As we approach 6 months since the initial invasion of Ukraine, the economic fallout continues to be felt around the world. The solution lies in the supply chain.
Supply chain disruptions can no longer be considered isolated occurrences, with businesses rushing to minimise the impact on their operations and maintain the flow of goods, money, and information along the supply chain. The necessity for most firms to have more robust supply chains in place has been reinforced by the war in Ukraine.
Immediately after the invasion, a significant supply chain economist, Chris Rogers pointed out that the greatest economic repercussion of this crisis on the UK and Europe “is very much going to be in terms of what it means for supply chain cost inflation”.
Mr Rogers could not have been more right.
The UK consumer price index has increased by 10.1% in the year to July, up from a reading of 9.4% in June, according to the Office for National Statistics. This inflation, last higher in February 1982, has been fuelled by rising food and fuel prices as households in the UK and across Europe struggle to cope with soaring costs of living.
We are forced to accept higher prices because of the disruption on food and other exports from Ukraine and the sanctions imposed on Russian exports. Modelling done by Barron’s finds that the war has led to a 30% increase in oil prices, a 90% increase in European gas prices and a 17% increase in food prices.
The interconnectedness of global supply chains means that when one price goes up, others tend to follow.
As the war has drawn on, Europe’s over-dependence on Russian natural gas and crude oil, as well as its reliance on both countries for essential agricultural goods, has been exposed.
It is for good reason that Russia and Ukraine are known as the ‘breadbasket of the world’. The Food and Agriculture Organization of the United Nations estimates that more than 25% of the world’s wheat trade, more than 60% of the world’s sunflower oil, and 30% of the world’s barley exports come from Russia and Ukraine. Furthermore, since Russia is a significant exporter of fertilisers, any supply issues or access restrictions may influence crop yields globally.
What’s more, within the commodity markets exist potent feedback loops. Their transport, fertiliser, and heavy machinery demands all require a lot of energy, which makes energy a significant cost for agricultural production. Consequently, the increase in energy prices caused by the war itself helped to push up food prices around the world.
“Supply chain shocks, possibly in combination with loose monetary policy, are the underlying causes of the current inflation surge” – Oliver Chapman, OCI
So, what can be done to curb inflation?
The most appropriate way to control inflation in the short term is for the central bank and government to keep control of aggregate demand to a level consistent with productive capacity. Aggregate demand is usually better controlled using monetary policy, as apposed to an over-reliance on using fiscal policy as an instrument of demand-management.
The traditional tool of monetary policy is interest rates. If inflation is too high, the Central Bank can try to raise interest rates. In theory, this should reduce spending and aggregate demand. For example, higher rates increase the cost of mortgage payments, giving people less to spend. Higher interest rates may also appreciate the exchange rate, bringing about a fall in the cost of imported goods and services and a fall in demand for exports.
Given that this current spate of inflation has been caused by external shocks, controlling demand is likely to be wholly ineffective in the short run. Higher interest rates don’t lead to more cars, more oil, more grains, more fertilizer, or more powdered milk. On the contrary, making investments more expensive may actually impede an effective response to supply-side problems.
The solution, therefore, lies on the supply side.
In the long run, it is the growth of a country’s supply-side productive potential that hands an economy the flexibility to expand without suffering from an acceleration in cost and price inflation.
Policies to address this would most likely include improved childcare, higher minimum wage, and much greater public investments in green energy. However, the role of the supply chain is often neglected, particularly when it comes to supply chain resilience.
The supply-chain operation has always operated with the assumption that everything would go to plan. Now, organisations must learn to build resilience, the ability to recover quickly from catastrophes, and redundancy, building slack into a process so that it can withstand shocks, into their supply chains.
Mr Chapman, of OCI, says “To defeat inflation in the medium and longer-term, we must avoid second and third round inflationary effects. It is mission critical that organisations learn the lesson of the current crisis urgently, instigate a detailed audit of their supply chain and introduce more resilience and redundancy.”
Successful leaders will take decisive action to respond to the immediate risks of this crisis and to stabilize their supply chain. They will also embrace the long-term view, recognizing that this crisis is most likely to elevate the importance of many of the fundamental and structural changes to global supply chains that were already being accelerated as we emerge from the COVID-19 pandemic.