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The COVID-19 crisis calls for pre-emptive monitoring of production and distribution chains

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Via VOX EU

The COVID-19 crisis calls for pre-emptive monitoring of production and distribution chains

As economies around the globe shut down, governments and central banks are announcing radical policies to avoid economic collapse. The first projections are alarming: unemployment across the world may increase by tens of millions, and the output drop in several countries may reach double digits. However, the goal of avoiding economic collapse is in conflict with the goal of containing the pandemic (Baldwin 2020). Italy’s decision to shut down all non-essential business activities is a dramatic example of this. 

Governments in other countries must pay very close attention to the situation in Italy, learn from it, and act pre-emptively. With a significant fraction of workers sick or in quarantine, stay-at-home policies and the closing of borders, the possibility of disruptions in supply chains must be given proper consideration. With such disruptions and possible surges in demand due to panics, free prices no longer act as a suitable coordination device, as firms may not be able to react to price incentives, for example, due to intermediate goods or labour supply shortages.

To guarantee access to essential goods during the pandemic crisis and keep the economy functioning, we propose the urgent creation of an EU monitoring cabinet cabinet to coordinate national monitoring cabinets composed of both private and public sector professionals and governmental officials. The aim of such monitoring cabinets would be to collect and use real-time big data to anticipate, and ideally avoid, interruptions in the supply of essential goods. Once there is the prospect of a rupture in supply, the government may issue warnings in advance and inform the population about the date when products will be available again. In such a case, private firms must cooperate in conjunction with governments to assure the stream of supply of essential goods within and across European borders. 

In democratic regimes with decentralised economies, disruptive events of the magnitude of the COVID-19 pandemic – which is impacting all members of society at the same time – must be met with a response that safeguards both material wellbeing and democracy. The actions of a monitoring cabinet could contribute to a sense of confidence and control of the crisis among the population, helping to avoid panics and social unrest. The great perils we face call for an EU-level monitoring and coordination cabinet interacting with national counterparts.

In modern decentralised economies within a worldwide context, each good or service is, in most cases, produced by firms (which may be located in different countries) responding to prices. Suppliers of one good assess the state of the market for that good and decide how much to produce. They also determine the combination of capital, labour, and intermediate goods to use in production. Figure 1 describes the flow of goods and labour (Part A) and information (Part B) across the production and distribution chains. 

Figure 1 Monitoring and coordination

One immediate impact of the COVID-19 outbreak is that many workers are off work because they are ill. The effect on labour is magnified because of the quarantine that co-workers have to follow. Moreover, one typical response to the COVID-19 outbreak is the stay-at-home requirement. This imposes a separation between workers, between capital and labour, and also between suppliers and customers (either intermediate or final). This means that the flows connecting firms with other firms (domestic and foreign) and households in Figure 1 will be broken. Information from the Health System, Social Security and Employment Office will be vital to evaluate the availability of the workforce. Information on employment and on absenteeism and its motives should be collected in real time as individuals are deemed unable to work either because of hospitalisation or mandatory quarantine. Flows of workers between distinct situations (employed at work, sick, quarantine, unemployed) will be more fluid than in normal times.

Confronted with falling demand, a lack of workers, or just the tremendous uncertainty we now face, firms may have to (or choose to) stop production or even close down. As they close down, the probability of entering a vicious circle is enormous. Their suppliers will see the demand for their output decrease and may also close down; at the same time, their customers are left without supplies and may also be forced to close down. Households may be deprived of essential goods.

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The maintenance of this chain of production is especially important in the context of a paradigm of close-to-zero stocks (or the ‘just-in-time’ paradigm), which implies that if one supplier stops producing, that firm’s customers will not have stocks to keep their production running. In other words, if one firm stops producing, all its customers and the customers of its customers will also stop producing soon after.

The globalisation of production activities adds an additional layer of complexity to this problem: the production chain interweaves firms from different countries. This dimension of economic integration is even more acute in the EU, where trade flows across countries are very intense. If intermediate goods cannot flow between countries, production will stop in the countries where the customer firms are located. The fact that the current crisis is global means that this mechanism will be a critical element in the unfolding of the economic crisis. The closing of national borders in the EU for health reasons raises concerns about the circulation of goods between countries, and therefore about the status of production chains in Europe. Ensuring that borders remain open to the international circulation of goods is therefore of paramount importance. Closing national borders and shifting production of goods and services to national sources will lead to further losses and inequalities across Europe, especially in smaller countries.   

The crisis has also produced a sudden massive change in the structure of demand. The demand for healthcare and certain health-related goods has increased sharply, as well as demand for communications, home delivery services, and storable food. On the other hand, demand for certain durable products (namely, cars), petrol, and many services (travel, tourism) has plummeted. On the supply side, specific sectors have shut down or are severely constrained. The market mechanism will lead to an increase in the price of the goods that are now in high demand and to lower prices of the products in low demand, to bring the market to equilibrium. Higher prices (meaning higher profits) will prompt entrepreneurs to shift resources to the production of those goods, away from the production of products that are now in low demand.

In some instances, production facilities can be quickly redesigned to produce different goods, and workers can change their production activities with little trouble; in other cases, it may not be so easy. One critical factor is the time horizon for the reorganisation/investment decision: firms may decide not to change their line of business if they believe that the current surge in demand will not last long enough to make the investment profitable. One week after the COVID-19 outbreak, some Portuguese firms were already converting their factories to produce goods in high demand. For example, apparel and textile factories are now producing personal protective equipment. One brewery factory is using high-proof alcohol adapted to make hand sanitizer. A group of entrepreneurs gathered several firms, universities, and public agencies to produce ventilators. This is all excellent news.

In the current situation, however, the market mechanism, or entrepreneurs’ ‘moral sentiments’, may not be enough. First, we may not be able to wait the required time for the market adjustment to balance supply and society’s critical needs. Second, the unconstrained market equilibrium may imply ignoring mandatory stay-at-home instructions, with negative externalities. Third, under the current exceptional circumstances, prices may become an ineffective coordination device. For example, due to a shortage of supplies or workers, firms may be unable to increase production in response to a price surge. In such a case, prices will no longer act as a signalling device but rather as a rationing device – one that guarantees that only the more affluent will always have access to essential goods. The equilibrium prices may be so high that parts of society would react angrily, putting social cohesion and, in the extreme case, even democracy at risk. Under these exceptional circumstances, it may be possible to achieve a better outcome by central monitoring and coordination of the decisions of the various agents. At this point, price gouging needs to be monitored closely by existing economic authorities. Some preventive rationing may be considered for some essential goods to ensure that no artificial scarcity is created by stockpiling (this is particularly true for medicines, but it may also apply to other essential goods or high-demand goods under the pandemic circumstances).

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In this scenario, we propose that central monitoring and coordination be carried out by a monitoring cabinet (see Part B of Figure 1). This monitoring cabinet would aim to detect problems (bottlenecks or insufficient production levels) along the production and distribution chains of essential goods in real time. The monitoring cabinet should be seen as a catalyst for private sector – both profit and non-profit – initiatives that intend to promote the sustainability of supply chains and of international trade flows critical to the availability of essential goods. 

When problems in production and distribution chains are detected, the cabinet would pass on that information to entities such as public agencies (e.g. regional employment centres), municipalities, business associations, unions, and banks so that the obstacles to production are eliminated in a timely and coordinated way. If the monitoring cabinet is successful at identifying problems in production and distribution chains, it can inform the population about the availability of goods in a credible and reassuring manner. In a democracy with a decentralised economy, monitoring and coordination may be an effective way to prevent temporary shortages of goods evolving into generalised hoarding or even panic, which would only make the situation worse.

To achieve its goals, the monitoring cabinet will probably have to take three steps.

  • The first step is to identify the goods and services that should be prioritised in the current crisis. Obviously, medicines, medical equipment, protective equipment, and testing kits, besides food and other goods related to basic needs, communications, and the services provided by public utilities, must be given priority. The logistics activities needed for delivering the goods are also indispensable.
  • The second step is to determine the input-output linkages that lead to the desired output. Detailed real-time information at the firm and individual level will be essential for estimating demand by region and by type of good, and to monitor production chains. This information might come from national statistical offices, the health system, tax authorities, social security, banks, utilities, retail and communications firms, and firm managers. Additionally, each household may become a source of information about the availability of supplies by making use of its mobile phone. National statistical offices and sector regulators would integrate the different datasets and share them across the EU (with full respect of data privacy regulations). This colossal endeavour may require the joint effort of experts from public agencies, universities and private companies. Real-time data and data analytics may make an essential contribution to the analysis of the information and to the definition of adequate measures.
  • The third step is to determine which resources may be allocated to the industries in the essential input-output linkages, either from unemployed resources or from resources allocated to non-essential activities. This monitoring/coordination effort will depend on the answers to questions such as the following. Can workers in non-essential activities be trained, in a short time, to work in essential activities? Can they move to the region where the vital production takes place? Can they work under the required safety conditions? Can they be isolated to ensure that they are not infected? Can immune or low-risk persons (e.g. those under 50 with no health pre-conditions) persons be conscribed to work in essential activities? Can big data/data science techniques be useful for estimating demand and optimising resource allocation? Can a pack of essential goods that can last for two weeks be designed (according, in particular, to dietary guidelines) and be distributed to those in isolation? Can 3D printing be useful?

Some monitoring and coordination activities may be carried out at the municipal level because at this level there may be more detailed knowledge of the structure of economic activities, and also because it may be unfeasible to do this sort of analysis quickly at the national level. The monitoring and coordination activities will need the involvement of municipalities, business associations, unions, banks and retailers, among others. 

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However, local industries employ inputs from other regions, and domestic firms rely on inputs from other countries. Therefore, it will be necessary to coordinate the municipal analysis at the national level, and to coordinate national plans across countries, essentially at the EU level.

The monitoring cabinet should include specialists in logistics, operational research, engineering, big data/data science, and input-output analysis, from both the public and the private sector, from universities, from armed and police forces, from wholesale, retail and transport firms, from the firms that produce goods and services identified as essential (or essential for the production of essential products and services), from financial institutions, from management consulting firms, besides government and municipal staff, civil protection entities, and legal experts.

The leading retail companies have an extensive and granular presence in the whole territory. Those retail chains have full and real-time information about the suppliers (national and international) and about the risks of stock shortages. In the context of the COVID-19 crisis, cooperation between the leading players in the retail market is crucial to ensure the timely distribution of essential goods to the population. For example, in a specific location, if no retailer has enough workers to maintain its store open, perhaps it will be possible to keep one open by allocating all the workers to just one of the retailers. 

Credit and payments flow mainly through networks built by financial institutions. Like retail firms, financial institutions have branches across the whole territory, and their payment networks are used in all the major retail outlets. Therefore, they too have detailed information about economic activity, but from the point of view of monetary flows. They also have information about the financial condition of their customers (households and firms), especially of those that have received credit. It is vital to monitor the financial health of economic agents to prevent liquidity shortages and the onset of a financial crisis.

The monitoring cabinet must be accountable to the democratic institutions. Monitoring cabinets across the EU need to work in close cooperation with each other, in a network mode, to ensure international trade flows are uninterrupted.

The success of this approach will depend crucially on free trade. In these exceptional circumstances, labour mobility in the EU has been severely restricted. From an economic point of view, this may not be a huge problem as long as goods and services keep flowing. However, in times like this, some governments may face pressures to block exports of essential goods. The President of the European Commission, Ursula von der Leyen, warned that trucks carrying medicine and other goods are being blocked at the frontiers. Therefore, crisis management must also be done at the European level – close coordination between national governments is crucial. We cannot be caught in a blocking situation in which countries prevent the mutual supply of strategic goods and services. The failure to support Italy cannot be repeated. The great perils we face call for an EU monitoring and coordination cabinet that interacts with national counterparts. If this is not solved quickly, not only will the EU be at risk in the medium run, but also in the short term everybody will lose.

Signatories

Ana Paula Faria (Universidade do Minho)
Anabela Carneiro (Universidade do Porto)
Aurora Teixeira (Universidade do Porto)
Cátia Batista (Nova SBE)
Carla Sá (Universidade do Minho)
Emma Szhao (Bank of Portugal)
Fernando Alexandre (Universidade do Minho)
Fernando Anjos (Nova SBE)
Francisco Veiga (Universidade do Minho)
Hélder Vasconcelos (Universidade do Porto)
Joana Pais (ISEG, Universidade de Lisboa)
João Cerejeira  (Universidade do Minho)
João Correia da Silva (Universidade do Porto)
José Tavares (Nova SBE)
Luís Aguiar-Conraria (Universidade do Minho)
Miguel Faria-e-Castro (Federal Reserve Bank of St. Louis)
Miguel Portela (Universidade do Minho)
Odd Straume (Universidade do Minho)
Óscar Afonso (Universidade do Porto)
Pedro Bação (Universidade de Coimbra)
Pedro Brinca (Nova SBE)
Pedro Mazeda Gil (FEP – Universidade do Porto)
Pedro Pita Barros (Nova SBE)
Rita Sousa (Universidade do Minho)
Rosa Branca Esteves  (Universidade do Minho)
Sandra Maximiniano (ISEG, Universidade de Lisboa)
Sara Cruz (Universidade do Minho)
Susana Peralta (Nova SBE)
Tiago Sequeira (Universidade de Coimbra)


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