ARTICLE

How Companies Can Prepare for a Long Run of High Inflation

byVijay Govindarajan,Hassan Ilyas,Felipe B. G. Silva,Anup Srivastava, andLuminita Enache

May 02, 2022

Why inflation is so high right now

First, despite demand for goods and services reaching or even exceeding pre-pandemic levels, supply hasn't caught up. Covid-related supply chain issues persist, with many goods remaining stuck in ships or ports. Shipping, freight, and insurance rates haveskyrocketed to multiple timestheir pre-pandemic levels. China'szero-covid policycomes with lockdowns and closures of the world's most importantmanufacturing and shipping hubs. Many factories remain closed or have not resumed operations.Wages keep rising, and companies are stillstruggling to hire enough talent. A widespreadshortage of truck driversis affecting production chains.

Second, compounding those factors is Russia's attack on Ukraine and the West's subsequent sanctioning of Russian goods and trade. These developmentshave direct and indirect effectsthat fuel inflation. Russia is still animportant supplierof oil, gas, and coal to European factories.Ukraine and Russiacombined are the world's largest exporters of grains, feed crops for cattle, and fertilizers for growing crops. Cutting off these supplies or even reducing them significantlythrows a wrenchin a well-functioning global supply chain system. Even if the war were to end tomorrow, sanctions and trade embargoes are unlikely to reverse soon and could take years (if not decades) to sort out.

The risks of protectionism

One likely outcome of these developments is that countries could turn protectionist, reversing decades of trade and specialization progress. For example, over the last 40 years or so, manufacturing moved away from the U.S. significantly. Meanwhile, California's Silicon Valley became the global leader in new digital businesses ideas, Taiwan became the global supplier ofsemiconductors, and China'sShenzhen region created an ecosystemfor manufacturing electronic products. In addition, Brazil became the largestexporter of beef, China ofsteel, Canada ofaluminium, Germany ofcars, and the U.S. ofradios and TVsandrefined petroleum.

In other words, each region started specializing in producing goods in which it hadcomparative advantageor economies of scale. Goods crisscrossed the globe at various production stages before reaching customers. This specialization and trade lowered prices of goods and services and accelerated innovation. Just consider the price you recently paid for a large-screen LCD TV. You might find it to belowerthan the inflation-adjusted price you paid for a small black-and-white TV in the 1990s. This was the outcome of well-functioning specialization and global trade. In other words, countries are better off specializing in a few things and trading the rest,instead of trying to be self-sufficient.

Now there is a real danger that at least some of thatprogress could be lost or reversed, forever. Countries may revert to more protectionist policies and attemptto become more self-reliant. Imagine a scenario where each country attempts to have its own steel mills, produces its own cars, runs its own airlines, and has its own oilfields and refineries. In addition, many countries would spendmore on defense, which means fewer funds for real development. All of this would make goods and services more expensive.

Fragment. To read the full article please visitHow Companies Can Prepare for a Long Run of High Inflation (hbr.org)

1. According to the article, recent developments such as the Covid-19 Pandemic and the Russia-Ukraine conflict could turn countries more protectionist. This is in addition to the direct impact of these events on the process of globalisation.
   1. How do you think the Covid-19 Pandemic and the Russia-Ukraine conflict have affected the process of globalisation? Provide 2 examples to illustrate your answer.
   2. Why do you think these events may turn countries more protectionists?
2. What is the most likely impact of countries turning to more protectionist policies on global inflation? Use the external economies of scale graphical framework to illustrate your answer.