7

6 Business Economics • October 2005 Who Supplied My Cheese? Supply Chain Management in the Global Economy

Thomas F. Siems is senior economist and policy advisor in the Research Department at the Federal Reserve Bank of Dallas. He also teaches at Southern Methodist University. He earned a B.S.E. from The University of Michigan, and M.S. and Ph.D. degrees from SMU. He has pub- lished more than 50 articles in vari-

ous academic journals, books and Federal Reserve publica- tions. He has also published four children’s books and plans to release another, The Dangerous Pet, very soon.

Today, with an Internet connection and some special- ized skills, individuals and companies located in the remotest ends of the earth can compete and collaborate globally. This paradigm shift has occurred as techno- logical forces, the fracturing of political barriers, and a relentless drive for greater efficiencies changed how we work and where we work, ushering in the age of global- ization in ways never imagined previously. While many factors can influence macroeconomic variables—includ- ing better monetary and fiscal policies, freer trade, and fewer economic shocks—evidence is presented here that

Who Supplied My Cheese? Supply Chain Management in the Global Economy INNOVATIONS HAVE PROFOUND MACROECONOMIC EFFECTS

By Thomas F. Siems

better global supply chain management and a more global economy should not be overlooked. On the one hand, these new practices have likely helped to keep inflation lower, reduce economic volatility, strengthen productivity growth, and improve living standards. On the other hand, these new practices cause greater uncer- tainties and calls for protectionist policies, as outsourc- ing and offshoring move work to lower cost providers with little regard for geopolitical boundaries.

T hroughout history, innovation and the adoption of new technologies have led to productivity improvements that generate stronger econom- ic growth and higher living standards. In busi- ness, much of the productivity-oriented focus

of technological innovation over the past century has been in the design and manufacturing processes that occur largely within individual firms. But in many industries, physically moving raw materials, components, and prod- ucts through the firm’s supply chain can comprise an important portion of the total cost of goods. As a result, for-

This paper won the Edmund A. Mennis Contributed Paper Award, presented at the NABE Annual Meeting, September 26, 2005. The award was sponsored by Standard & Poor’s. The views expressed in this paper are not necessarily those of the Federal Reserve Bank of Dallas or the Federal Reserve System. The usual disclaimer regarding errors and omissions applies.

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 7

malized transportation arrangements, telecommunications networks, and integrated information systems have signifi- cantly helped supply chain managers improve their ability to plan, order, monitor, and evaluate these processes. In particular, new information and communications technolo- gies have helped transform supply chain operations from mass production to mass customization.

New technologies have also contributed to greater globalization as individuals and firms can compete and collaborate from anywhere on the planet. In recent years, many nations have reduced regulatory barriers and become more open and engaged in world trade. As a result, business supply chains now span the globe, connecting firms and individuals to markets and opportunities that could not have been imagined only a few decades ago.

The theme of the 2005 NABE Annual Meeting and Edmund A. Mennis Contributed Paper Competition was “Change and Competitiveness: Who Moved My Paradigm?” In this paper, I explore the impact of recent supply chain innovations and the effects of increased globalization on macroeconomic productivity. Spencer Johnson’s (1998) classic book, Who Moved My Cheese? reveals profound truths about how to deal with change. This idea is adapted here to investigate global supply chains, i.e., “who supplied my cheese?”

Today’s advanced performance-management informa- tion and communication systems connect retailers, ware- houses, manufacturers, and suppliers instantaneously. Consequently, any activity that can be digitized—includ- ing virtually all information flows—can be cheaply moved to anywhere in the world in seconds. Thus, with an Internet connection and some specialized skills, individ- uals and companies located in the remotest ends of the earth can compete globally…and in real-time.

This is a significant paradigm shift as both product markets and resource markets are expanded and compa- nies around the world transform themselves to take advan- tage of this new era of technological change and increased global competition. The way goods and services are pro- duced and delivered differs markedly from earlier supply chain eras. Indeed, the answer to the question “Who sup- plied my cheese?” is becoming increasingly complex, and the greater degree of openness and connectedness have profound economic implications for people everywhere.

The explosion of information technology occurred as other technological forces, the fracturing of political bar- riers, and a relentless drive for greater efficiencies changed how we work and where we work. Almost virtu- ally unknown to consumers today, a few clicks on a cor- porate e-commerce website or a scan of a product’s bar code through a checkout line can instantaneously send a

production signal to a manufacturer located on the other side of the world. Connecting economic activities across borders and through markets in real-time has ushered in the age of globalization in ways never imagined previous- ly. World trade (exports plus imports) as a percentage of gross world product (GWP) is now at twice the level it was in the 1960s.

For the United States, better global supply chain man- agement appears to positively impact macroeconomic pro- ductivity and output (Siems, 2005). While many factors can influence macroeconomic variables—including bet- ter monetary and fiscal policies, freer trade, and fewer economic shocks—evidence is presented in this paper that better global supply chain management should not be overlooked. In addition to other factors, important changes and emerging trends in management practices have likely made companies more efficient, and these changes, in turn, have likely ushered in a more competi- tive global business environment and contributed to the nation’s improved macroeconomic performance.

Rather than emphasizing the benefits to individual firms, this paper takes a macroeconomic approach to examine how improvements from applying new informa- tion technologies to global supply chain management processes have impacted the U.S. economy. To develop a better understanding of this global paradigm shift—that is, the implementation of new information technologies on supply chain operations—it examines the impact on prices, employment, economic output, living standards, and productivity. It should be noted, however, that this analysis is exploratory and does not consider all the potential factors that may impact these macroeconomic variables.

Still, there is strong suggestive evidence that the effect of new information technologies on global supply chain operations, in conjunction with increased globaliza- tion, has benefited consumers and the macro-economy in many significant ways. As the global winds shift and new technologies converge to move better information faster and cheaper, the nature of business has changed, too.

The Evolution of Supply Chain Management Despite the increased attention paid to supply chain

management in recent years, including university courses solely devoted to the topic, it is not a new business disci- pline. Supply chain management is as old as trade itself. The general purpose of supply chain operations is to get the right resources and products to the right places at the right times, while yielding the highest possible profits.

The evolution of supply chain management practices can be partitioned into the following four eras: the indus-

8 Business Economics • October 2005 Who Supplied My Cheese? Supply Chain Management in the Global Economy

trial revolution (1776-1912), the mass production era (1913-1973), the lean manufacturing/quality control era (1974-1995), and the information engineering era (1996- today). The time boundaries that define each of these eras are simply approximations based mainly on anecdotal evi- dence and significant milestones, as technological inno- vations have continuously transformed supply chains and management practices.

During the industrial revolution, many businesses came into existence through the division and specializa- tion of labor and expanded markets and opportunities. The development and effective implementation of electricity, railroads, transportation, and communications systems pulled people away from family farms and into factories. The forces of globalization intensified during this era, as improved transportation and communications networks further integrated markets across and between continents.

The mass production era started around the time Henry Ford created the first moving assembly line in 1913. During this era, businesses developed and utilized capital equipment to improve production operations, focusing their efforts on defining and improving special- ized tasks through scientific management methods, oper- ations research techniques, and mass-production moving assembly lines.

By the early 1970s, U.S. manufacturers were profi- cient producers, but their superiority was challenged by foreign firms (specifically Japanese manufacturers) who could make higher quality products at lower costs. This global shift ushered in the lean manufacturing/quality control era, where U.S. manufacturers increasingly focused their attention on improving quality and eliminat- ing defects in their supply chains. More specifically, busi- nesses concentrated on improving internal processes by monitoring production methods and implementing lean production ideas like just-in-time (JIT) inventory, total quality management (TQM) programs, and enterprise resource planning (ERP) systems.

Then, beginning around 1996, the information engi- neering era came into full bloom. Businesses began to learn how to more effectively use the Internet, e-com- merce and associated new information and communica- tions technologies in their supply chains. With better information about demand requirements, logistics chan- nels, and in-transit and supplier inventory levels, manu- facturers could mass-produce customized products. Sometimes referred to as the mass customization era, the sharing of critical information in real-time with key part- ners is really what helped make this epoch different from earlier periods. Properly employing new information tech- nologies, firms found that they could dramatically

improve service and delivery processes by integrating their internal systems with those of their external partners.

Thus, while earlier supply chain improvements cen- tered mostly on internal processes, more recent enhance- ments have concentrated on production and distribution channels. Improved inventory management, streamlined logistics systems, and newer information-sharing tech- nologies like the global positioning system (GPS), radio frequency identification devices (RFID), the Internet, and other wireless telecommunications platforms have all greatly improved supply chain operations. In the informa- tion engineering era, information replaces inventory. The collection, analysis, and distribution of information through improved technologies have become more accu- rate and far less expensive. Consequently, short of a cata- clysmic event that might completely shutdown upstream production channels, lower inventory levels can likely be maintained throughout the supply chain, yet still allow producers and suppliers to meet anticipated demand.

Some authors have identified these improvements and proclaimed a New Economy (see Shapiro and Varian, 1999; Baily, 2001; and DeLong and Summers, 2001), where some of the old rules regarding the trade-off between unemployment and inflation appear to no longer apply, and where productivity advancements brought on by new information technologies radically change the way goods and services are delivered. This New Economy par- adigm, which may more accurately be termed the Real- Time Economy, allows firms to make better decisions as information flows can be separated from product flows, and thus analyzed and responded to in real-time.

Yet, even as new information technologies have come of age, at roughly the same time the global economy took another giant leap forward as individuals around the world began to be able to collaborate and compete with one another. Geographic and geopolitical boundaries began to fall along with the Berlin Wall in 1989. As shown in Figure 1, total world trade has increased, particularly as more regional trade agreements have been signed. Thomas Friedman (2005) describes this “flattening” of the world as one where technologies converge and allow the sharing of work and knowledge to anyplace in the world—and in real-time, without regard to geography, lan- guage, or distance.

The Impact of New Technologies on Supply Chain Operations

In order to investigate the impact of new technologies on supply chain operations, the supply chain is divided into four distinct components: production, inventory, transportation/distribution, and payments. All four com-

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 9

ponents have been transformed and have become more tightly interconnected by new technologies that bring more accurate information to decision-makers in real time. Information can be stripped from products/services and analyzed in isolation to make better decisions regard- ing production, distribution, marketing, sales, etc. Each of these components is explored in greater detail below.

The production channel seeks to understand and explain the essential purpose of the business enterprise. What should the business produce? Where should it design and manufacture products? And how much should be made? To optimize these decisions, business managers need to know their customers’ requirements and seek to satisfy their needs and desires. For the most part, infor- mation needed to make these decisions comes from the market as it sends out its many signals. By capturing sales data in real-time and making the information available to upstream producers, consumer and market research efforts can be streamlined to more accurately understand changing preferences, tastes, styles, etc.

Moreover, a more streamlined and efficient produc- tion channel can positively affect the amount and location of required inventory levels. In a sense, a well-run supply chain can use information to substitute for inventory. The real-time transmission of information about sales, produc- tion, on-site and in-transit inventory, and suppliers’ pro- duction and distribution schedules aids decision-makers and allows firms to keep lower inventory levels than they would otherwise.

The transportation/distribu- tion channel seeks to understand and explain the best ways to answer the question, “How should products be moved and stored?” This involves understanding the entire supply chain, from the raw materials to the end consumer, and then taking advantage of the most efficient and effective logis- tics and inventory systems. Again, information at all points along the supply chain can be integrated by using new information and com- munications technologies to enable better decisions regarding inventory levels and movement of products.

Finally, the payments chan- nel seeks to understand and explain the best way to move money in exchange for delivered

goods and services. The essential question addressed here is, “How and when should suppliers be paid?” Knowing and understanding the supply chain operations of all the firms involved is crucial to making the payments system flow smoothly and accurately. ERP systems that commu- nicate and share information in real time can lead to com- petitive advantages.

All four of these channels have been transformed by new information and communications technologies. The effective implementation of these new technologies allows firms to quickly collect and analyze important information throughout the supply chain, including monitoring demand in real-time. In short, information flows within and between businesses can be reorganized through new technologies, resulting in better and more timely decisions across all channels of the supply chain (see Lee and Whang, 2001).

Information is Everything As discussed in the preceding section, the supply

chain is full of important information. Firms spend time and resources to find and acquire suppliers, to enforce contracts, to maintain appropriate inventory levels, to transport products to the next production process, and to attract and retain customers, among many other activities. All of these activities contain valuable information that can be made available in real time through the Internet and other technologies. For example, new information and communications technologies can monitor inventory at all points along the supply chain and then make it instanta-

F I G U R E 1

T O T A L W O R L D T R A D E & R E G I O N A L T R A D E A G R E E M E N T S

Source: World Bank

Total World Trade, Constant 2000 US $ (trillions) Regional Trade Agreements, Number

12

6

2

0

4

10

14

8

18

16

30

10

0

20

50

60

40

80

70

'65 '70 '75 '80 '85 '90 '95 '00 '03

10 Business Economics • October 2005 Who Supplied My Cheese? Supply Chain Management in the Global Economy

neously available to all decision-makers in the supply chain. Similarly, customer buying patterns, supplier responsiveness, and production quality levels can all be made available to anyone with a need to know without having to spend additional time and resources to collect and assimilate such information.

When businesses do not effectively use this informa- tion, however, demand uncertainties and variability can be magnified and ripple through the supply chain. Such information distortions are the main cause of the “bull- whip effect,” named after the way the amplitude of a whip increases down its length. This effect has been observed in many industries and across all of the different supply chain channels and has been identified as the primary cause of supply chain inefficiencies (Lee, Padmanabhan, and Whang, 1997).

Alternatively, better information availability should result in more efficient supply chains and lower costs. I examined several indicators in an attempt to find such improvements across the various supply chain channels. First, with respect to demand management, real-time mon- itoring of sales should help producers more closely match production output with actual sales. Second, average inventory levels should be permanently lower as new infor- mation systems help move the right things to the right places at the right times. Third, logistics costs as a per- centage of total output should be lower as goods are shipped more efficiently through the supply chain. And finally, procurement costs should be lower as firms utilize payments systems that help elimi- nate paperwork and streamline cash flows.

These expected efficiency improvements come from the com- bination of better information man- agement and increased globaliza- tion and should permanently lower supply chain costs and reduce out- put variability. The efficient and effective movement of informa- tion—digital strings of zeroes and ones—to anywhere in the world in seconds at virtually no cost should enable businesses to better man- age production, inventory, logistics and payments.

Production and Sales Volatility With almost real-time moni-

toring of sales, shipments, quality and output, along with more reli-

able performance measures of lead times, forecast errors, etc., less volatility in output would be expected. Information that can be shared to all points along the sup- ply chain allows decision makers to better manage their specialized tasks. Without being able to share this infor- mation quickly and accurately, information distortions can increase when traveling further up the supply chain from customers to suppliers, creating a bullwhip effect of increasing volatility in production relative to sales.

Figure 2 illustrates the reduction of the bullwhip effect over time with a rolling ten-year average of the stan- dard deviation of durable goods production growth and of durable goods sales growth. In a sense, this captures the volatility at one end of the supply chain (production) and compares it to the volatility at the opposite end of the sup- ply chain (sales). As shown, ten-year sales growth volatil- ity averaged about eight percent during the 1960s, gradu- ally rising to an average of around 12 percent during the 1970s and 1980s, and then fell back to the eight percent range in the 1990s and early 2000s. In contrast, ten-year production growth volatility averaged between about 15 and 18 percent during the 1960s, ‘70s and ‘80s, but then fell sharply during the early 1990s, finally settling in near an average eight percent in the mid-1990s.

Perhaps of greatest interest here is to compare the dis- tance between the two lines for evidence of the bullwhip effect. The further apart the two lines are, the greater the bullwhip effect. Figure 2 shows that the difference between production growth volatility and sales growth

F I G U R E 2

R E D U C E D B U L L W H I P E F F E C T F O R D U R A B L E S

Source: Bureau of Economic Analysis

10-year moving standard deviation of one-quarter annualized growth

15%

0%

5%

10%

20%

'69 '71 '79 '83 '89 '93 '95 '01 '03'73 '75 '77 '81 '85 '87 '05'99'97'91

Sales growth volatility

Production growth volatility

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 11

volatility appears to have been eliminated in the early 1990s.

This dramatic improvement —particularly in production growth volatility—occurred as improved manufacturing and quality control processes and new information technologies appear to have contributed to advances in supply chain opera- tions. Indeed, information distor- tions in the production channel of modern supply chains appear to be far less of a problem. In more recent years, the marriage of bet- ter production and logistics methodologies with new informa- tion technologies that supply real-time information to all points along the supply chain seems at least partly responsible for the improvement.

Inventory Unused and unsold inventory can carry burdensome

costs. There are holding costs, including warehouse and production-line storage costs, insurance costs, and costs due to obsolescence and spoilage. At the same time, how- ever, sufficient inventory must be maintained to meet demand and keep production operations flowing as smoothly and efficiently as possible. In this way, inventory acts as a buffer to smooth production as demand fluctuates.

Even so, better information about product demand, potential bottlenecks, change orders, etc. should allow firms to hold less inventory throughout the supply chain and still provide sufficient buffers to meet unexpected changes in demand. Doing so would increase returns to shareholders as inventory holding costs are minimized. In essence, new information and communications technologies should allow firms to substitute inventory with information and then use the information in more productive ways.

Figure 3 shows the monthly inventory-to-shipments (IS) ratio for manufactured durable goods from January 1959 to May 2005. This ratio provides additional evi- dence that firms are becoming increasingly sophisticated in managing industry supply chains, maintaining smoother production schedules, and holding smaller inventories and/or accurately projecting actual demand requirements. The IS ratio moves in a range of about 1.85 to 2.50 from 1959 to 1992. But then, roughly correspon- ding to the time frame of the dramatic drop in production

volatility seen in the early 1990s, the IS ratio quickly improves, dropping to about 1.50 in the late 1990s, and then to about 1.30 following a brief up-tick in the ratio during the 2001 recession.

Figure 3 also shows the IS ratio and its relation to recessionary periods in the economy. During most reces- sions (indicated by the grey bars), the IS ratio climbs and peaks very close to the end of the recession. But during the 2001 recession, the IS ratio peaked near the start of the recession and did not grow worse. Again, better and timelier information may help explain this change in cyclic inventory levels. It appears that during the 2001 recession, producers of durable goods had better foresight of demand prior to the beginning of the downturn and took the necessary steps earlier in the business cycle to ensure that inventory levels did not get too high relative to sales.

Additional evidence that firms are better managers of inventories is provided by Koenig, Siems, and Wynne (2002), who follow an analysis by McConnell and Perez- Quiros (2000). Examining time series data from 1959 to 2001, Koenig et al. find that GDP growth volatility is about half as much in the post-1983 period and that 41 percent of the reduction came from inventory investment. While cause and effect are difficult to disentangle, new technologies com- bined with better supply chain practices appear to have con- tributed to the economy’s increased stability.

Logistics Virtually all goods that are consumed are taken from

one place and transported for processing or consumption

F I G U R E 3

I N V E N T O R Y M A N A G E M E N T I M P R O V E S

Source: Census Bureau

Manufactured Durable Goods Inventory/Shipments Ratio

1.50

1.25

2.00

2.50

2.25

1.75

2.75

'60 '65 '70 '80 '85 '90 '00 '05'75 '95

12 Business Economics • October Who Supplied My Cheese? Supply Chain Management in the Global Economy

to another place. For tangible goods, this movement often involves freight transportation of some kind, as raw materials are pulled from the ground, sent to facilities that convert and trans- form the materials into useable goods, and then delivered as final goods to consumers.

In the past, logistics systems focused mainly on stored inventory. That is, the goal was to get goods shipped from point A to point B, and there was an expectation that inventory would need to be stored at each delivery endpoint. Conse- quently, large warehouses and/or distribution centers were required to hold vast inventories. But now, improved technologies can manage information flows separate from the flows of goods. By connecting critical points along the sup- ply chain, logistics systems focus more on meeting produc- tion schedules and managing in-transit inventory. In other words, now the goal is to get the right goods shipped to the right places at just the right times, without storing and hold- ing much inventory.

As a result, the role of transportation providers is changing. Today, the transportation of goods often involves greater distances and requires careful coordination. Figure 4 shows that re-engineering logistics systems to be more efficient is a worthwhile effort over the long run, despite recent cost increases as supply chains have become more global and security measures tightened. The main reason for the long-run downward trend in costs has been more efficient inventory management, reduced warehousing expenses, and better risk management. Inventory carrying costs have also fallen along with lower interest rates.

Warehousing expenses have dropped as firms imple- mented automated systems and increasingly relied upon third party logistics (3PLs) providers to furnish specialized and customized end-to-end delivery solutions. Outsourcing logistics operations is becoming more common as providers prove to effectively respond to shifts and changes in the global economy. In short, this sort of specialization and trade helps to make industry supply chains more efficient because specialists can provide expertise, reach, reliability and flex- ibility. This is consistent with Gupta and Basu (1989) who argue that IT-induced reductions in transactions costs will motivate companies to parcel out, or outsource, many eco- nomic activities currently done in the firm.

Since 1981, transportation costs have declined by four percent and inventory carrying costs have dropped about 57 percent. Moreover, Figure 5 shows that air and sea freight costs both have declined significantly in real terms over the long run.

Procurement As technology costs continue to fall and electronic

connections between companies increase, more firms are going digital and eliminating paper transactions and human contact. Automatic order placement, billing, and payment can all be triggered and performed by computer without human intervention and/or a trail of paperwork. And such electronic transactions can now be accom- plished faster and cheaper, thereby enhancing the effi- ciency of the supply chain.

These supply chain improvements—less production volatility, lower inventory levels, more efficient logistics, and streamlined procurement systems—all have this common characteristic: better methodologies and new information and communication technologies are used to manage infor- mation more efficiently and effectively. Improved informa- tion management and better information engineering can help to lower transactions costs, whether those costs are in procurement, production, logistics, inventory, or wherever.

And this includes the movement of manufacturing facilities and the outsourcing of routine service operations to lower cost regions of the world. These global undertak- ings are successful because new technologies make more and better information available in real-time at lower

F I G U R E 4

L O G I S T I C S C O S T S H A V E F A L L E N

Source: Bureau of Economic Analysis, Wilson (2005)

Percent of Goods Component of GDP

35

10

20

40

30

25

15

5

Total Logistics Costs

Transportation Costs

Inventory Carrying Costs

'81 '82 '86 '90 '93 '96 '98 '02 '03'83 '84 '85 '87 '91 '92 '04'00'99'95'88 '89 '94 '97 '01

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 13

costs to those who need it most. Figure 5 shows the spectacular decline in real telecommunica- tions costs over the past 70 years. The end result of moving more information faster and cheaper is that consumers can also benefit through lower prices, higher quality products and services, and a greater variety and selec- tion of goods.

Macroeconomic Evidence In the United States, real

GDP growth has become notice- ably less volatile over the past 20 years. As shown in Figure 6, extreme ups and downs in output are far less likely today, even though real average growth has remained fairly consistent. Indeed, there have been only two relatively mild recessions in the past two decades. Figure 6 also shows that the frequency of years in which annual real GDP growth has been negative has been far less in recent years than in the past. Moreover, as shown in Figure 7, strong productivity growth in recent years has been the bulwark of the U.S. economy.

This combination of low volatility of real GDP growth and high productivity growth has important macroeconomic policy implications, as faster economic growth may be tolerated with less worry about inflationary pres- sures. To explain this new para- digm, several competing hypothe- ses have been put forth (see Ahmed, Levin, and Wilson, 2004; Clarida, Gali, and Gertler, 2000; Blanchard and Simon, 2001; Jorgenson and Stiroh, 2000; and Kahn, McConnell, and Perez-Quiros, 2002). Perhaps the leading explanation is that better monetary policies and lower inflation rates during the Volker and Greenspan eras have ushered in a new period of increased economic stability and stronger productivity growth. Another popular explanation is that increased globalization and greater openness and trade

among nations—as illustrated by the fall in tariffs shown in Figure 8—has allowed firms to set-up shop in lower cost regions of the world and then pass those productivity gains and savings along to consumers. Still others argue that fewer global shocks and better risk management can help explain the recent period of macroeconomic stability and stronger productivity.

While evidence can be produced to argue each of

F I G U R E 6

R E A L U . S . G D P G R O W T H L E S S V O L A T I L E

Source: Bureau of Economic Analysis

Real Gross Domestic Product, (SAAR, Bil. Chain indexed. 2000 $)

10%

-5%

-10%

5%

15%

0%

20%

1960 1965 1975 1995 20001970 1980 1985 1990 2005

F I G U R E 5

A I R , S E A , A N D T E L E C O M M U N I C A T I O N S C O S T S T U M B L E

Source: Busse (2003)

Telecommunications

Air Freight

Sea Freight

1990 US Dollars

200

50

100

250

150

0 1930 20001940 1960 19901950 1970 1980

14 Business Economics • October 2005 Who Supplied My Cheese? Supply Chain Management in the Global Economy

these hypotheses—and, indeed, many factors have likely contributed to this new paradigm—the focus here is on another, complementary explanation: that businesses in the real-time global economy have radically improved their supply chains by successfully adopting new tech- nologies that bring better information to decision-makers faster and cheaper.

As new technologies help firms to quickly and inex-

pensively collect, analyze and process information, it makes sense that industry supply chains would become more efficient, i.e., that firms would become more productive. Figure 7 shows that productivity growth has averaged 3.1 percent annually in the infor- mation engineering era (since 1996) but was less than half that rate at 1.5 percent per year dur- ing the lean manufacturing peri- od (1974-1995) and somewhat lower at 2.7 percent during the mass production era (1948- 1973). Moreover, high rates of productivity growth have occurred more often and low rates less often in today’s information engineering era than in the previ- ous two eras.

Inflation is also affected by new technologies on supply chain operations. In a competitive eco- nomic environment, supply chain improvements that bring less pro- duction volatility, lower inventory levels, reduced logistics costs, and more efficient procurement methods, as described in the pre- ceding section, should exert downward pressure on prices. Figure 9 shows that toward the end of the mass production era of supply chain management aver- age annual inflation was 2.72 percent. During the lean manu- facturing era, it was 5.70 percent. During the information engineer- ing era to date, it has been 2.45 percent.

Moreover, volatility of the inflation rate seems to have been

reduced in that the percentage of years in which the econ- omy experienced low inflation (less than 2.5 percent annu- ally) is greater in the information engineering era than in the prior two eras.

It should also be noted that over the past ten years, inflation for core commodities has been nearly unchanged, averaging close to 0.1 percent per year; whereas prices of core services have risen about 3.1 per-

F I G U R E 7

P R O D U C T I V I T Y G R O W T H R I S I N G

Source: Bureau of Labor Statistics

Nonfarm Business Sector: Output Per Hour of All Persons (SAAR, % Chg)

4

1

0

3

2

5

1952 1956 1968 1992 20001964 1972 1980 1984 20041960 1976 1988 1996

F I G U R E 8

A V E R A G E T A R I F F R A T E S D E C L I N I N G

Source: International Monetary Fund, Busse (2003)

Percent, Unweighted

0 '80

5

10

15

20

25

30

35

'82 '84 '86 '88 '90 '92 '94 '96 '98

Industrial Countries

Developing Countries

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 15

cent annually. This divergence— shown in Figure 10, which also shows the general decline in inflation—is what one would expect, given that commodities are much more amenable to sup- ply chain improvement.

Also, the 2001 recession is the only recession on record since World War II where produc- tivity continued to grow by at least two percent annually. In other words, productivity growth continued throughout the 2001 recession as firms quickly adjust- ed labor hours to lower output levels. Clearly, this can have a negative impact on employment, and perhaps that should be expected more in the future as new technologies often provide labor-saving solutions to supply chain problems.

Figure 11 shows that even though manufacturing jobs have generally declined from their peak in 1979, output (industrial production) has mostly trended upward. This once again demon- strates the power of productivity. In the information engineering era, industrial production increased at a three percent annual rate while employment fell two percent per year.

Our ability to innovate—to improve production processes, implement labor-saving tech- nologies, use more accurate information flows in real-time to better manage production, inventory and distribution, engage in greater specialization and trade with partners located around the globe, and further upgrade our knowl- edge and skills—allows us to get more for less. And stronger productivity growth directly translates into high- er standards of living for an economy’s citizens (see Lewis, 2004). To be sure, new technology solutions frequently eliminate the need for labor, whether it is counting inven- tory, processing orders, streamlining production opera- tions, or moving products from one location to another. Moreover, as information is collected and processed in

real-time, businesses have a better understanding of the demand for their products and can take necessary actions quicker to adjust output and/or labor resources.

As the World Churns… Nevertheless, despite all of the positive long-run

effects that increased globalization and improved global supply chain management might have on prices, produc- tivity, economic growth, and stability, this paradigm shift also creates greater uncertainties—particularly in labor markets. Even though Figure 12 shows that the U.S.

F I G U R E 9

H I G H I N F L A T I O N L E S S A T H R E A T

Frequency of Time in Each Inflation Rate Range

Source: Bureau of Economic Analysis, Bureau of Labor Statistics

Average = 2.72 Average = 5.7 Average = 2.45

>2.5% Inflation 2.5%-5% Inflation >5% Inflation

32%

18%

50% 41%

14%

45%

46% 54%

Mass Production Era (1948 - 1973)

Lean Manufacturing Era (1974 - 1995)

Information Engineering Era (1996 - 2005)

F I G U R E 1 0

I N F L A T I O N R A T E S L O W E R

Source: Bureau of Labor Statistics

CPI Inflation, 12-month % change

5

-5

0

10

20

15

'68 '70 '72 '80 '86 '90 '96 '00 '04'74 '76 '78 '82 '84 '88 '92 '94 '98 '02

Core Commodities

Core Services

16 Business Economics • October 2005 Who Supplied My Cheese? Supply Chain Management in the Global Economy

unemployment rate has not fared badly in the current information engineering era, net private-sector job cre- ation has been very slow to recover after the two most recent recessions. Figure 13 traces private-sector employ- ment growth over the previous seven business cycles by indexing employment at its peak month, prior to the start of each recession. Individual lines show employment growth patterns following the 2001 and 1991 recessions, and the average of the five previous recessions (excluding the 1980 recession). The shaded area represents the range

of employment growth possibili- ties for these five business cycles.

The ability to strip informa- tion from supply chains—includ- ing real-time sales data, invento- ry levels, and production out- put—has created a new variant of outsourcing knowledge work. Sales-transaction processing, account management, call cen- ters and the like can be separated from physical supply chains and outsourced. Such work can be done remotely, and in virtually real-time, creating employment opportunities all around the world. Indeed, offshore outsourc- ing by U.S. companies is being blamed for destroying American jobs as work is moved overseas to lower cost providers with little regard for geopolitical bound- aries.

But outsourcing makes sense to companies and consumers. In the global economy, a company’s physical location is of little rele- vance as businesses around the world will increasingly specialize and then trade: doing what they do best and outsourcing the rest. As long as there are workers in China or India (or elsewhere) willing and able to perform the same work for less pay, U.S. firms will increasingly examine off- shore outsourcing as a viable business option to hold the line on costs and remain globally competitive (see Siems and

Ratner, 2003). Globalization and new technologies bring better information faster and cheaper to those who need it, thereby opening the door for the entire world to become part of every supply chain.

Still, what about jobs? The U.S. economy is one of the most resilient, dynamic, and flexible economies on the planet because its free-market system has come to accept Schumpeter’s (1939, 1950) principle of creative destruc- tion—also known as “the churn.” That is, innovations that create economic growth simultaneously destroy spe-

F I G U R E 1 1

M A N U F A C T U R I N G J O B S D E C L I N E A S O U T P U T R I S E S

Source: Federal Reserve Board, Bureau of Labor Statistics

Manufacturing Jobs (Thousands)

17,000

14,000

12,000

13,000

16,000

18,000

15,000

20,000

19,000

Industrial Production Index 1997=100

60

40

80

20

120

100

'50 '60 '75 '80 '85 '90 '95 '00'55 '65 '70 '05 0

Manufacturing Jobs (Left axis)

Mass Production Era (1948-1973)

Manufacturing Jobs Growth: 1.02% Industrial Production Growth: 4.57%

Lean Manufacturing Era (1974-1995)

Manufacturing Jobs Growth: -0.41% Industrial Production Growth: 2.25%

Information Engineering

Era (1996-2005) MJP: -1.95% IPG: 3.04%

Industrial Production (Right axis)

F I G U R E 1 2

H I G H U N E M P L O Y M E N T R A T E S H A V E D E C L I N E D

Frequency of Time in Each Unemployment Rate Range

Source: Bureau of Economic Analysis, Bureau of Labor Statistics

33%

16%

51% 56%

42%

2%

45% 55%

Mass Production Era (1948 - 1973)

Lean Manufacturing Era (1974 - 1995)

Information Engineering Era (1996 - 2005)

Average = 4.77 Average = 6.91 Average = 5.02

0%-5% Unemployment 5%-6.5% Unemployment >6.5% Unemployment

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 17

cific jobs and industries as new technologies and ideas replace older ones. Building walls and barriers in an increasingly borderless world will not save jobs nor bene- fit the economy in the long-run (see Baily and Lawrence, 2004). As difficult as it is to do, we must let the old jobs go and make way for the new, unknown ones.

Some evidence that economic protectionism is not the solution can be found in the employment rigidity data compiled by the World Bank. Regulations that hinder employment practices by placing restrictions on hiring, firing, and the number of hours worked would seem to result in slower economic growth, sluggish productivity growth and lower standards of living. For selected coun- tries, Figure 14 shows the Rigidity of Employment Index along with the three sub-indices that make up the index: the Difficulty of Hiring Index, the Difficulty of Firing Index and the Rigidity of Hours Index.

Higher index values indicate more rigid regulation. As shown, the industrialized economies generally score best and the least developed economies generally score worst, with the developing countries scoring between these extremes. Index values for the United States are among the best in the world. Less regulated and more flex- ible labor markets contribute to “the churn,” and Figure 15 shows that while United States employee turnover (job

gains and job losses) is volatile, it is generally growing on net, from year to year.

The World Bank’s “Doing Business” indicators, shown in Figure 16, also include several indices that point to a similar pattern. The World Bank (2005) reports that businesses in poor countries face greater regulatory bur- dens than those in rich countries. Entrepreneurs find that simplified regulations allow them to have greater access to capital and credit, which create greater opportunities for expanded markets. So by way of comparison, the United States is, and historically has been, far better positioned to take advantage of new opportunities for growth.

But the need for reduced regulatory burdens to gener- ate new and better jobs and stronger economic growth is only part of the story. Another necessary ingredient appears to be the quality of a nation’s labor force. Entrepreneurship and innovation depend on a broadly educated workforce committed to continuous learning and risk-taking. In the past, the United States has been able to create better and higher-paying jobs at home as new tech- nologies and greater international competition have taken away the old ones. Some evidence that indicates why America has been able to maintain a competitive advan- tage in innovation and entrepreneurship is shown in Figure 17, where the United States is a leader in higher

Employment Index, Peak month = 100

101

97

94

96

99

102

98

104

103

95

100

-3 -1-2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 323125 26 27 28 29 30

Index, Peak +/- months

Average of Previous 5 Downturns 1991 Recession 2001 Recession

F I G U R E 1 3

J O B L E S S R E C O V E R I E S M O R E C O M M O N

Source: Bureau of Labor Statistics

18 Business Economics • October 2005 Who Supplied My Cheese? Supply Chain Management in the Global Economy

education and the average years of schooling. This figure also shows that the more advanced nations of the world are far more educated than the least devel- oped and developing nations.

In summary, as the world churns and work is moved to nations that can perform tasks cheaper, the United States needs to look inward to develop greater skills for more people and reduce regulatory burdens on entrepreneurs. Instead of erecting barriers to keep old jobs, Americans need to embrace competition and change as a positive force that keeps prices lower and produc- tivity higher.

F I G U R E 1 4

E M P L O Y M E N T R I G I D I T Y L E S S I N D E V E L O P E D E C O N O M I E S

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

Industrialized Nations Developing Nations Least Developed Nations

Difficulty of Hiring Index Index, 0 = Low Difficulty

10 0

20 30 40 50

60 70 80

Rigidity of Employment Index Index, 0 = Low Rigidity

10 0

20 30 40 50 60 70 80 90

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

Industrialized Nations Developing Nations Least Developed Nations

Rigidity of Hours Index Index, 0 = Low Rigidity

0

20

40

60

80

120

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

Industrialized Nations Developing Nations Least Developed Nations

100

Difficulty of Firing Index Index, 0 = Low Difficulty

10 0

20 30 40 50 60 70 80 90

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

Industrialized Nations Developing Nations Least Developed Nations

100

F I G U R E 1 5

T H E C H U R N L I V E S

Source: Bureau of Labor Statistics

Source: World Bank, 2004 Data

Thousands 40,000

30,000

20,000

10,000

00

-10,000

-20,000

-30,000

-40,000 '92 '93 '94 '98 '01 '03'95 '96 '97 '99 '00 '02 '04

4,000

3,000

2,000

1,000

0

-1,000

-2,000

-3,000

-4,000

Thousands

Job Gains (Left Axis) Job losses (Left Axis) Net Change (Right Axis)

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 19

Conclusion While improved supply chain operations combined

with new information technologies and increased global- ization may not have been given much macroeconomic attention in the past, their effective implementation can help firms reduce costs, increase revenues, boost efficien- cies, and expand market opportunities. This paper pres- ents some evidence that these improvements have result- ed in a reduced bullwhip effect (production volatility that more closely resembles sales volatility), lower inventory levels, reduced logistics costs, and streamlined procure- ment processes. Taken one step further, there is strong suggestive evidence that these improvements result in macroeconomic benefits like lower inflation, more stable economic output, higher productivity growth, and better standards of living. Furthermore, these improvements have occurred even in the face of powerful economic shocks, including the post-2000 stock market bubble and IT investment bust, the 2001 recession, the September 11 terrorist attacks, corporate governance scandals, and ris-

ing energy costs, among others. Of course, technology is not a cure-all solution as

innovations that create economic growth simultaneously destroy specific jobs as new technologies replace older ones. Thus, even as nations such as China and India are developing competitive advantages by making effective use of the Internet and other information technologies and providing high quality products at lower prices, U.S. workers must remain vigilant in upgrading their knowl- edge and skills and reinventing themselves to take advan- tage of the next new ideas and opportunities. ■

A C K N O W L E D G E M E N T S I am grateful to my colleagues in the Research

Department at the Federal Reserve Bank of Dallas for their insightful comments and suggestions on an earlier presentation of this material, and to Daniel Lamendola and Timothy J. Schaaf for providing excellent research assistance.

F I G U R E 1 6

D O I N G B U S I N E S S I S E A S I E R I N T H E D E V E L O P E D W O R L D

T I M E T O S T A R T A B U S I N E S S ( D A Y S ) T I M E T O R E G I S T E R P R O P E R T Y ( D A Y S )

Source: World Bank, 2004 Data

Index, 10 = Highest

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

United States

United Kingdom

Japan Mexico China India Mozam- bique

HaitiCongo, Dem.

50

0

100

150

200

250 Days

50

0

100

150

200

250 Days

3

0

4 5 6 7 8 9

10

2 1

300

0

400 500 600 700 800 900

1,000

200 100

Days

Industrialized Nations Developing Nations Least Developed Nations

Industrialized Nations Developing Nations Least Developed Nations Industrialized Nations Developing Nations Least Developed Nations

Industrialized Nations Developing Nations Least Developed Nations

T I M E T O E N F O R C E C O N T R A C T S ( D A Y S ) L E G A L R I G H T S I N D E X

Who Supplied My Cheese? Supply Chain Management in the Global Economy20 Business Economics • October 2005

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F I G U R E 1 7

D E V E L O P E D N A T I O N S M O R E E D U C A T E D

AVERAGE YEARS OF SCHOOLING

Source: World Bank, 2004 Data

United States

United Kingdom

Japan Mexico China India Mozambique HaitiCongo, Dem.

6

0

8

10

12

14 Years

2

4

Industrialized Nations Developing Nations Least Developed Nations

United States

United Kingdom

Japan Mexico China India Mozambique HaitiCongo, Dem.

Industrialized Nations Developing Nations Least Developed Nations

50

0

60

70

80

90 Percentage of population age group

30

40

20

10

G R O S S T E R T I A R Y E N R O L L M E N T

Who Supplied My Cheese? Supply Chain Management in the Global Economy Business Economics • October 2005 21

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