In the summer of last year, hopes were riding high that the global economy could quickly return to pre-pandemic levels of output due to the success of the vaccine roll-out and economies gradually opening up again. However, the economic recovery thus far has been marred by stretched supply chains, clogged up ports and sky-high freight costs, making it clear that a return to ‘normal’ wouldn’t be smooth sailing. Consensus expectations are now that supply chain issues will contribute to lower growth, input shortages and higher inflation well into the current year. However, the latest data on shipping rates and lead times give a glimmer of hope that the global economic machinery is finding its rhythm again sooner than expected.

When talking about the health of global supply chains, what is actually meant is how efficient markets are at providing businesses with intermediate goods and production inputs. In practice, this boils down to two things: 1) whether businesses can purchase required inputs at affordable prices and 2) whether they can be delivered within a reasonable timeframe.

Looking at the cost side, we can start with the Baltic Dry Index, which tracks the cost of shipping raw materials. The index shows that the worst should be behind us in terms of the spike in shipping costs in the dry bulk market. While the annual increase in costs was still above 60% in the last week of December 2021, this is well down on the 643% increase from May last year and in fact the lowest rate of increase since December 2020.

Moreover, we can also look at container shipping rates using the HARPEX, which shows that prices have come down around 5% from levels seen at the start of Q4 2021, though they remain elevated. In terms of the timeliness of deliveries, the Suppliers’ Delivery Times sub-index of the Markit Manufacturing PMIs is one useful gauge to consider. In the case of the UK, this sub-index rose for a second consecutive month in December 2021 to reach a 12-month high, indicating an improvement in delivery times. Again, this is a welcome improvement though at 23.8 the index still stands well below 50 and therefore deeply in negative territory. Economists from the New York Fed have looked at these and other indicators in conjunction, coming to a similar conclusion. Their Global Supply Chain Pressure Index, shows that “global supply chain pressures, while still historically high, have peaked and might start to moderate somewhat going forward.” [1]

Looking ahead, a central question will be what impact the emergence of Omicron will have. Judging by our experience from previous waves, it has to be assumed that Omicron will cause further disruption to supply chains although not at the same level as the Delta variant. Consumers might again start to substitute spending on services with goods purchases as was the case during the emergence of the ‘isolation economy’ in 2020 [2], though at present it doesn’t look like this will be fuelled further by government stimulus. In the short term, labour shortages will be exacerbated as the highly contagious variant leads to a high number of people who need to isolate either due to infection or contact with an infected person. Again, some governments have already reacted to this by shortening self-isolation requirements. Businesses have also become better at operating under a certain level of Covid containment measures, e.g. by facilitating remote working in industries where that is a possibility. Meanwhile, most countries (with the notable exception of China) have abandoned ‘zero Covid’ strategies making a return of full-scale, lengthy lockdowns less likely. 

In summary, the early evidence of easing supply chain pressures is promising though due to Omicron, the next couple of months will be challenging. Moreover, a look at history shows that the end of a period of supply shortages bears its own risks. As the world economy emerged from a similarly severe supply chain crisis in the mid 1970s, firms who had put a lot of effort into filling their inventories during the shortage suddenly moved from restocking to destocking, causing a painful drop in production output. Policymakers would be well advised to heed the lessons of the past to avoid a similar contraction once supply chains unsnarl.

1: https://libertystreeteconomics.newyorkfed.org/2022/01/a-new-barometer-of-global-supply-chain-pressures/
2: https://cebr.com/reports/uk-isolation-economy-snapshot-12-9bn-annual-rise-in-core-at-home-spending-says-legal-general