Shrinking supply chains, greater welfare?

28 Jun 2017

Michael Bell

Recent tectonic shifts in the global economy are challenging the ocean container shipping sector. In “The crisis in the container shipping industry and its resolution” (Thinking Outside the Box, 1/11/16) some of the causes of the current malaise in the container shipping industry are presented. Since then, the situation has not noticeably improved, and indeed additional economic factors adding to headwinds facing the industry have become evident (for a succinct and readable discussion of these factors, see the Danish Ship Finance 2016 Shipping Market Review.

As economies develop, there is a natural shift in the composition of gross domestic product away from tangible goods to intangible goods and services. In addition to this, the digitisation of some products means their physical distribution is no longer necessary. Books are being replaced by ebooks and DVDs by music and film downloads. Of course, there is still a demand for tangible goods, if only to enable ebooks to be read and music and film downloads to be played. However, even here, we see some products becoming more compact, for example flat screens are becoming flatter, meaning that more will fit in a shipping container. 

The relentless march to automation in production is reducing the attraction of large pools of cheap labour, which in the past enabled first Japan and then Korea and China to industrialise and develop. Increasingly it makes good commercial sense to move some forms of production closer to the consumers, thereby reducing transport costs and inventory in the supply chain, and enabling products to be better tailored to meet customer needs. 3d printing is the ultimate expression of this trend, as it opens up the possibility to relocate production directly to the consumer equipped with a 3d printer, and tailor it to meet the consumer’s needs. This shift to sourcing products locally or regionally rather than importing them by sea from afar is contributing to less demand for ocean container shipping.

The whole range of technologies covered by the “fourth industrial revolution”, or “industry 4.0”, will do little to rescue the container shipping industry (“Logistics Trend Radar” by DHL, provides an excellent review of these technologies and their anticipated impacts on supply chains). On the one hand, robotics, artificial intelligence, autonomous vehicles, the internet of things, and 3d printers make production more mobile, thereby facilitating greater local or regional sourcing. On the other hand, these innovations could result in relatively jobless economic growth, improving productivity but without distributing income to workers who would consume, and without this consumption there is little to drive a growth in containerised imports.

A recent article in the Economist (“The Retreat of the Global Company”, 28/1/17) presents statistics which show that multi-nationals are losing profitability in comparison to local rivals. Labour costs, particularly in China, are increasing and in any case automation is making labour a less significant input in production. Multi-nationals are difficult to run because of the need to operate under multiple jurisdictions and the scope for reducing taxation through imaginative transfer pricing is increasingly meeting with resistance from taxation authorities.

All-in-all, supply chains are shrinking in terms of both volume and length, so the demand for ocean container shipping will stagnate at best. There will, of course, be short-term recoveries, and there is no suggestion of terminal decline, but the trend is clear. Further reductions in unit cost brought about by increases in ship size and improved operational efficiency resulting from the consolidation of container shipping lines into three mega alliances (the 2M Alliance, the Ocean Alliance and the THE Alliance) will maintain downward pressure on freight rates, but cannot reverse the shrinkage of supply chains.

In the earlier Thinking Outside the Box (1/11/16) piece, it was suggested that container shipping lines could look to greater vertical integration in supply chains as a solution. The two to three weeks that containers spend on the High Seas could be put to productive use by converting mega carriers into factory ships. This would suit processes that take time but could be automated, like brewing or the cultivation of certain plants. In this Thinking Outside the Box piece, we consider the welfare implications of shrinking supply chains.

A fundamental dimension of welfare is diversity. Economic theory suggests that the greater the range of products available to the consumer the greater consumer welfare. However, there is another side to welfare, namely job satisfaction. The greater the range of job opportunities open to a given population, the higher the chance that each worker will find a satisfying job. One of the consequences of globalisation and the lengthening of supply chains has been that manufacturing has gravitated to locations where large pools of cheap labour are to be found or to where particular skills have accumulated (or, agglomerated, as economists say), leaving behind not only industrial dereliction but also pools of unemployed workers, some with valuable skills. This thinning of the range of jobs available in any given location reduces welfare, unless labour is mobile, in which case industrial dereliction is added to. It also reduces the diversity of products available to consumers as the economies of scale lead to market domination by a limited range of products.

The current shortening of supply chains has the potential to reverse this process. Local sourcing can increase the diversity of products available to all consumers and at the same time provide a wider range of careers for all, irrespective of residence. Rather than concentrating cheese production in, say, France it would create a vast range of local cheeses with different characteristics and flavours, and at the same time provide employment for would-be cheese makers from many countries and regions. Few would dispute that this constitutes a welfare gain! It would also, ironically, restore some longer supply chains as French consumers discover the delights of Australian cheese, although French cheese lovers may prefer to travel to Australia for the full experience.