From Complex Supply Chains to Bottlenecks to Inflation

With today's global processes to create some goods, a disruption in one part of the world can topple production.

"The production process today is more fragmented and is more complex than what it was several decades ago," said economist Ana Maria Santacreu. Santacreu, a Federal Reserve Bank of St. Louis research officer, discussed the processes in a January 2022 Timely Topics podcast episode, "How Broken Supply Chains Affect Inflation."

You've likely heard a lot about supply chain disruptions in recent years. It's issues in these complex production processes spanning the globe that contributed to unexpected delays for businesses and consumers after the COVID-19 pandemic was declared. And nearly three years later, how long it takes for you to get your hands on the product of your desire could still be affected.

Shock Effects Spread along Supply Chains

The production of durable goods is organized in what are called supply chains, Santacreu explained in an August 2022 Timely Topics episode, "The Need for More Resilient Supply Chains." The production of a final good (or an intermediate input along the way) may involve several countries instead of a single location.

The COVID-19 pandemic exposed several risks of complex production processes.

For example, she talked about lockdowns that were put in place around the world to try to contain the spread of the virus, which impacted supply chains. "What we observed was that countries that had more severe lockdowns or countries that source their imports from other countries that were experiencing strict lockdowns also experienced more supply chain disruptions," Santacreu explained.

Those disruptions were followed by a crisis in the shipping sector, and then delivery delays, shortages of workers and other delays, she said, all of which led to bottlenecks.

In the August Timely Topics episode, Santacreu continued the explanation:

"If there's any shock that affects a firm in a particular country, those shocks are going to be propagated along the supply chain and are going to affect the final producer," she said.

Illustrating Supply Chain Disruptions with a Block Tower

Video Description

In the video above, Santacreu and St. Louis Fed Research Associate Jesse LaBelle use a block tower to illustrate how supply chains like those for a car can be disrupted. A car is made up of about 30,000 components produced by various manufacturers in different countries.

Stacked colored block sections represent various parts of the automotive supply chain:

• Orange on the bottom for metal mining in China
• Purple for semiconductor production in Taiwan
• Blue for electronics assembled in Germany
• Green for products shipped to Mexico
• Yellow for cars assembled in Mexico
• Red for cars shipped to the United States

"Supply chains are initially strong and hard to topple," Santacreu said, while shaking the table to illustrate that the solid block tower remains intact.

However, the tower is flipped to show that a "weakened top affects everything below," she said.

Santacreu and LaBelle removed a few blocks:

• Orange and purple for lockdowns in China and Taiwan
• Blue for virus outbreaks in Germany
• Green and yellow for slowdowns in shipping to and assembling in Mexico

With missing blocks, the supply chain is a lot weaker, Santacreu pointed out.

"So, when there is a large demand shock, the whole chain can fall apart," she said while tossing a block at the tower, which falls into disarray.

Change in Consumers' Purchases Affected Supply Chains

Unlike in previous recessions, consumers locked down in 2020 changed their purchasing habits, which threw another "block" into supply chains.

"During a typical recession, the consumption of services doesn't move, mostly, but the consumption of durable goods declines, and then it starts recovering until it gets back to the initial level," Santacreu said in her August podcast.

During the pandemic, however, "there were lockdowns, and then, there was this huge increase in the demand for these goods," she said.

She noted that the consumption of durable goods initially declined at the start of the pandemic recession but then increased dramatically. This can be seen in the FRED graph below. In 2022, durable goods consumption was about 40% above what it was in February 2020, Santacreu pointed out.

In addition to the increased demand, production of durable goods was slow to adjust because of some disruptions in the production process, Santacreu said. The resulting mismatch in supply and demand, which wasn't transitory, led to increases in prices and to inflation, she said.

How Supply Chain Disruptions Affected Inflation

In analyzing the impact of supply chain disruptions on inflation, Santacreu studied producer price inflation, which is measured using the producer price index, or PPI. The PPI basically reflects the cost of production for firms, she explained.

Essentially, if the parts to build a product are more expensive, then the firm, or the sector, is going to experience an increase in producer price inflation.

"What we find in our research is that those industries in the U.S. that were more exposed to foreign bottlenecks through supply chains experienced higher increases in producer price inflation," she said.

For a chart illustrating these findings for the period from January to November 2021, see the May 2022 Economic Synopses essay by Santacreu and LaBelle, "Supply Chain Disruptions and Inflation During COVID-19."

Examples of Industries Exposed to Supply Chain Issues

The car industry relies on parts from Canada, Mexico and China. Since China experienced strict lockdowns, the motor vehicle industry experienced big supply chain disruptions, Santacreu said.

"What we find is that the motor vehicle industry experienced large increases in producer price inflation. So, car manufacturers now had to input goods that were more expensive, so their costs of production were increasing," she said.

Other exposed industries included basic metals and energy.

"In general, what we find is a strong correlation between how exposed an industry is because it's importing a lot, but also because it's importing a lot from countries that are suffering supply chain disruptions and PPI inflation in those industries," she continued.

How Can Firms Create More Resilient Supply Chains?

Santacreu said that firms could:

• Diversify their suppliers so they are not reliant on an individual supplier.
• Create allies and regionalize their supply chains, so that they source their inputs from just a few nearby countries.
• Increase inventories, so if another shock hit, they could use supplies on hand.

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