The cost of complexity in supply chains

Adam Smith, the father of modern capitalism, believed that fair markets required a shared moral framework between buyer and seller. This is not surprising, given that his ideas grew out of the 18th century marketplace, in which producers and consumers were likely to be neighbors. Advances in technology, transportation and communications have taken us a long way since then, creating complex global supply chains. These have lowered consumer prices but introduced risks of their own, ranging from market-distorting monopoly power to labor exploitation and environmental degradation.

One of the costs of these supply chains – which exist in both physical products and global capital – has been the rise of powerful trading intermediaries. These include companies like, for example, Cargill, which transports more than 200 million tons of food and other goods per year, and a number of large financial institutions that package complex titles, Big Tech platforms like Amazon, giant retailers like Walmart or even real estate brokers who mediate between home buyers and sellers.

These middlemen grease the wheels of capitalism, but also twist it in ways that undermine our economy and our society, argues Kathryn Judge of Columbia University in her new book Direct: the rise of the intermediate economy and the power to go to the source. Intermediaries allow us “to buy goods made halfway around the world, build a diversified investment portfolio, order groceries from the comfort of our sofa,” she writes. But this power of connection “undermines accountability” by creating such a separation between buyers and sellers that it is impossible to calculate the true cost of convenience and low prices.

There are many supporting examples, from textiles made with child labor to outbreaks of E. coli in complex food supply chains, to disproportionate rents charged by intermediaries in financial services or platform technology. In the latter case, information asymmetries make it difficult for market participants to have a common understanding of what is being bought and sold (another thing which, according to Smith, was a prerequisite for well-functioning markets).

Hyper-globalization and extreme concentrations of corporate power are certainly factors behind market failures, from the subprime mortgage crisis of 2008 to the supply chain shortages of recent years. But Judge thinks that “intermediate economy growth” itself is the problem because it disintermediates accountability, and even morality, within our market system.

Consider, for example, how the landscape of public company ownership has changed in recent decades. In the United States in 1950, only 6.1% of those shares were held by institutions – the rest were held by individuals who voted on issues such as who should sit on a board of directors. Today, institutional intermediaries like pension funds, mutual funds, hedge funds, etc., hold 70% of these shares. Most use two other big intermediaries, proxy advisers ISS and Glass Lewis, to tick the boxes on corporate voting matters despite efforts by the Securities and Exchange Commission to crack down on this “robovoting.” All of this makes true corporate social responsibility difficult.

There are many other such examples. Is it any wonder that after decades of a market system controlled by intermediaries focused on lower costs, higher risk-adjusted returns and “efficiency”, we have more financial volatility, a growing number of supply chain disruptions and a warming planet?

The two big questions are how to create system change and who will bear the cost. There is no silver bullet for either, although technology offers new possibilities for connecting buyers and sellers. The rise of peer-to-peer lending, direct-to-consumer retailers, and 3D printing that enable shorter supply chains are all examples, although none are currently delivering at close scale to replace current systems. financing or manufacturing.

A better and clearer account of the input costs of our current market system could be helpful. Just as the infamous 18th century block engraving of a slave ship showing humans crammed head to head in horrific conditions changed the way average individuals viewed their sugar bowl, so too has the growing body of research revealing the correlations between things like cheap food and obesity, or fast fashion and landfill dumping, or complex securitization and predatory lending, could help create demand for a fairer and more sustainable market system today today.

The challenges of inflation (which will push some consumers and policymakers toward low prices as the only measure of well-being) and inertia will be powerful headwinds against system change. Still, it’s important to remember that this is already happening in some areas, albeit slowly. As Judge, an expert in financial regulation, points out, we are only just beginning to understand, some 15 years after the 2008 crisis, how reducing the layers of complexity in lending systems has led to more stable banks and less consumers. in debt.

Just as the subprime mortgage crisis caused us to look at the costs of financial intermediaries, today’s supply chain disruptions may require us to calculate the true cost of low prices for other goods and services.

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Sharon D. Cole