Economic situation is changing

The future is unknown, although some commentators attempt to guess ‘megatrends’. So, looking into the future could be considered as a ‘time wasting exercise’; but that is not so. A better proposition for supply chain professionals is to obtain a clearer understanding of the most likely future trends in global supply chains and be flexible in their operations to adapt as events happen.

A recent report from the consulting firm McKinsey considers possible scenarios for business in developed countries over the next five years. Their starting point is that economic and political situations which have existed for the past twenty years are less likely to continue. The main features of the past twenty years in developed countries have been:

• Low interest rates to stimulate economies; therefore asset prices and debt grew. From 1995 to 2021:
  • In the US, the market value of real estate expanded 1.5 times faster than GDP
  • In the UK, the market value of real estate expanded 1.8 times faster than GDP
• For every U$1 in investment U$1.90 of debt was generated
  • The value of equities (shares) in the US has grown at three times the rate of GDP growth
• Among G-7 economies, the growth in productivity has slowed:
  • Between 1980 and 2000, productivity grew at 1.8 percent per year.
  • Between 2000 and 2018, productivity grew at 0.8 percent per year

Because borrowed money was at very low cost, corporate strategies focussed on leveraging finance. This included leveraged corporate acquisitions, leveraged asset growth, increasing corporate debt, and share buybacks. Due to continuing low economic growth, corporates emphasised efficiency over building resilience into their businesses.

It now appears that the economic and geopolitical policies of governments and central banks could change these trends. Executives who have experienced the past twenty years of economic and business relationships therefore need to prepare for different approaches. But which scenario is the most likely and how will it affect the business?

The big unknown is the cost of adapting economies to Climate Change, given the difficulty in predicting how it will affect an economy’s capacity to produce goods and services. As the climate crisis intensifies, there will be major financial losses in economies, requiring either increased taxes or lower expenditure in areas of government budgets.

As an example, Australia has recently published its Intergenerational Report covering the next forty years. The report identifies that if global warming is held at 1.5 degrees, the loss to the country is forecast at $A135b and if global temperatures exceed 2 degrees, the losses will reach $A420b at today’s dollar value. There will be higher government spending on natural disaster recovery and resilience (i.e. mitigation) efforts and, in addition, the cost to decarbonise heavy industry and transition the energy sector to renewables is estimated to cost $A225b.

Factors that can influence strategic thinking

Below are examples of factors to consider when building corporate scenarios. These factors interact and amplify each other, which can increase the likelihood and frequency of disruptions, with unknown outcomes. All countries and businesses will have considerations that are similar in scope, but weighted to their geographies, economic structure and social needs.

Weather disruptions

• Climate impacts can vary significantly across a country – an impact may be small at the national level, but extreme for a local community’s infrastructure, businesses and people:
  • More frequent droughts and floods. Heatwaves are also more frequent and intense and will last for longer
  • ‘Compound Extremes’ in weather events are forecast to increase, whereby multiple extreme weather occurs together or in sequence, thus compounding the impact
  • Variable rainfall patterns will become increasingly erratic
    • Declining rainfall over agricultural regions can lead to a substantial reduction in production and yields
• Supply shortage for products and increased prices until conditions improve following natural disasters. As disruptions become more frequent, severe or protracted, prices could become more volatile and remain higher for longer, if there are persistent adverse effects on productive capacity
• Lower levels of national business investment and household spending. Both could rebound when infrastructure and homes in regions need to be rebuilt following disasters. However, that expenditure diverts investment away from potentially more productive opportunities
• More insurance claims, higher premiums, and fewer insurance holders. As people exit the insurance pool, it leads to a cycle of increased premiums and then more people cancelling their insurance
• Unemployment is reduced if physical assets are destroyed and need to be rebuilt following an extreme weather event. But unemployment could become higher if people are unable or unwilling to leave a region that has suffered from extreme weather and related job losses
• Reduced health outcomes and productivity for employees caused by higher temperatures

Geopolitical situation and events. ‘Globalisation’ may be replaced by ‘Security’ as an international driver. Defence spending increase by governments can reduce investment in other productive or socially needed areas.

International trade regulations and agreements e.g. ‘Free Trade’ agreements (FTAs). Global trade flows could focus more on those between ‘friendly’ countries and blocs. National governments may increase protection for industries and companies that can influence supply, through providing subsidies, concessions, local content rules and direct spending on selected industrial sectors.

Business finance situation and forecast.

Technology development and implementation forecast.

Energy prices increase if an economy transitions from fossil fuel to renewable energy in an inefficient and costly manner and users must absorb the increased costs.

Primary industries demand and supply forecasts. Supply chain investment by governments and businesses to protect ‘critical materials’.

Consumer demographics and buying behaviour. Retirement and other savings may reduce, due to increased cost of living. Labour share of national income may increase, due to bargaining power in wage negotiations, which leads to increased consumer spending.

Economic Scenarios selected by McKinsey

Four scenarios were selected as having the most potential to happen over the next five years:

1. Balance sheet expansion resumes as before
2. Inflation remains high over multiple years
3. Asset prices correction and de-leveraging financial initiatives
4. A future period of higher productivity and growth

For each scenario, the factors listed above (plus others that are relevant) are applied. To what extent does the team/committee consider that a factor improves or degrades the scenario statement? Then place a score or weighting against the factor, which provides an optimistic, mid-point and pessimistic ranking. From this process, identify the scenario considered as most likely – although that is not a guaranteed outcome.

The most likely scenario becomes an input to the Scenario Analysis and Planning process for the organisation’s Supply Chains group (Procurement, Operations Planning and Logistics). This will be discussed in the next blogpost.

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