Friday, June 5, 2020

The limits of pursuit of efficiency at all costs

I have blogged earlier about the problems with the excessive search for efficiency.

The idea of using the least amount of resources, at the lowest cost, quickest time, and with the least redundancies and waste has come to be identified as a prominent feature of progress and development.  

Izabella Kaminska points to a problem driven by the "laissez faire efficiency" maximisation that the Covid 19 pandemic has thrown up, with global supply chains,
For example, the just-in-time supply chain system can be viewed as the real economy’s version of a fractional reserve system, with reserves substitutable for inventories. Meanwhile, the real economy’s presumption that additional inventories can be sourced from third party wholesale suppliers at adjustable prices as and when demand dictates, is equivalent to the banking sector’s presumption that liquidity can always be sourced from wholesale markets. Though there is obviously one important difference. Unlike the banking sector, the real economy has no lender of last resort that can magically conjure up more intensive care beds or toilet paper at the stroke of a keyboard when runs on such resources manifest unexpectedly.
She argues that there are two responses to address short-term supply shortages, as is happening now with Covid 19's demands on the health care system. Either immediate investment to build up new supply capacity, or temporary re-allocation of existing resources to new production purposes. But the former is expensive and inefficient, apart from being difficult to develop in quick time. This leaves us with the latter as the only practical response to "surge-demand related crises like pandemic flu". She points to some illustrative examples, comparing with the financial markets,
On liquidity: yes, greater adaptability could be factored into the system. A certain percentage of event space could be mandated to have the adaptable capacity to turn into pop-up hospitals at short notice. Private hospitals could get tax breaks if they added critical care functionality to more of their general beds. A territorial reserve of volunteer emergency health workers could be trained up to deal with surge scenarios. A territorial reserve of volunteer supply-chain workers could also be put on standby. Ventilators, meanwhile, could be designed from scratch to cater to multiple patients not just individual ones. And manufacturers of non-essential goods could introduce capabilities to shift production into essential goods when needed.

On capital ratios: yes, governments could mandate makers of non-perishable emergency goods (such as medicines, toilet paper, face masks, hand sanitiser) to always keep two-weeks’ worth of additional supply on hand. And companies could also be mandated to maintain some share of total supply chain production capability entirely domestically, making them more resilient to globalised shocks.
On bail-inable capital: kind of, more private sector health care investment could be encouraged by loosening the rules governing NHS patients’ ability to top up with private care if they can afford to (something that is currently restricted). In exchange private hospitals could be contracted into interruptible-style agreements that formally release their resources to the national health service in times of emergency. Manufacturers could be given tax breaks for running adaptable production lines that easily switch from non-essential to essential goods in emergency times. (Doing so would protect their balance sheets in crisis times and prop up their share prices.)
Amazon, widely touted as the epitome of efficiency, too has been found out in the crisis, with its delivery systems failing and performing only slightly better than competitors. Sample this,
But the crisis is laying bare the cracks in Amazon’s ability to be there for its customers when they need it most, much less to “delight” them, as Chief Executive Jeff Bezos once urged his employees to do. Those cracks include times when up to half the workers in some of the company’s facilities haven’t shown up, with some saying it was due to their fear they wouldn’t be adequately protected from coronavirus. It’s also due to Amazon’s just-in-time supply chain, reliance on third-party sellers and largely automated systems of buying and selling that were never designed to handle such a crisis... the promise to ship anything to our doorstep in a day or two that has gained it the trust of an astonishing 112 million Prime members in the U.S. (a nation of 129 million households) has evaporated nearly overnight...

In the mid-2010s, Amazon initiated a program called “hands off the wheel,” which replaced many of the functions of Amazon’s white-collar retail workers—those responsible for managing inventory and negotiating with sellers—with AI and automated systems, says Alex Kantrowitz, who wrote the book “Always Day One,” about Amazon’s management strategies. This means Amazon’s systems respond more quickly to increases in demand than humans could, but it also leads to breakdowns when they encounter unexpected shocks—e.g., a global pandemic. In this case, when products became suddenly scarce, price gouging naturally occurred.
The quest for efficiency trades-off with another attribute resilience, captured in the three examples above, which will be the subject of the next post.

Update 1 (21.06.2020)

Rana Faroohar points to the issue of some of the pursuits of efficiency in food industry which has come at the cost of resilience,
There are also two entirely separate supply chains — one supporting supermarkets, the other restaurants and institutions such as schools and hospitals. When demand in the second supply chain collapsed thanks to pandemic-related shutdowns, grocery prices in the first supply chain surged on higher demand, even as farmers destroyed crops that could not be easily funnelled from restaurants to retail outlets. That is the downside of efficiency and specialisation. Efficiency is also responsible for iceberg lettuce, one of the most ubiquitous (and tasteless) vegetables ever created. I cannot believe that anybody really wants to eat it, except as a vehicle for scooping up blue cheese in a wedge salad. But it has been a major cash crop in America for most of the last 50 years because the lettuce heads travel well and survive in long supply chains for months. Yet iceberg is mostly water and has few nutrients. That underscores the fact that while productivity has increased, US farmers are encouraged to plant commodity crops rather than fruits and vegetables needed for the country to have a healthy diet — the kind that provides better immunity from diseases such as Covid-19. Instead, Americans waste fuel shipping items like iceberg lettuce all over the country... Basically, we need to find a middle ground between 19th-century agriculture and modern industrial farming — between efficient and resilient.

Update 2 (19.10.2020)

A very good interview of author Roger Martin who has a new book on the problems with America's obsessive pursuit of economic efficiency. This obsession is captured by the interviewer Sarah Green,

Companies and policy makers have become consumed with the idea that the economy can be “made ever more perfect by pursuing increasing levels of efficiency” — things like shorter customer call times, fewer retail employees per square foot, the cheapest possible procurement costs, or mergers and corporate consolidation.

Martin uses the metaphor of complex adaptive systems to describe economy, society etc,

I think the best metaphor is a complex adaptive system. We’ve set up the economy for Amazon, and we should set it up for the Amazon. Amazon is a big machine, the Amazon is a complex adaptive system. First, it’s a system, so the pieces of the puzzle connect and influence one another. It’s complex in that it’s really hard to tell in advance what exactly affects what. And lastly, and maybe most importantly, it’s adaptive. So whatever state it’s in, it optimizes to that state. Think about the jungle — if there’s a little tree growing behind a big tree, it’s going to grow sideways to get out from the out from the shadow of the big tree. Or if there are predators in this part of the rain forest, you will go scurrying over to that part. 
So what does that mean? It means that if you’re if you’re a Nobel economist, you can say, “Well, if we increased money supply by 2.8%, we’ll get this much GDP growth.” Chances are, you’re just going to be wrong. Because you don’t actually know what’s going to happen. The other implication is that adaptivity has got every chance of overwhelming whatever you tried. People will say, “Ah, I know how to exploit that. And I’m going to start behaving differently.” So we have all these machinists pulling levers and hoping that things will happen the way they want, but it doesn’t happen the way they want. People just adapt to it and game the system for their own purposes, and that has all contributed to having outcomes that that almost nobody wants... I don't say that efficiency is bad. I say the obsessive pursuit of it, with no attention to resilience, is going to kill you. Just keep that in mind that there's a certain amount of resilience that that you need. And if your top line has dropped by half, right, it’s not actually pursuit of efficiency to lay off half your staff. You're no more efficient than you were when your business was 2x, right? That's not increased efficiency. That's just being non-stupid.

Update 3 (15.05.2021)

John Dizard points to another example of the problems with too much complexity is supply chains in international trade. Bouyed by containerisation, advances in ICT, trade liberation, and the general trend of globalisation, global manufacturing has become extremely efficient on the back of creation of global supply chains. 

“Paddy” Padmanabhan, of the Insead Emerging Market Institute in Singapore, who co-wrote an influential 1997 paper on “information distortion in supply chains”, he says: “Twenty or 30 years back you had three or maybe four layers in supply chains. We have so many more layers that it is not clear we are adding to viability. We could have more bottlenecks and more chaos than before.” At the moment, people across the globe are experiencing many more idiosyncratic shortages, from oxygen in Indian hospitals to gasoline on the US East Coast to automobile semiconductors pretty much everywhere. Geopolitical tensions such as US-China military manoeuvring over Taiwan, the Ruhr Valley of advanced semiconductor manufacturing, have added to worries on supply chain vulnerability. Specific supply shortfalls will be solved. The question is whether they are part of a general trend of intensifying cycles of shortages, followed by recovery and overstocking, which lead in turn to speculative binges and then to deeper recessions spurred by inventory liquidation. That is part of what concerns Padmanabhan. Recessions would be amplified by these shocks (such as Covid) that impact the global supply chain. He cites shipping. Some 90 per cent of the world’s goods trade is transported by ship, according to the OECD. Padmanabhan points out many crews are from India. So a lack of Covid vaccine distribution and oxygen supply in India affects much more than the country’s own exports and imports. 

The point is this - how much supply chain integration is too much. 

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