Will Budget 2024 address costs of de-globalisation like supply chain inefficiencies and sticky inflation?

The adoption of localised or domestic approaches disrupts established global supply chains.

In the ever-evolving global economy, the winds of change have begun to blow in a direction that echoes a departure from the era of unfettered globalisation, once hailed as an engine of global growth and prosperity.

There is now a discernible move towards de-globalisation, marked by a post-Covid surge in protectionist measures that continues, escalating trade tensions, and a reassessment of global supply chain dynamics.

Adding geopolitics and strategic considerations make things worse as they induce sub-optimal choices such as re-shoring (moving back to in-country production) and friend-shoring (relocating production to friendly countries) instead of buying and sourcing from the most efficient suppliers irrespective of their locations. The result is inefficient supply chains and sticky cost-push inflation. Obviously, this type of inflation can't be tackled by monetary tightening alone.

Stay tuned with our live updates on budget. 

De-globalisation, in simple terms, refers to a shift away from the interconnected and interdependent global economic system. It involves reducing reliance on international trade, investment, and cooperation in favour of more localised or domestic approaches to economic problems. This shift can manifest through policies that prioritise national interests over global economic integration, leading to reduced trade and economic interdependence as well as reconfiguration of supply chains.

De-Globalisation And Supply Chain Inefficiencies 

However, the adoption of localised or domestic approaches disrupts established global supply chains, leading to increased production costs, diminished economies of scale, and disruptions in logistics. Limited access to global resources and increased competition for local materials further strains supply chain resilience. The complexity of managing multiple, smaller supply chains hampers coordination and communication, while the fragmentation of supply chains across various locations introduces inefficiencies.

Increased trade barriers, protectionist measures, and geopolitical tensions impede the smooth flow of goods, resulting in delays, administrative burdens, and additional costs. Furthermore, creating backup plans in the supply chain to reduce risks can improve resilience, but it comes with the downside of more complexity and higher costs i.e. inefficient supply chains.

Inefficient Supply Chains And Cost-Push Inflation

When supply chains encounter inefficiencies, such as delays, disruptions, or increased production costs, businesses often pass these additional expenses onto consumers. These cost increases can stem from factors like transportation bottlenecks, supply shortages, or complexities associated with managing fragmented supply chains.

As businesses face higher operational costs, they are compelled to raise prices for goods and services to maintain profitability. This ripple effect, stemming from inefficient supply chains, directly influences the overall cost structure across industries, ultimately contributing to cost-push inflation. Consumers, in turn, experience a rise in the general price level, leading to an overall increase in inflationary pressures within the economy.

To summarise, increasing de-globalisation and emphasis on (supply chain) security over efficiency leads to supply chain inefficiencies. This shift can lead to reduced supply elasticities (i.e. supply of goods doesn’t increase in response to increase in their market prices) and increased volatilities in prices, making it difficult to predict and manage market fluctuations.

India is no exception to this trend. Like many other countries, it has raised tariff and non-tariff import barriers in the last couple of years to curb imports and support indigenous manufacturers. Besides, its policy of promoting national champions is increasing the concentration of economic power in fewer hands, and exploitation of that power by corporations is likely to make inflation sticky.

The Way Forward

Since the cause of this inflation is not entirely increased consumer demand (rather it’s weak if the latest GDP data is any indication), demand control measures alone i.e. monetary tightening, will have a limited impact when it comes to reining in inflationary pressures. A little wonder that despite a 250 basis points hike in benchmark interest rates, inflation is still above the RBI’s comfort level. In fact, it has remained above 4 percent for the last 51 months in a row.

It’s worth mentioning that high interest rates – by raising the cost of capital – aid rather than check cost-push inflation and make things worse. Thus, monetary tightening in the absence of supportive fiscal and trade policy measures will be of little help. What India really needs is a well-coordinated use of fiscal, monetary and trade policies to deal with its inflation challenge.

Among others, it calls for lowering import tariffs on key industrial inputs such as steel and textile fibres by junking raw material protectionism. However, lowering import tariffs will come into conflict with the policy of using tariff walls to promote indigenous manufacturing. But that’s really needed if we are really serious about containing inflation. Despite that, hikes in import duties have become a common feature of Indian budgets that’s making the country’s inflation containment strategy largely ineffective.

Nevertheless, the government must resist pressure from business lobbies seeking further hikes in import duties in Budget 2024. Instead, today’s Budget should rationalise its import duties in a way that supports value-added production.

Moreover, India also needs a prudent antitrust legislative framework and its tighter enforcement that not only will check the abuse of market power but will also curtail growing concentration of market power. For instance, through mergers and acquisitions which are often justified on the grounds that they will bring in cost efficiencies benefiting customers but end up with sharp increases in prices aimed at rewarding investors.

Along with tightening the country’s antitrust regime, allowing freer imports can also be an effective bulwark against collusion and price rigging that penalises downstream industries, and in turn end-use consumers.

Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited, a policy research and advisory startup. He tweets @RiteshEconomist. Views are personal, and do not represent the stand of this publication.