Introducing the RSM Supply Chain Index

Sustained growth depends on retooling

Dec 08, 2020
Supply chain Economics

The infrastructure that supports the domestic and global economies has experienced a significant stress test over the past few years. The twin policy shocks caused by the 2017-20 trade war and the decision to effectively shut down elements of the global economy during the pandemic have resulted in an effective simulation of what deglobalization looks like. 

To capture this shift, we have created the RSM US Supply Chain Index, which provides a near real-time and forward look of the elements of transportation, manufacturing, sales and labor that underscore the manufacturing and service sectors.

Using a linear regression model, we found that our index is statistically correlated at a 99% confidence level with multiple major inflation indicators: The consumer price index, core CPI, personal consumption expenditures and core PCE. The result is a confirmation that supply chain disruptions are largely behind the recent surge in inflation. 

Our composite index incorporates different measurements of the economy:

  • Delivery times, prices paid and inventories in the manufacturing and services sectors
  • Inventories held by retailers, wholesalers and manufacturers
  • The inventory-to-sales ratio
  • Intermodal freight traffic, which measures freight moved in trailers and containers after they are unloaded from the ships
  • The job openings-to-vacancies ratio 

An index value of zero is defined as a normal, nonrecessionary level of supply chain efficiency. Positive values of the index suggest adequate levels of supply chain efficiency; negative levels suggest deficiencies.

We expect to update the index to capture the changing dynamics of the economy as it emerges from the pandemic and the changing risks associated with the nascent omicron variant of the coronavirus.

Disruptions to global and domestic supply chains have resulted in reduced availability and choice for producers and consumers, and those disruptions are the primary catalyst for rising prices not only in the United States, but also across the world. 

The bottlenecks are about more than ships waiting to be unloaded at the Southern California seaports. The shock to the system began with the trade war in 2017 and then accelerated during the pandemic. If anything, it has exposed how the aging condition of the U.S. supply chain, which has been deteriorating for years, has profoundly hampered the U.S. economy. 

Fixing the supply chains

While fixing the supply chains will require spending on railroads, roads and bridges included in the infrastructure package, it also points to the need for realistic trade policies.   

Let’s begin with the initial problem of an economy that was slowing before the 2020 pandemic shutdown. Already, the global manufacturing sector was in recession because of the trade war, with delivery times and prices paid increasing, as reported by the ISM survey of manufacturers. 

This implied a dwindling inventory of intermediate goods in an economy already in the latter stages of a business cycle and then hobbled by a trade war. Our supply chain index peaked in early 2019 and began its descent into the pandemic.

And though it could be argued that the 2019 decrease in the inventory-to-sales ratio was more a function of the ability of the supply chain to facilitate just-in-time ordering than it was the inability to acquire adequate inventories, that declining trend reemerged in the months after the initial shock of the pandemic. 

But while the composite index has remained underwater ever since, the source of the problems has changed. The inability to restock inventories for some goods is now because of production disruptions among U.S. trading partners still suffering from COVID-19 outbreaks. This comes on top of a supply chain infrastructure ill-equipped to handle a once-in-a-century surge in demand. 

While the inventory-to-sales ratio exploded during the 2020 economic shutdown as consumers suddenly stopped buying and production came to a halt, that shock was over by November 2020. 

The presence of ships waiting in San Pedro Bay might lead to the conclusion that production stoppages among U.S. suppliers in Asia are not so much the overriding issue as are the problems of moving the freight once it hits the ground. 

There are reports of capacity limits on the rail lines, a shortage of warehouses near the Los Angeles ports and shortages of truck drivers to move the goods across the country.  

The limits of public policy

Can public policy play a role in fixing supply chain problems? Will the disruptions unwind once the public finishes its pre-holiday shopping spree? Or has the pandemic uncovered yet another flaw in the way the economy works?

We would argue a little bit of the former and a lot of the latter.

Short of enlisting the logistics capabilities of the military or wage incentives, there are limits to government policies that might quickly increase the number of truck drivers or increase warehouse and train-yard capacity.

We expect the supply chain to continue to be a drag on economic growth and for prices to continue to remain elevated until the supply chain bottlenecks are overcome.  

While there was a surge in industrial production, it was driven, in part, by the ebbs and flows of the pandemic, as well as by the robust fiscal and monetary policies. We are now in a different situation where supply shortages have begun to limit growth and industrial production is easing. 

Lessons learned

Still, there are three lessons that we can take away from this crisis.

  • Public investment in infrastructure has been shortsighted for at least 40 years. The $1.2 trillion infrastructure package recently passed by Congress will in part remedy that.  
  • Our mass transportation system is a relic of another time. Our roads and bridges are scary and costly for the consumer. Our public utilities are underfunded and chronically unreliable. Our water system is unhealthy and costly. These problems will require an increased commitment to the modernization of the economy. 
  • Public policy needs to spur investment in the health and education of the labor force and in research. Initiatives like these can kick-start the next productivity boom, and are necessary for the United States to compete with the rest of the world.

The takeaway

The failings of the supply chain are just the start of the nation’s economic challenges. It’s understandable that the public has forgotten that much of our infrastructure was created 75 years ago, or that the national highway system was a bunch of two-lane back roads until the Eisenhower era. But those failings need to be resolved immediately.

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