Economic Analysis: Supply Chain Crisis Could Spawn Productive Innovation

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As we see light at the end of the tunnel of our collective COVID nightmare, it is reasonable for economists to examine how the pandemic has changed the organization, production, and distribution of goods and services. We find the 1937 ideas of the late Nobel Prize-winning economist Ronald Coase very instructive.

Coase asked the following question: what parts of the production process are carried out by the company selling the good, and which parts are carried out by other companies? For example, why does a car company typically assemble the engine and body of its cars while relying on other companies to manufacture many, if not most, of the components for its cars?

Coase attributed the reason to a simple principle: there are costs and benefits to directing employees to transform an asset, and there are costs and benefits to using an outside contractor to accomplish the same task. The choice of what is done in-house and what is outsourced depends on a judicious calculation of what is more advantageous for the bottom line of the company.

Are the results of these cost-benefit calculations set in stone? Absolutely not! Getting it right is a matter of inspired insight as well as trial and error. The decision of what to produce in-house and what to outsource is constantly reassessed, subject to endless experimentation. While many of these experiments fail, new ways of organizing production often lead to huge improvements in productivity.

But more to our theme: Changes in the external environment inevitably change these choices. As we argued in March 2020, the COVID crisis is making out-of-company or out-of-country sourcing more expensive. This has been validated by persistent supply chain disruptions, whether due to COVID-related shutdowns at Chinese suppliers or due to disruption of transportation by disgruntled Canadian truckers.

But one of the wonderful attributes of a profit-driven free enterprise system is that crisis often spawns productive innovation. A recent Wall Street Journal article reported that investment in technology-focused supply chain companies totaled $24.3 billion in the first nine months of 2021, nearly 60% more than the total for all of 2020. customers and partners, have come up with a wide variety of strategies to cope with – or even take advantage of – recent chaos in supply chains,” the article states.

And another wonderful attribute of free enterprise is that this constant but necessary refiguration of the economy cannot be directed by a central national authority. Human creative freedom triumphs. Even during COVID-19.•

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Bohanon and Curott are professors of economics at Ball State University. Send your comments to [email protected]

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