Stagflation and Supply Chain Disruption

KOMPAS/AGUS SUSANTO

Container loading and unloading activities at Tanjung Priok Port, North Jakarta, Thursday (23/9/2021). The supercommodity cycle or supercycle is expected to end in September 2022.

The historical record may appear broken. However, a new tread is sometimes created from a broken storyline. Like the moment of an ambush, it is often unexpected.

Vladimir Illich Ulyanov, better known by his pseudonym Lenin, once said: "There are decades where nothing happens, and there are weeks where decades happen.” Lenin was right, Russia was broken and the world changed.

The first week of January 2020 could probably go down as the week that changed the course of the decade. During that week, the World Health Organization (WHO) announced a cluster of pneumonia-like infections in Wuhan, believed to have caused by a type of coronavirus. Suddenly, we learned about what is now called the “new normal”. Suddenly, isolation was celebrated. The pattern of life was broken and, perhaps, is forging a new path.

What about the post-pandemic world?

I don't know. There are more questions than answers. One thing is certain: there is so much that we don't know. Many things have changed. I am not going to talk about all the changes that have taken place. This paper will be limited to the questions: How will global production processes and supply chains change post-pandemic? What are the implications for Indonesia?

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To answer these, several things need to be taken into account. First, supply chain disruptions may experience stagflation (stagnation-inflation). Look at the impacts of the energy crisis in China.

Global economic recovery has resulted in increased demand for energy. On the other hand, drought struck several regions of China and reduced hydropower output. As a result, demand for coal increased. At around the same time, China began cutting coal production for environmental reasons and stopped importing coal from Australia. As a consequence, the increased coal demand caused global coal prices to skyrocket. As a result, the electricity supply declined and China was hit by an energy crisis.

There is an important lesson here: The transition to clean energy must be planned and run well. Otherwise, it risks triggering an energy crisis.

The story does not stop there, though. The energy price hike in China also pushed up production costs. Because China is a very important production base in the global supply chain, the cost increase also affected production costs globally. In essence, China exported its inflation.

Kompas

President Joe Biden meets virtually with Chinese President Xi Jinping from the Roosevelt Room of the White House in Washington, Monday, Nov. 15, 2021. (AP Photo/Susan Walsh)

We also know that the pandemic has affected production as a result of supply disruption. On the other hand, the increased vaccination rate has enabled people to better adapt to the situation. Mobility is

growing and economic activities are returning to normal levels. Demand is also increasing. However, there is a problem because demand is increasing faster than production output. Inflation rises. The world now faces the risk of stagflation. The world economy could potentially weaken, which could occur simultaneously with a rise in inflation.

Turmoil in one place will have an impact in another. There are doubts about globalization.

This is complicated, as inflation is driven by limited supply, not surplus demand. The policy to raise interest rates to tackle the inflation risks is deepening the impact on the supply side. In fact, the world economy is just starting to recover. Covid-19 has opened our eyes to the vulnerability of global supply chains in the event of a disruption or a pandemic. The integrated world has its dark side. Turmoil in one place will have an impact in another. There are doubts about globalization.

We still remember the issue of vaccine nationalism. Limited vaccine production had forced several producing countries to limit vaccine exports and prioritize domestic needs. Non-producing countries grew worried. Dependence on other countries created a problem. The distribution of vaccines and medical supplies was disrupted. This was not really surprising. Game theory teaches us about the prisoner’s dilemma, wherein people rationally choose not to cooperate even though cooperation will actually give better results.

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This made people question globalization. Not only that, Basri and Rahardja (2010) showed that Asian countries with relatively large domestic markets were in a better position when the global financial crisis hit world trade. In other words, countries with lower global integration were in a better position. Indonesia's success in overcoming the 2008 global financial crisis was due to a combination of the right policy response and the luck of having a large domestic market, or a combination of good policy and good luck. That is why the domestic market is important.

Second, if the domestic market is important and the global supply chain is vulnerable to disruption, why don't we turn to the local markets? Should we limit our integration to global supply chains? This option does not solve the problem. Indonesia, as well as other countries, is unlikely to become an autarky (closed economic system). Not everything can be produced domestically with good quality and at relatively cheap costs. Even if a country has the capacity, the production cost may be higher so consumers will bear the burden.

In addition, eliminating dependence on overseas inputs by focusing on domestic sources will not help either in a pandemic, since the pandemic has also hit mobility in the country. The current data also show that imports still remain an important component in encouraging investment in Indonesia. More than 90 percent of Indonesia's imports are raw materials and capital goods. The increase in imports indicates that production activities have begun to grow.

AP PHOTO/ELAINE THOMPSON, FILE

FILE - In this Oct. 2, 2019, file photo trucks hauling shipping containers drive near containers stacked five-high at a terminal on Harbor Island in Seattle. US and China are trying to finalize a modest trade agreement to deescalate a trade war that has rattled financial markets and hobbled global economic growth. (AP Photo/Elaine Thompson, File)

In addition, Basri and Rahardja (2010) showed that the spillover effect from exports resulted in increased household spending. This simply shows that an increase in commodity prices, energy, or manufacturing exports helps push up consumer buying power. As a result, household spending increases. Here, we see that integration with the global economy is still important for the Indonesian economy.

Even though Indonesia has a large domestic market, it still needs to be integrated with the global economy, especially with other ASEAN countries that have relatively smaller domestic markets.

In 2021, we see how exports played a key role in saving our economy and government revenues, thanks to soaring coal and palm oil prices. Even though Indonesia has a large domestic market, it still needs to be integrated with the global economy, especially with other ASEAN countries that have relatively smaller domestic markets.

Third, I see that the political aspects of the economic policy is much more complicated and complex. Political pressure to reduce global dependence will increase. This is not unique to Indonesia. There are several reasons: the national interest of economic security (since dependence on other countries can be a source of risk) and hardening identity politics as a result of post-pandemic widening in income inequality. In addition, there is also pressure from interest groups to protect their economic rent from global competition.

On the other hand, however, integration with global supply chains is still urgently needed, as consumers still need access to quality goods and services at low prices. Global supply chains can increase production capacity and efficiency. If domestic production is more costly due to inefficiencies or limited capacity, companies cannot pass their high production costs on to consumers. Their weak buying power prevents them from doing that. In this illustration, the political aspects of the economic policy are more complicated. This tug-of-war will further determine economic policy.

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Fourth, considering the above factors, what will the supply chain model look like in the future? I am of the view that Indonesia and other Southeast Asian countries should remain part of the global supply chain, but with some modification. Global pandemics and conflicts have taught us about the importance of maintaining balance between global integration and strong domestic markets.

The trick is to strengthen domestic demand and export competitiveness by investing in physical infrastructure and human resources (soft infrastructure). However, supply sources must also be diversified. Export products and destination countries should also be diversified. We must not depend on just a handful of supply sources, export products or export destinations.

The risk of disruption can be avoided if we have diverse supply sources and export destinations. In addition, the pandemic has taught us that the sectors that have been able to survive are those able to transform digitally, with less or minimal physical interaction between people.

This trend will make technology even more important in minimizing disruption. Big data and artificial intelligence, for example, can help us provide information about existing supplies and where inputs are available. In addition, automation and 3D printing technology can help minimize the impacts of disruption when mobility restrictions are applied (Shih, 2020). One thing to note is that the methods of supply management could change.

Supply costs may increase, as it will be too risky if inventory is managed solely on the just-in-time (JIT) method of receiving supplies only when needed. Companies need to increase supply in anticipation of global disruptions or conflicts. As a result, costs are certain to increase. However, this is better than risking a supply shortage in the event of a disruption.

AFP/NHAC NGUYEN

This photograph taken on December 11, 2020 shows women riding on a motorcycle past a clothing store in Hanoi. - A strong response to the coronavirus pandemic, a surge in exports and healthy public spending has helped Vietnam buck a global downward economic trend in 2020 and fast track its recovery. (Photo by Nhac NGUYEN / AFP) / TO GO WITH Vietnam-economy-virus-health-coronavirus, FOCUS by Alice Philipson and Tran Thi Minh Ha

Job creation strategies must also change. The growing middle class in Asia and the growing importance of the digital economy require better skilled workers. As a result, there will be a shift from unskilled jobs with low wages to good or decent jobs. The government can no longer focus only on creating jobs, and must also focus on how to create decent jobs (Rodrik and Sabel, 2021; World Bank, 2021).

In the future, Indonesia can no longer depend solely on natural resources or cheap labor. The government needs to prepare a process of adjustment, because certain groups of people will be significantly affected. There is room for improvement in industrial policies, but not in the form of protectionism. Industrial policies need to encourage research and development. Human resource quality should be improved through education and training. Public-private partnership is the key to upskilling workers.

KOMPAS/HERU SRI KUMORO

Chatib Basri

The argument above shows that what Indonesia and many other countries need is not to change their development strategy to an inward-looking approach. What is needed is to redefine their development strategy with modifications that are in line with the existing changes. The new path forces us to adapt. The week in early January 2020 did change the decade. The plot may be broken but it will create a new path, as history has shown. We know that civilizations grow through correction and adaptation. When the facts change, my mind also changes.

“What do you do, Sir?” wrote economist John Maynard Keynes. And he was right.

Muhammad Chatib Basri, Lecturer at the University of Indonesia Economics and Business School

(This article was translated by Hendarsyah Tarmizi)