Global supply chains, the circuits that keep global trade flowing, have stumbled of late. The system has been rocked by a series of tumultuous events. From Trump’s trade crises to the pandemic, to major war and then sanctions, the current system is clearly unraveling and its fragility is being laid bare. The result has been not only trade disruptions, but also the resurgence of long-absent inflation. The economic crisis has led to calls to rethink the underlying philosophy, at the heart of which is the minimization of costs through the optimal use of resources through techniques such as inventory and just-in-time production (JIT). ). It is well established that JIT and multi-source systems can be very cost effective, but when a single component is delayed, the whole system comes to a halt and the ripple effects can be considerable.
Given the current challenges, two opposing views seem to emerge on how the system should be redesigned. One, expounded by Larry Summers, the former US Treasury Secretary and resonating with many Westerners, argues that global supply chains should move from just-in-time to “just in case”. That is to say, we must move from an emphasis solely on profitability to one that takes into account national strategic interests.
The other opposing view, coming from the International Monetary Fund, is that global supply chains should be made more resilient through increased diversification. The implications for the global economy from both viewpoints could be significant. While the first seeks “relocalization” and a domestic bias by bringing production back to the developed world, the second seeks diversification through greater substitutability of inputs and production sites.
There is no doubt that globalization, embodied in global supply chains, has been good for the world. The rapid globalization that has brought us to where we are today took off in the 1990s under the effect of three catalysts: the advent of the Internet, the liberalization of China and its adoption of free trade after an earlier phase of experimentation, and the fall of the Soviet Union.
The increased trading opportunities offered by globalization allowed nations to focus on producing the goods in which they had a comparative advantage and which they could produce most efficiently. Multinational companies, using transformative technologies and advances in logistics, have localized parts/component production and assembly in different countries to minimize costs. The aim was to make supply chains as integrated as possible in order to optimize the use of resources and reap the benefits of efficiency.
The world has benefited from all this. Resources, especially in manufacturing, have been optimized while costs have been minimized. It is no coincidence that inflation has been kept under control globally, at least until the recent debacle led to its resurgence. The United States and large parts of the world experienced the “Great Moderation,” growth with low inflation for nearly three decades. Return on capital has increased, as have equity returns for investors. More importantly, globalization has allowed emerging countries to industrialize simply by participating in the global supply chain. Only the basics – land, labor and the will to play by the rules of globalization – were needed.
But there were downsides. Maximizing efficiency required specialization. With facilities in different countries specializing in specific components, the need to orchestrate logistics meant that the system became highly interconnected and very complex. Worse, it has led to concentrations. China has become the factory of the world and the world now depends on Taiwan for semiconductor chips. Taiwan’s TSMC (Taiwan Semiconductor Manufacturing Company) alone is estimated to account for just over 50% of the global semiconductor foundry market and nearly 90% of the high-end variety.
Such a concentration, especially of critical components, undoubtedly increased the vulnerability of the system. Almost every business around the world appears to have been impacted by the pandemic shutdowns, whether or not they had direct exposure overseas. Yet it would be nearly impossible for a country to break away from existing supply chains entirely and move them ashore. Interdependencies can be too deep and too ingrained.
Since no country can produce all of its needs, at least not competitively, costs and comparative advantages will remain. But where the previous mindset was efficiency at all costs, new thinking could turn into resilient systems with increased substitutability. This would require a dissolution of the current bottlenecks created by concentration. And such a dissolution can only be done by dispersing or spreading out the production facilities.
It would also require redundancies and built-in slack to deal with contingencies and avoid the kind of problems we are facing now. And this is where emerging markets could benefit. As the necessary realignment of global supply and value chains takes place, developing countries can and must position themselves as beneficiaries. Their suitability and attractiveness will depend on the availability of good infrastructure, including digital ones; transparent and corruption-free governance; rule of law; policy coherence; and minimal trade barriers.
While it is true that a global supply chain with built-in slack and redundancies may be less cost competitive, the current highly efficient but fragile system with too many choke points and fragility may increase costs much faster when it breaks than a resilient, albeit less efficient system. .
Dr. Obiyathulla Ismath Bacha is Professor of Finance at INCEIF University
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