How Middlemen Are Sending Shocks Through the Global Supply Chain

In an interview from Motley Fool Live, recorded on June 17, Columbia Law School professor and financial regulation expert Kathryn Judge answers a question about the role of middlemen in the global supply chain crisis and how it's been impacting companies in different ways.

Kathryn Judge: Yeah. What we saw, again, is you had these larger intermediaries. It justified this further disaggregation of the production process, or at least it seemed to. You had these multi-nodal processes and each node really undertook only what it could do so most efficiently or most cheaply. Sometimes it was because there were superior skills. Sometimes there was just weaker labor production. There are a variety of different reasons you had this disaggregation over time.

But what we're seeing now is not only when you had these long chains, the weaknesses, very far extreme potentially of downstream consequences. But most firms were not able to actually understand all of the upstream risks to which they were exposed. This is one of the reasons that once you have a shock, whether it's the pandemic or Russia's invasion of Ukraine, that the shock disrupts the system. There is an inherently a shock that happens.

But you often have outsized consequences because in this complex system, every player is now looking out for themselves. There might be signaling that they need more than they actually need of a good to try to get some. Suddenly you can have this, and sometimes it's referred to as a pull-up effect where you have these outsized consequences of atomistic behavior suddenly popping up in a way that builds on itself. Not only does that matter for individual firms, but of course right now it matters a lot for the Fed.

There's a lot going on in terms of the contributors to the current inflationary environment. But one of the core challenges, as we saw from much of 2021, particularly in the early period, the Fed kept insisting and it wasn't their fault they said incomplete information, that the supply chain shocks were transitory. That they were going to self-correct. I think we saw similar errors by the Fed in '07. They kept pumping new liquidity into the market and saying OK, well we have enough liquidity, the situation is going to correct itself.

Part of what I look out at are the parallels between what happened in '07-'08 and what's happening right now where you have these very long chains and a shock to the system, rather than being absorbed in an orderly way where people can make rational corrections. They have incomplete information, there's uncertainty, and there's panic. You actually have an environment where the shock creates continued disruption and can fit into additional dysfunction.