workers with customer-facing jobs, while people in other positions (and much higher salaries) did not. In a period where managers get billion-dollar bonuses for leading their companies through unprecedented market conditions, it would take millions of average workers losing their jobs to impact the household income statistic. As we have seen earlier, the goods whose production has been the most disrupted are those that require a large number of suppliers, generally electronics, cars, and other complex “luxury” goods, that those people who lost their jobs wouldn’t even think of buying. Demand for products that have higher probabilities of supply being disrupted has, therefore, not decreased.


Market failures

When it comes to certain goods, especially basic necessities, governments around the world tend to enact laws that prevent companies from raising prices in extreme situations by putting a price ceiling. The problem is that, when consumers get emotional instead of being rational and start to panic because of an adverse event (for example the covid-19 outbreak), their consumption choices will reflect their emotions, by stocking up on certain products. This usually generates market failures, situations in which the allocation of goods and services by the free market is not efficient: demand exceeds supply and prices are fixed, so goods inevitably run out of stock.

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