The New Epoch for Global Business Has Arrived
If the watchword for supply chains in the era of globalization was efficiency, the watchword in our new era of fragmentation is resiliency.
Apart from the legal requirements, many companies are seeking to reduce their carbon and methane emissions for reputational reasons and often to meet customer demands. Consequently, companies need to track not only the increasing political and legal constraints on trade resulting from environmental concerns but also the indirect impact as customers incorporate greenhouse gas reductions into their supply chains.
The disruptions to global supply chains caused by COVID-19 demonstrate both the production and the political risks of certain global supply chains. Productive facilities in many cities were directly affected by shutdowns, creating spot shortages of products.
From a policy perspective, many supply chains were affected by a type of “resource nationalism” centered on medical equipment and supplies. During the pandemic, countries sought to ensure their own needs were met for COVID-related products at the expense of other countries. This created a particularly complicated situation for firms with global suppliers—for example, U.S. companies producing face masks in Mexico or China. Medical experts suggest that pandemics are likely to be a continuing feature as our world grows hotter and more crowded. As companies develop or renew their supply chains, they need to account for that likelihood.
Friend-shoring, Near-shoring, and On-shoring
Partly in response to the issues outlined above, and partly due to traditional trade protectionism, the U.S. government is pressing American companies to remake their supply chains. The government calls for companies to move out of China for national security, geo-political concerns, human rights, and supply diversification. Friend-shoring is to some extent a euphemism for moving out of China, but more broadly, it refers to developing supply chains in countries considered more politically reliable. Nearshoring carries the concept even further: seeking to reduce transportation and political risks by moving production to close neighbors. To some degree, that also begins to address traditional protectionism, as imports to the United States from Mexico or Canada are far more likely to incorporate U.S.-origin components than imports from farther abroad.
Finally, on-shoring—moving investment and jobs into the United States rather than relying on foreign suppliers at all—appears to be the ideal goal for many U.S. political leaders. The policy tools to encourage these shifts are limited but growing. For example, the extensive tariffs on China might incent companies manufacturing for the U.S. market to shift out of China. The recently approved Inflation Reduction Act includes tax incentives for electric vehicles made in the United States.
Global Rules are Unenforced
As these challenges to the rules around global supply chains mount, the WTO’s enforcement mechanism has been dismantled. One of the WTO’s advances was creating a tool for dispute settlement that could adjudicate challenges to trade practices alleged to violate the WTO rules. The final step of this mechanism is an appeals board—the Appellate Body—which makes the final ruling on such violations, potentially authorizing the injured country to retaliate but usually leading to the withdrawal of the offending measure or other compensation to the victim. The Appellate Body is a standing group of seven members appointed to four-year terms by the entire WTO membership. In recent years, however, the United States has vetoed the appointment of any new members to replace those whose terms expired. As a result, there are now not enough members to form a panel, and the Appeals Board has ceased to function. Making WTO rules less enforceable increases uncertainty for companies involved in international trade.
Domestic Rule of Law
As global rules fray, domestic rule of law in several key countries is increasingly unpredictable. According to the Global Justice Project’s Rule of Law index, in 2021, 74.2 percent of surveyed countries experienced declines in rule of law performance, while only 25.8 percent improved. The 74.2 percent of countries that experienced declines that year account for 84.7 percent of the world’s population, or approximately 6.5 billion people. Importantly, this decline deeply affects the business community. In China, Xi Jinping is increasing his control over the Chinese Communist Party and the state. In the European Union, a few member states exhibit increasingly authoritarian tendencies, particularly in efforts to control the judiciary. And in the United States, the executive arbitrarily invokes national security to increase tariffs or oversight of business. Companies thus need to evaluate the supply chain risks of potential arbitrary government actions in many countries.
If the watchword for supply chains in the era of globalization was efficiency, the watchword for supply chains in our new era of fragmentation is resiliency. The CEO superstars of the 1980s and 1990s drove efficiency and cost reduction in supply chains, making global networks achieve just-in-time production. Companies that emphasized the security of supply chains over efficiency lost out in the marketplace, as the cost of less efficient but nearby or redundant suppliers reduced their competitiveness. But the risks of relying on those complex and often far-flung supply chains became all too clear during the pandemic. Now faced with the collection of political risks outlined above, companies need to re-evaluate their supply chains, mitigate some of the risks via engagement with policymakers and the public, and adapt to those risks through resiliency in their supply chains.
The replacement of efficient “just-in-time” supply chains with resilient “just-in-case” supply chains will enable firms to survive adverse events in better shape, but it will come with higher costs in normal times. At the individual firm level, each company will need to evaluate that trade-off to find the right balance between cost and efficiency. At the macro level, the shift to resiliency will raise costs, likely resulting in some combination of higher inflation, lower profits, and slower wage growth. Measuring those costs will be a future project for a more skilled economist. And evaluating whether the results justify those costs will be an even more challenging project for the future.
But there is an immediate need for companies to recognize the challenges of this new epoch, evaluate the risks and opportunities it presents, and act on those insights.
David D. Nelson is a former U.S. ambassador to Uruguay. His domestic assignments focused on economic and business policy, including at the White House/National Security Council under President George W. Bush, and as the most senior economic official in the State Department during the first six months of the Obama administration. After retiring from the State Department in 2011, he worked on international issues for the General Electric Company (GE), and in 2018 established his own consulting firm.