U.S. Port Strike Threat Highlights Supply Chain Risk

One issue we’ve raise over the year is the ways that the corporate fetish for offshoring and outsourcing greatly increases business risk. Even when savings are realized (and as we’ve discussed, in many cases, the main result is a transfer from factory/lower level workers to managers and executives), they are seldom weighed properly against the increased fragility of the operation, and the resulting exposure to big losses. For instance, extended supply chains entail more communications across the chain, longer production cycles, more shipping, all of which increase the odds of writeoffs via having too much inventory or inventory in the wrong place, and those occasional losses can swamp the savings over time.

Those supply chain risks have come into focus, as the Financial Times reminds us, as the possibility of West Coast port strikes looms. Key sections of the article, which I encourage you to read in full:

Fears of a strike or lockout at the west coast ports that handle more than 40 per cent of all container imports to the US are disrupting businesses’ supply chains, as shippers anticipating a stoppage divert cargo to Canadian ports.

Canada’s largest rail network has already imposed restrictions on handling goods bound for the US after a surge in cargo diverted to the ports of Vancouver and Prince Rupert in British Columbia. Prince Rupert’s container imports for June were 22 per cent up on the same month last year. Canadian National Railway (CN) took the action amid concerns that talks between US port employers and the International Longshore and Warehouse Union over a new contract might end in a strike or lockout. The port workers’ existing contract expired on July 1.

The expiry of a previous six-year contract in 2002 led to a 10-day lockout and serious traffic disruption that ended only when the federal government intervened. The two sides later reached agreement in 2008 with only minor disruption.

Truck drivers at Los Angeles and Long Beach ports – which handle around a third of US container imports – went on strike last week in a separate dispute…

JJ Ruest, CN’s chief marketing officer, told customers on July 8 that delays at terminals in Vancouver and Prince Rupert had become “untenable”. The company would allot space on trains for shipping lines based on their traffic earlier this year and a percentage above that. Any other cargo might not be handled, he warned…

Because it prioritises Canadian traffic, CN’s stance should ensure the company avoids a repetition of the criticism it and Canadian Pacific, its main rival, faced earlier this year over their handling of grain from last year’s record harvest. In March, the Canadian government threatened both railways with significant fines unless they boosted movements…

Anthony Hatch, an independent rail analyst, said that while a work stoppage would affect supply chains, rail companies had grown better since 2002 at handling unusual events. “From a rail perspective, I don’t think it would be as disruptive,” he said…

Port Metro Vancouver confirmed it had seen diversions of US-bound cargo but could not quantify them.

Yves here. Notice the divergence in risk assessment. CN, which is one of the two critical back routes for getting goods into the US, says the terminal delays at the two Canadian ports are “untenable”. So the cheery remarks about the Canadian railroads being able to handle traffic better than in 2002 are moot if the bottleneck is the Vancouver and Port Rupert terminal operations.

Now these concerns will prove to be irrelevant if a strike is averted or proves to be short. But the fact that anticipatory diversions are already straining the alternative delivery routes is not a good sign.

A new article at Project Syndicate (hat tip David L) discusses supply chain risk as a systemic risk. As a result of the crisis, many commentators have been conditioned to think of “systemic risk” as something that produces a sudden, wide-spread seize up. But the bubble aftermath in Japan demonstrates that economic train wrecks aren’t necessarily accompanied by explosions. In the Japanese case, activity ground down over a period of years.

Intriguingly, this article sees the globalization as producing systemic risk through social and political instability, which can then produce economic shocks. However, yours truly is worried about more mundane risks, like the US dependence on China for ascorbic acid, a critically important food preservative (among other uses) and chips.

By Ian Goldin Project Syndicate:

…while globalization has created unprecedented opportunity, it has also unleashed a new form of systemic risk – one that threatens to devastate political institutions and national economies….

Furthermore, increased openness and market integration, driven by rapid technological change, is exacerbating divisions within and among societies. Those who miss the globalization train at the start often are unable to catch up later.

CommentsView/Create comment on this paragraphNowadays, the world’s most pressing challenges – from climate change to cyber-crime – increasingly transcend national borders, making them extremely difficult to address effectively. Worse, they can have a cascading effect, with, say, a pandemic or cyber-attack provoking a financial or political crisis and imposing costs disproportionately on those who can least afford them. The vectors of connectivity – such as the Internet, financial markets, airport hubs, or logistics centers – facilitate “super-spreading” of globalization’s effects, both positive and negative.

This is similar to an issue discussed here often, following Richard Bookstaber: that tightly-coupled systems (where the degree of interconnection is high, so that activities move in chain reactions that are impossible to stop) are vulnerable to catastrophic breakdowns. Yet the objective of economic and business policies over at least the last 30 year as been to increase efficiency, which means removing both the risk buffers (redundancies) and frictions that serve to make systems safer. Highly efficient systems are prone to breakdown. For instance, Formula One cars, optimized for speed, can run only one race.

Our leaders have engineered a system which is highly prone to catastrophic failure. And even better, they’ve come up with pay deals that let them profit in the good times and not give much (if anything) back when the inevitable large-scale problems result. Is it any wonder that they haven’t bothered to take steps to make our business and financial systems safer? Unless those in charge have to eat their bad cooking, nothing will change.

This piece is cross-posted from OilPrice.com with permission.