It’s the economy, Covid!

The current health crisis highlights cracks in the international economic system.

The coronavirus pandemic has had a disastrous effect on the world economy, setting national and global growth back significantly[1]. In many countries, lockdown measures allowing only essential workers to continue their jobs normally left much of the workforce inactive for months; obviously, when the majority of the money making in a given nation stops happening, the economy is put on pause. Internationally, however, it isn’t so much the accumulation of reduced national economies that had deleterious effects, but specifically international trade slowing down. 

This is only partly the fault of Covid-19. The structure of the current international market makes it extremely vulnerable to any disruption.

First, hyper specialized national production is increasingly subject to political pressures: the stability of the model is being challenged because of the nature of relations between nations. This problem is outside the direct scope of economics. That being said, this is a recognized challenge to specialization, as fluctuating tariffs and incentives represent a rise in opportunity costs and proportionately decrease the possibilities for economies of scale.

Second, companies are increasingly able to attain more competitive prices by aiming for in-house control over intermediate and capital goods: the viability of the model is being challenged. In other words, not only is vertical integration emerging as a solution in unstable markets, its viability is now apparent even in stable ones.


Globalization requires that the streamlined worldwide supply chains keep operating in order to function properly. Picture a machine operating in a factory. It is the only machine inside the factory, and it produces everything sold in all markets. If it ever stops, even for one second, the consequences are beyond terrible.. Globalization is that machine, and the entire world is a customer of that factory; Covid-19 is a pebble that found its way between the gears of the machine, and it ground the global economy to a halt.

In short, globalization is a system of economic interdependencies. At once, it streamlines production and makes it more efficient, but there are strings attached.

As a political tool, interdependency works well: higher stakes in keeping economic pacts intact (countries that trade with one another mutually benefit) turn boiling geopolitical struggles into a simmering half-seen, half-hidden stew (this was, for instance, explicitly the aim of the European Coal and Steel Community[2]).

Economically, this requires a whole operating system. Production is global, highly specialized, optimized for large quantities and low costs. The best item to produce isn’t necessarily the best quality product; quality increases costs after all. In truth, or at least in economic theory, consumers seek to optimize attained value: to spend the least money for the best possible product. And when asked to choose between quality and price, it’s usually quality that they’re willing to sacrifice. As a result, the cheapest goods have a decided advantage on the world market.

How did we come to this?

You may have heard the story of Andy George and his attempt to create a chicken sandwich from scratch[3]. The end tally rose to $1500 in total manufacturing costs: he grew all the products he needed to use, and even made salt himself from seawater. If we compare this insane cost to the price of a chicken sandwich in any store, it is several dozen orders of magnitudes lower to streamline the production process and have multiple companies dealing each with, let’s say, one element of that chicken sandwich; and it’s all thanks to specialization[4]


Expand that to the scale of worldwide goods production and you get a rough but relatively accurate picture of how globalization works. To put in abstract terms: a specialized (Ricardian[5]) system in an international context uses three separate businesses to build chicken sandwiches. Business 1 harvests the grain to make loaves of bread; Business 2 harvests poultry parts. Both sell their goods to Business 3 (who assembles them into the final product, the mighty chicken sandwich); but both Business 1 and 2 have to make a profit (to pay their workers, to finance their machinery, to pay the rent, expand their business, pay dividends to their investors, etc). So the price at which Business 3 acquires bread and chicken is higher than the price of production for both goods. As a result, the consumer, seeking to acquire a mighty chicken sandwich, ultimately pays the cost of three groups of laborers in the cost of the final product (because, naturally, Business 3 must also make a profit for the same reasons as Businesses 1 and 2). And that’s discounting the price of transporting loaves and meats from Business 1 and Business 2, which involves at least one other company specialized in transportation, Business 4.

Originally this made sense: the economies of scale[6] resulting from each company’s specialization allowed corporations to drive prices down, as the alternative was having to make sliced bread and chicken bits and then assemble them all at the same location. However, given the plummeting costs of producing goods and a creeping stacking of prices to benefit the businesses in the supply line (due to all sorts of reasons; for example, let’s say Business 2 unionized and now the relative cost of labor for loaves is much higher), the advantages of hyperspecialization seem to be vanishing. 

Elon Musk made headlines with SpaceX by relying on vertical integration, meaning the integration of all the processes necessary to create a good under one roof, and produced a rocket orders of magnitude[7] cheaper than the market price set by his competitors[8]. When he implemented a similar system in Tesla, it revolutionized the automobile industry, joining Toyota[9] in aiming for vertical integration.

Given the above, what sense does it make to pay for facemasks to be produced in China?

Thus far we’ve only explored economic costs. But it goes deeper than that: there are now political costs to the existing system. Gone are the days where consumers wouldn’t care that their shoes are made by child labourers halfway across the world under the auspices of a mustachioed dictator, and that the profits go to sustaining said dictatorship. Consumers now care about the provenance of their goods, whether they were produced ethically (for example, in an environmentally sustainable way), and who was involved in production. Woe befall he who produces a shoe unethically! Such endeavors are only acceptable when the end product is lobbed at (surprisingly nimble) politicians.

So consumers are now looking at goods in a different light. However consumers and businesses aren’t the only actors in the world economy. Governments, who in democratic systems are accountable to said consumers, must therefore also consider the implications of freely trading with oppressive regimes.

Here, we come to the linchpin of the matter. Hyperspecialization allows for disparate centers of production, benefiting from economies of scale, to harmoniously produce goods at the lowest possible prices. In order to allow for the lowest prices, there has to be free circulation of goods, meaning no trade barriers. These are the elements that comprise globalization.

The Covid crisis throws into sharp relief the issues with this system: that the production of goods relies on an absence of trade barriers with regimes of all types in order to ensure production. If anything gets in the way of that (say, a regime that suddenly has reasons to keep the goods it produces within its borders to deal with a crisis, screwing everyone else[10]), everything grinds to a halt, and Ricardian hyperspecialization looks a whole lot like economic dependency on a rival nation. One inoperative, or unwilling, cog could be enough for the machine to fall apart. As an economic tool, interdependency is a dangerous game.

Worse yet, with consumers no longer aiming to buy bottom-dollar goods but instead looking for goods that reflect their values, these trade networks become shackles, shady deals with unethical partners, as opposed to mutually beneficial boons.

And finally, companies like Tesla and SpaceX (and Toyota, and Amazon, and Target, and Netflix, and Disney, and everyone who is now aiming to centralize their production processes[11]) are showing that the benefits reaped through hyperspecialization are no longer incredibly significant. The result of this is, in essence, a capitalist critique of globalization. Whereas before all actors (businesses, consumers, and nations) were incentivized to look outward, now there are more and more reasons to look inward. Things like France’s AOC (Appellation d’origine controllée: controlled designation of origin) or the EU’s AOP(Appellation d’origine protégée: protected designation of origin) – labels that serve to certify a product’s geographic origin – have as a primary, though somewhat understated, goal to enforce the protection of certain methods of production, and a certain quality of the finished product. Localized production is no longer the market of a protectionist backwater, but increasingly something to aspire to. It’s seen as a pathway to sustainability, denotes national pride and freedom, and allows for political flexibility as nations disentangle themselves from one another.

The current situation raises many questions. While Covid may have served as a catalyst for the fracturing of a system that was already under enormous structural strain, it is by no means clear what could emerge as an alternative. And, as we mentioned above, there are major advantages to having interdependent economies; it tends to prevent wars. Before we move to jettison the existing system, we would be wise to keep in mind Chesterton’s Fence [12].

If we don’t throw globalized economies out with the rising water levels, it might be important to have failsafes. In a rush to create the globaliziest of economies, we can’t assume that everything will always work perfectly – in fact, it’s appalling that we ever did. The price of just-in-time production is the risk of (occasional, unanticipated, ruinous) failure. But the cost of the reverse were the wars of the 20th century.


Sources:

  1. World Economic Outlook Reports, “A Crisis Like No Other, An Uncertain Recovery”, International Monetary Fund, June 2020
  2. “A peaceful Europe – the beginnings of cooperation”, European Union Website
  3. How To Make Everything, “How to Make a $1500 Sandwich in Only 6 Months”, Youtube, September 15 2015
  4. Wendover Productions, “Why Chicken Sandwiches Don’t Cost $1500”, Youtube, November 8 2016
  5. “Ricardian Model of International Trade: An Overview”, Economy Watch, June 29 2010
  6. “Economies of Scale: Cost benefits from higher output levels” Corporate Finance Institute
  7. Whitman Cobb, Wendy, “How SpaceX lowered costs and reduced barriers to space”, TheConversation, March 1 2019
  8. Tran, Jake, “Space X: Capitalism at its Finest”, Youtube, May 26 2020
  9. “Vertical Integration by Toyota”, DMillsToyota, April 2 2017
  10. Bradsher, Keith; Alderman, Liz “The World Needs Masks. China Makes Them, but Has Been Hoarding Them.” New York Times, March 13 2020
  11. Schumpeter, “Keeping it under your hat”, The Economist, April 16 2016
  12. “Chesterton’s Fence”, Wikipedia.org

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