INSIGHTS

A CASE FOR ECONOMIC DIVERSITY, PART 2

Kenji Baugham
|
May 20, 2022

It is late 2019. The global economy is expanding, manufacturing is humming along, and equities are reaching historic highs. The sudden arrival of the COVID-19 virus shocks the world and businesses start to close down one by one. As suppliers shut down, the factories that rely on raw materials must also shut down. Since most manufacturers operate on JIT principles, they have limited stock on hand and immediately become unable to operate due to even short-term supply shortages. The parts manufacturers then can't supply the integrated product manufacturers. Before long, super market shelves run out of key goods while ships are simultaneously backing up in ports, unable to offload cargo. The carefully orchestrated dance of the global commerce system comes out of sync and grinds to a crawl, millions of people are out of a job, and the economy suddenly requires enormous levels of economic intervention to avoid massive contraction.

In last week's article, I discussed the just-in-time (JIT) production model and the productivity benefits it has provided to our economic systems. However, the COVID-19 pandemic has brought to light serious shortcomings in the model, threatening its dominant position in our global economy. As consumer markets continue to open and close based on successive virus surges, the demand for various commodities and products rises and falls erratically. When consumer demand rises, the manufacturers are not ready to meet the resulting demand and there are product shortages. As demand falls, inventory begins to back up and the perceived benefits of JIT fail to materialize. The success of JIT depends on the ability to forecast product demand with decent accuracy. The JIT production model is not designed for an erratically fluctuating market, and as a result there is difficulty not just at the level of trying to maintain adequate supply chains, but also at the level of maintaining optimal production levels and inventory. The whole system has been thrown into chaos for several years now to the point where experts are discussing whether or not the era of JIT is over.

In biology, the viability of any given species is highly dependent on the biodiversity of its ecosystem and the diversity of its gene pool and survival strategies. Species that are highly specialized, either geographically or in terms of food sources, are at high risk for catastrophic population failure, while species that inhabit thriving and diverse ecosystems and have flexible survival strategies continue to show resilience even in the face of challenging years, or dangerous stressors to an ecosystem -- such as a severe winter freeze, an extensive drought, or the disappearance of a particular food source. The coyote, able to live in a wide range of habitats across North America, including on the periphery of human settlements, and able to eat a wide variety of foods, continues to thrive year after year. In contrast, the axolotl, highly specialized to survive in only a small range of waterways immediately around Mexico City and highly sensitive to change in the environment, might have very recently gone extinct in the wild.

What we have developed economically, via JIT, is an extensive network of entities, all with very specialized inputs and outputs, and all highly interdependent on each other. It is a system that was always vulnerable to catastrophic failure, because any localized failure by design has the potential of rippling out across the entire economic ecosystem. Failures in key areas like shipping or energy could cause entire sectors of the economy to come abruptly grinding to a halt. While this rippling effect is nothing new, the sheer scope of the pandemic’s impact has brought about serious doubts regarding the future of the JIT production model.

In next week's article, we will take a look at some examples of a few commodities, the differences they show in the diversity of their inputs and outputs across the global economy, and how this reflects on the stability of their supply and value.

References
1. Roser, Christoph, et al. “What Is ‘Just in Time.’” AllAboutLean.com, 8 Mar. 2022, https://www.allaboutlean.com/what-is-just-in-time/
2. Hadwick, Alex. “The End of Just-in-Time? | Reuters Events | Supply Chain and Logistics Business Intelligence.” Reuters Events, 3 July 2020, https://www.reutersevents.com/supplychain/supply-chain/end-just-time

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