While there is some correlation, it is wrong to say supply chain kinks are a primary cause of inflation. There is a common misconception that when supply chains are disrupted, entities along the supply chain shore up more resources to overcome the supply and demand imbalance.
With the excess cost ultimately passed onto consumers, this supposedly causes an inflationary ripple effect across the economy. A further myth is that this inflation then boomerangs onto the supply chain, leading to a vicious cycle.
When the global supply chain was disrupted during COVID-19 lockdowns in 2020, one ubiquitous component that had vast implications on the supply chain was the computer chip.
The chip, also known as a semiconductor, is a fundamental component in all electronic devices such as computers, mobile phones, lightbulbs, home appliances and credit cards.
At the onset of the pandemic, chip production was halted and shipping slowed down due to various factors, including a predicted drop in demand.
However, with a large proportion of the population working and studying from home and the rapid digitalisation of businesses, the demand for electronic devices actually increased significantly.
This soon led to a global chip shortage affecting most manufactured goods’ supply chains worldwide. On the supply side, the chip shortage caused the automotive industry to reduce vehicle production and delay delivery to consumers.
What compounds the supply-demand imbalance is the fear of further shortages when entities along the supply chain stockpile inventory in anticipation of even higher demand.
But inflation began to slow down even when the trajectory seemed to be heading towards a vicious cycle of supply chain disruption and inflation impeding the supply chain even further.
Previous production expansions and equipment tooling up to resolve the shortage can turn into inventory surplus and excess capacity. Given the oversupply, manufacturers begin to reduce capital spending and and hiring. Hence, amid weaker demand, prices will fall.
The semiconductor industry, primarily driven by market factors, often undergoes cyclical peaks and troughs. Inflation and supply-side disruptions associated with shortages are usually short-term. Therefore, the inflationary myth.
Except for COVID-19 as an anomaly, while there is a correlation between supply chain disruption and inflation, the former is not the primary contributor.
One thing businesses need to be aware of is the ‘bullwhip effect’ in resolving shortages. The bullwhip effect is a supply chain phenomenon often used to explain inaccurate information in assessing demand.
Care needs to be taken so distortion of information along the supply chain does not lead to excessive fluctuations.
Given the concentration of production in a single location, supply chain disruption in one region had sizable ramifications globally. But market forces tend to solve bottlenecks.
The chip debacle highlights the susceptibility of the global supply chain to external shocks and hence the need for risk management to ensure supply chain resilience.