Raw materials and intermediate goods, which were a matter of course and in large quantities before the pandemic, are suddenly in short supply. Prices are exploding. Ifo expert Lisandra Flach explains in an interview with Capital.de what the bottlenecks in world trade are all about – and how they can be avoided.
Industry and construction complain of bottlenecks. Everything seems to be missing: important raw materials, preliminary products, chemicals. How do you explain this globalization bottleneck?
Lisandra Flach: There are many reasons for the bottleneck, both on the supply and on the demand side. Because of the corona pandemic, production was shut down all over the world, then there were disruptions in container shipping – not only the accident in the Suez Canal, but also congestion in ports and bottlenecks in the containers. Now the demand for consumer goods has risen sharply worldwide, the trade is on a very strong expansion course and is now at a higher level than before the pandemic. So we cut production and demand increased again, but not synchronously in all sectors and regions of the world.
In the case of intermediate products from the Asian region, however, production should have increased again earlier because the pandemic there subsided earlier, right? That would rather speak against bottlenecks.
No, not necessarily. On the supply side, we still have a reduced production capacity. An analysis by the Ifo Institute also shows that the prices for container ships have risen enormously with lower capacity. As a result of the Corona crisis, some routes are no longer used as they used to be, as providers concentrate on the main routes. Some ships even drove empty from the USA back to China in order to load goods there faster and to be able to export them again in the West. The container ship market was therefore not flexible enough to adapt to the upward trend in world trade.
Good, so fewer routes were served. But does that alone explain the drastic price increase?
There are different factors at work. First, there is some market concentration in the container shipping sector. Three companies or alliances control almost 83 percent of the entire market, which is an enormous concentration.
They then dictate the prices?
Exactly. They have less incentive to offer more container ships. This market concentration is not due to Corona, but of course it has an impact if we see stronger demand here. Second, the container ships have become bigger and bigger, which was also a big discussion in the Suez accident. The enormously increased capacity naturally has positive economies of scale on income. On the other hand, you lose flexibility as a result. This means that not all ports are served because the giant freighters can only load or unload their containers at a few ports. These are structural factors independent of the pandemic, but they also serve to explain why we now have this bottleneck effect in transport.
How serious are the bottlenecks in the supply chains in the various sectors from your point of view? Your institute recently warned that the shortage of materials in the building is likely to worsen again.
According to a survey by our institute, almost half of the companies complain about difficulties with the supply of intermediate products. However, the sectors are affected very differently by these material shortages, most likely the automotive industry because of the lack of semiconductors and plastic products, but also electrical equipment because of the shortage of chips and sectors such as furniture, wood and wicker because of the shortage of wood. Bottlenecks have also been reported for rubber and plastic goods.
The usual suspect China is often referred to, which is said to have bought short of markets such as the one for chips. If this is the case?
Buying empty would be an exaggeration. But of course production there has increased very quickly. China’s exports fell by 7.2 percent in the first quarter of 2020, but they rose again by 9.6 percent in the third quarter, and by as much as 11.5 percent in the fourth quarter, while other regions of the world are still experiencing the consequences of the corona crisis struggled and in the EU, for example, exports fell by five percent in the third quarter. This means that the demand for these intermediate goods increased significantly there before Europe. The situation is even more dire in developing countries. In Africa or Latin America, exports in the fourth quarter were still significantly lower than before Corona.
And that also affects the availability of raw materials?
It must also be clear to us that, except in times of war, we have never been in a situation where production has been shut down almost completely worldwide. The logical consequence is that many supply chains have been interrupted or are still impaired. Borders have even been closed, even within the EU. It will take some time before the global economy is completely back to normal. That is why we are now monitoring these bottlenecks. So at first production was shut down very sharply, while we are now seeing a boom again.
If we look again at the chip shortage, then others were simply faster.
Exactly. In the chip market, the demand has risen sharply, and exceptional events have also reduced the supply. A factory burned down in Japan, and an extreme weather event in Texas paralyzed production for a while this spring. So I think the supply chain problems arise both on the demand side and on the supply side.
If freight rates stay at this high level – and big players like Maersk expect it – what does that mean for the price advantages of globalization?
In our study, we were also alarmed that container shipping is increasingly becoming an Achilles’ heel of international trade. For reasons of cost or economies of scale, it makes sense to use large ships. But the frequency of ships on many routes has been falling for years, which limits flexibility. This is extremely important for the EU, since, for example, almost 80 percent of EU exports are shipped to third countries. German trade is also very dependent on container shipping.
Will we see re-nationalization or the re-shoring of products?
I believe that the border closings to contain the pandemic and the resulting bottlenecks clearly show us the risks of just-in-time production. But the question is whether there are any good alternatives to an open economy. Relocation of production would have enormous negative consequences for Germany’s economic strength, as we have shown in one of our studies. But there are also other ways to increase the robustness of the supply chains. For example, companies should rethink the just-in-time business model and reassess whether a certain storage of critical pre-products such as microchips is preferable. Especially with a high degree of automation, the benefits can overcompensate for the possible damage caused by delivery failures. Greater diversification of the supply chain in terms of suppliers is also a key element in increasing its robustness.
Now supply chain resilience is the new magic word. And Toyota, as the inventor of the just-in-time model, is evidently getting through the bottlenecks better because the Japanese have many suppliers nearby. Should German industry learn lessons from this?
Then we talk about near-shoring: For example, when Germany no longer manufactures goods in China, but in neighboring countries, such as Poland. This is not a panacea when you consider, for example, that a delivery from Italy was more difficult last March than from Vietnam. But we are actually seeing a trend towards more regional supply chains in our data. In other words, the EU has become more important as a region over time.
You have calculated that 17 percent of German value added is generated through global value chains. What does that say about our addiction?
Lisandra Flach is head of the Ifo Center for Foreign Trade and Economics Professor at LMU Munich.
We often talk about dependencies from the Asian region. But what we see in the data is an interdependence. So Germany procures intermediate products from China, while China uses intermediate products from the EU or Germany. The number mentioned is very high, which implies that Germany is very dependent on international value chains – also more than other countries, especially the USA or China. The global average is around twelve percent. However, the data also show that the majority of value added is generated within the EU. That is why strengthening the internal market is so important. Germany’s added value is primarily intertwined with the EU.
So the dependency lies within the EU …
…Yes. But the German supply chain is already highly diversified. Only eleven percent of goods are obtained from five or fewer countries. Where there are greater dependencies for individual goods, the recommendation would actually be to diversify and rely on several suppliers or stocks.
South Korea is reacting to the shortage of chips by investing billions in production facilities, and Intel also wants to increase the number in the USA. What should Europe do?
First and foremost, the right framework conditions must be created. That is the silver bullet. During the Corona crisis, we observed that protectionism is on the rise again. This is poison for the German export industry. That is why the revitalization of the World Trade Organization is also a political priority. With the new Director General, there is now an opportunity for reforms under the leadership of the USA and the EU. Alternatively, bilateral free trade agreements offer an opportunity to create better framework conditions and increase the robustness of supply chains.
Do you think it would make little sense to set up your own chip production facility?
In the end, this is a business decision.
You have indicated that you see the bottlenecks as more temporary. But the explosion in many prices, not just for building materials, should be with us for a while. What is the economic price we pay for it?
For some industries and goods it may remain problematic for a while. But I think the production will adjust again at some point. So I actually see these bottlenecks as a temporary situation. And of course, if we observe supply and demand bottlenecks for two reasons, then that of course drives up prices. But I think that too is temporary and will normalize over the course of the year.
Marina Zapf spoke to Lisandra Flach
The interview first appeared at Capital.de
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