Cross-border supply chains are one of the main features of a globalized economy. Such global value-chains (GVCs) have emerged and become more and more complex over time, but while they were long perceived unanimously as positive developments, they have been increasingly questioned over the past decade as sources of vulnerability. This has reached a peak with the Covid-related economic crisis. The objective of this contribution is to examine the reasons for these developments as well as the possible response to be given to mitigate the associated costs. In so doing, the focus will be placed on the opportunities for cooperation in the Indo-pacific region.
The article argues that the security of supply chains is a relatively recent concern; until recently it was almost exclusively perceived as a technical problem (to be solved by companies), but in a context of intensifying technological and economic rivalry it has become a geopolitical problem. Countries in the Indo-Pacific may derive significant gains from addressing the issue in a cooperative way.
Some initial thoughts on globalized supply chains and their downsides
The rationale for developing cross-border supply chains is to make the best of comparative advantages through specialization-based fragmentation of the production process. This can be done within a given company (offshoring) or through outsourcing. Driven by efficiency considerations, this organization of production has long been considered optimal or most cost-effective.
Some doubts started to emerge following major disruptions in GVCs, such as the Fukushima nuclear incident or the Thai floods, both in 2011. The concentration of the production of some critical components proved to be risky and made the whole chain vulnerable. Interestingly, however, these events did not lead to a deep rethinking of the prevailing logic, and there were only minor changes (if any) in the regional production networks in East Asia as a result. The reason is that the disruption was perceived to be temporary. By definition, disruptions caused by natural disasters are unpredictable and call for immediate responses, but their impact can be expected not to be long-lasting. From the companies’ perspective, although the security of the supply chain may be threatened, cost effectiveness is a priority that trumps all other considerations.
From the public sector’s perspective, the strategy was also found to be partly flawed but for a totally different reason. The problem is that systematic offshoring is likely to lead to deindustrialization, with substantial implications in terms of dependence and vulnerability. However, the long-held liberal consensus view was that it should not be perceived as a major issue.
Over time, the exclusive focus on economic considerations (with cost-reduction as the number one priority) and the resulting self-imposed dependence proved to be increasingly problematic, and the security of supply chains gained importance together with the need to balance security (strategic) and cost related (economic) goals. As pointed out by the OECD, “the relentless pursuit of efficiency gains through the specialization-based fragmentation of global supply chains has also led to vulnerabilities, some of which have been exposed in recent years.”
The COVID-19 crisis acted as an accelerator that laid bare the vulnerabilities resulting from the exclusive dependence on a limited number of suppliers for some essential (or critical) goods. An important point to note is that large amounts are not necessarily the core of the problem; even small amounts may turn out to be problematic if the products are really critical for the supply chain to operate properly.
Enter geopolitical rivalry: the risk of weaponized interdependence
The pandemic acted as a wake-up call, but more than the fragility of long and geographically dispersed supply chains, the problem lies with overdependence on unreliable partners. In addition to the doubts highlighted earlier, further concerns started materializing in a context of rising geopolitical tensions, with an awareness that interdependence could be easily weaponized. It is the fear that there may be a weaponization of interdependence that brought about a major change of mindset. And the criticality of some products makes weaponization all the more likely and powerful.
There is a widespread perception, rightly or wrongly, that global value chains have become unsustainably China-centric and that the resulting dependence, which is in and of itself already a problem, is further compounded by the risk of weaponization. To be fair, there are good reasons to be wary of such a weaponization (by China) of asymmetric interdependence. This has been exemplified in various recent cases, such as South Korea and Australia. More than the existence of supply chains and their potential vulnerability, the problem lies with China’s grip over some supply chains. In other words, the economic imperative behind resilience is compounded by strong political motives (Palit 2020). Gradually, the objective has become to restructure global chains away from China, repositioning them substantially in countries that don’t pose a security threat.
In other words, the resilience of supply chains is not only an economic problem, but also a security problem, broadly defined, and even more so if the sectors or products at stake are critical/strategic. It is not just about the security of the company in question, but it also affects the security of the whole country. In policymaking circles, the predominant thinking about ‘dependence’ and ‘over-reliance’ on China is more about political-strategic considerations and less about actual economic resilience.
This has led to a change in the calculus and in the trade-off between efficiency (or cost-reduction) and security considerations, with a rising importance of the latter and declining importance of efficiency. However, there may be tensions between private sector and governments’ concerns. The two sets of players do not always see eye to eye on this issue, and they may have different definitions of supply-chain security and different views about what can be done to enhance supply-chain resilience.
Making supply chains more resilient – A multi-layered strategy
When discussing possible options to enhance supply-chain resilience, different levels of action as well as different time horizons can be envisaged. While full independence from foreign partners remains elusive, the challenge is to combine cost-effectiveness and security in the best possible way, thus reconciling companies and government’s preoccupations.
The options can be organized around two major objectives: to reduce dependence, and to avoid the weaponization of dependence. Strategies at the national level and cooperative approaches can be combined to reach these objectives.
With respect to the first objective, it is worth stressing that any form of self-imposed dependence resulting from the choice of inappropriate policies should be avoided by all means.
The usual strategies to reach the former objective include reshoring, nearshoring and supplier diversification. All these actions can be taken at company level, but the snag is that these measures cannot materialize overnight; moreover, they are likely to enhance resilience at the expense of economic objectives. There may thus be a tension between the government and private sector’s objectives. A voluntaristic approach on the part of the government is likely to quickly reach its limits as exemplified by Japan’s unsuccessful attempt to encourage or even force reshoring through subsidization.
The second objective (to avoid the weaponization of dependence) can be reached more easily through a cooperative approach at the international level and within a shorter time horizon. The possible options range from diversification of suppliers to the identification of reliable partners.
With its new industrial strategy aimed at achieving strategic autonomy in key technologies and access to raw materials, the EU has chosen the first option. However, there is also scope to complement this strategy with some form of cooperative effort with trusted and like-minded partners so as to make the best of existing complementarities and ensure regular supply of some critical inputs. This could also take place through the promotion of industrial alliances involving non-EU partners.
The US-EU Trade and Technology Council (TTC), a cooperative endeavor that seeks among other things to expand and deepen trade and transatlantic investment ties (with a working group dedicated specifically to supply chain security) follows exactly this cooperative logic. It could provide interesting lessons and offer a template for cooperation between the EU and partners in the Indo-Pacific.
Some of the latter have themselves engaged in such minilateral initiatives, and it would certainly make sense to seek to capitalize on their experience. For instance, experience-sharing and information exchange with Indo-Pacific partners that participate in the Supply-Chain Resilience Initiative (SCRI) is certainly a promising avenue.
Lastly, such discussions could also be included in the G7 agenda.
This booklet is promoted within the fourth edition of the Asia & Europe Initiative "Stability and Security in the Indo-Pacific: The US, Japan, the EU and the Elephant in the Room" which gathers together leading experts, Asian and European think thank representatives, as well as Italian companies and agencies to discuss the increasing geopolitical interest in the Indo-Pacific Region.