Efficiency or resilience? Democracies can only pick one: Joachim Klement

The Trump-era trade wars as well as real wars in Iran and Ukraine have also amplified these concerns. Businesses are increasingly having to sacrifice efficiency to increase resilience now that critical trade routes – like the Strait of Hormuz – have been closed without warning, while supplies from huge exporters have repeatedly – and sometimes unexpectedly – been subject to tariffs or economic sanctions. We’re seeing supply chains reshaped in real time. For instance, European Central Bank economists found that companies in both the euro zone and the U.S. diversified their supply chains between 2016 and 2023 in response to trade wars, the pandemic and Russia’s invasion of Ukraine. Similarly, Asian and European companies have scrambled to find new supplies of energy and other goods this year amid the Hormuz shutdown. However, diversification of imports and trade links comes at a price. European imports from geopolitically close partners — defined here as countries that voted similarly to the bloc in UN votes condemning Russia's invasion of Ukraine — are about 30% more expensive than those from less aligned trading partners. The price gap the U.S. faces is even bigger, at 77%. These trade-offs are particularly relevant in energy policy, as efficient energy systems designed for low-cost, centralised production can be highly exposed to disruption. For example, in Ukraine, Russian attacks on centralised energy hubs could disrupt supplies for large parts of the country. Meanwhile, Iranian cyberattacks forced a small British power facility to shut down in July. An attack on a larger power station could have caused major power outages across the UK. Centralised energy supply from fossil fuels is efficient and cheap – but not when you don’t produce your own fossil fuels and are under attack. For much of Europe, generating sufficient energy via domestic fossil-fuel resources is not an option. Greater resilience is likely to require a more diversified energy mix, including nuclear power — ideally decentralised in the form of small modular reactors — and renewables distributed across the continent, including through offshore generation. But, as with trade diversification, this comes with a price tag – one that often isn’t popular with voters. Democracies face an efficiency problem of their own. Democracy’s greatest strength is its responsiveness. Politicians who fail to govern in people's best interests can be removed from office relatively quickly. But the flipside of this is that it can make it too risky for elected leaders to impose the short-term costs needed to build long-term economic resilience – whether through fiscal policy, energy policy or national security. Thanks to the modern media landscape, we now live in a constant election cycle that often incentivises politicians to adopt whatever position is popular. Facing higher energy bills? Let's subsidise fossil-fuel energy. Is the automotive industry losing profitability? Let's scrap electric vehicle targets. Too much government debt? Let's hope the central bank bails us out with quantitative easing and yield-curve control. Too few politicians in any democracy appear willing to tell voters the unfortunate truth: policies that can help ensure that a country remains resilient in the face of geopolitical and economic challenges aren’t going to be painless. They may require paying more for energy, goods and services, while receiving less in government subsidies and social benefits. Unless democracies find a way to make the costs of resilience politically sustainable, they risk ceding an advantage to less democratic systems that can pursue long-term industrial and strategic goals with fewer electoral constraints. That’s a price elected governments simply can’t afford. By Joachim Klement LONDON, Sept 2 (Reuters) - Efficiency has long been the prime objective of business and government policy. But the pandemic, trade wars and armed conflicts have called this into question, stressing the importance of resilience. Yet this too comes with a cost, and it’s one many elected leaders aren’t eager to pay. For generations, students of microeconomics and business have been taught that a firm should use scarce resources efficiently to maximise profits and shareholder value. The post-Cold War era became the greatest experiment in efficiency the global economy has ever seen. Former Soviet-bloc economies opened up, and China became more deeply integrated into global markets just as technological advancements were accelerating. Moving manufacturing from high-cost countries in Europe and North America to low-cost sites, alongside the increased use of automation, allowed businesses to reap enormous efficiency gains. Meanwhile, modern transport services allowed many companies to adopt the just-in-time delivery philosophy pioneered by Japanese automaker Toyota 7203.T. The result was lower inventories across many industries, which reduced costs and allowed for further efficiency gains. But efficiency has its own risks, which were exposed over the past decade by the trade wars of U.S. President Donald Trump, the COVID-19 pandemic and the wars in Ukraine and Iran. The pandemic revealed the flaws of the just-in-time philosophy by showing the world what happens if just-in-time turns into “two-days-late”. Indeed, supply-chain disruptions were a key contributor to the 2022 inflation spike, according to the Federal Reserve Bank of San Francisco’s estimates. The bank estimated that supply-driven factors accounted for roughly half of the gap between core Personal Consumption Expenditures (PCE) inflation in mid-2022 and its pre-pandemic average. This was still much lower than the roughly 5% average supply-driven inflation seen during the oil crises of the 1970s but well above the 0.8% average of the 30 years preceding the 2022 spike. This underscored the high cost of “low-cost” efficiency.

Efficiency or resilience? Democracies can only pick one: Joachim Klement

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