COVID-19 Exposed Supply Chain Flaws but Didn’t Cause Them: WH Report

Outsourcing, offshoring and insufficient investment in resilience rendered many supply chains “complex and fragile,” said the annual "Economic Report of the President," released Thursday by the White House Council of Economic Advisers. COVID-19 exposed and exacerbated widespread vulnerabilities in global supply chains, but the pandemic didn’t cause them, said the report.

The “evolution” toward flawed supply chains was driven by “shortsighted assumptions about cost reduction that have ignored important costs that are hard to turn into financial measures,” said the report. “The validity of these assumptions is reduced in a world where disruptions have become more prevalent and firms are more tightly interconnected.”

The COVID-19 pandemic “made these issues salient to the general public, which has experienced frustrating waiting times for the delivery of goods ranging from personal protective equipment to appliances,” said the report. Supply chains have “performed well in the aggregate,” with more than 20% more goods flowing through the economy in 2021 compared with “pre-pandemic times.” But it's still important to address supply chain fragility since “disruptions are likely to continue,” it said. “As disruptions become more common, private firms are beginning to increase their resilience through visibility, redundancy, and agility.”

The structure of production networks “has important effects on the macroeconomy,” said the report. The location of supply relative to consumers, plus high levels of “interconnection and substitutability among firms and industries,” can affect “the degree to which a shock to one firm or industry propagates through the entire economy,” it said.

Offshoring “can reduce exposure to domestic shocks by broadening supply or hedging against concentrated disruption,” said the report. But the farther “imported inputs must travel increases risks associated with transportation,” it said. For the 40% of U.S. “containerized imports” that funnel through the ports of Los Angeles and Long Beach, “the rise in demand for goods induced by the COVID-19 pandemic caused significant delays,” it said. “Even supply chains that had no production problems suffered from the shipping bottlenecks.”

Risks to a supply chain also can grow with “more global connections, because a disruption in one country will affect suppliers in all other countries,” said the report. It’s estimated a quarter of pandemic-related GDP declines in 64 countries “were related to global supply chain shock transmission,” it said. When disasters occur with supply chains abroad, “recovery takes longer than if the supply chain was local due to the longer lead time involved in shipping,” it said.

Dependence on a single supplier or a single location “also carries risk,” said the report. “This is true even if the suppliers are domestic,” such as when the severe 2021 freeze in Texas led to “months-long disruptions in U.S. and global supplies of plastics because of the concentration of petrochemical companies there,” it said.

In addition to moving production across “national boundaries,” companies have been holding less inventory of final and intermediate goods, said the report. Holding extra inventory for production increases storage costs, and “the lower their inventory, the less working capital is needed and the lower the probability the firm gets stuck with inputs that may become obsolete or spoil,” it said. But if supply is disrupted, “and the firm has a low ratio of inventory to final sales, it has less inventory to fall back on, perhaps requiring it to shut down production until its supplier can recover its ability to produce or another supplier can be found.”

“Just-in-time” production, as “originally envisioned” by Taiichi Ohno, the father of modern Toyota manufacturing, “combines low inventories with additional policies that offset the dangers,” by speeding up the supply chain’s “ability to recover from disruption,” said the report. “These policies include localizing production near consumers,” and increasing operational agility, it said.

Many U.S. firms “in contrast” have combined reduced inventory with longer supply lines, “and with workforce policies that limit their ability to respond to shocks,” said the report. “Low inventories by themselves do not necessarily lead to fragility; problems arise when low inventories are combined with low agility.”

Companies can build more agility into their supply chains by increasing “the flexibility of their production process” to enable the use of “a less specialized input,” said the report. A “variety of techniques” exists for promoting flexibility, including reducing lead times, investing in “surge capacity” or maintaining “collaborative relationships between suppliers and customers, to identify problems early and provide incentives to fix them,” it said.