US and European strategies for resilient supply chains
Balancing globalization and sovereignty
Senior Research Fellow, US and the Americas Programme, Chatham House
September 2021
Chatham House, the Royal Institute of International Affairs, is a world-leading policy institute based in London. Our mission is to help governments and societies build a sustainably secure, prosperous and just world.
Chatham House is pleased to share with you our latest publication from the US and the Americas Programme, US and European strategies for resilient supply chains: Balancing globalization and sovereignty.
Global supply chains have come under increased scrutiny as recent developments, such as the COVID-19 pandemic and semiconductor shortages, have highlighted the need to ensure supply chains can respond to and recover from unexpected disruptions by returning quickly to normal operations. This paper offers a public policy ‘toolkit’ for governments in the US and Europe to support efforts towards securing resilient and sustainable supply chains.
Key points
- Even before the COVID-19 pandemic, ongoing trends – such as geopolitical and geo-economic tensions in recent years, and the shift towards digital and low-carbon economies – have driven the rethinking and restructuring of global production networks. While the private sector and public policy approaches have traditionally emphasized efficiency, the focus is shifting towards strengthening supply-chain resilience.
- Governments have different – at times overlapping – rationales for supporting supply-chain resilience, including enhancing crisis preparedness and response regarding health, strengthening national security, creating domestic jobs and boosting economic competitiveness. In light of such manifold motivations, more public policy interventions in support of building resilient supply chains are likely.
- Supply-chain resilience is ultimately strengthened at the level of firms, but governments play a critical role by encouraging or constraining the sourcing and production decisions of companies. A mix of public policy tools is needed, ranging from increasing domestic production capacity and establishing stockpiles of critical products, to diversifying sources of supply. International cooperation at the bilateral, regional and global level is key to building resilient supply chains.
- Given the prominent position held by the US and Europe in international trade and the world economy, their recent resilience-oriented efforts will have wide-ranging implications for global supply chains. For the US and Europe, reducing global dependencies and increasing self-sufficiency do not have to mean dispensing with economic openness and international cooperation.
We would like to take this opportunity to thank the Hanns Seidel Foundation for its generous support of this project.
Excerpts from the contents
Summary
- Global supply chains have come under the spotlight in the wake of the COVID-19 pandemic and recent semiconductor But the rethinking and reconfiguration of global production networks have been driven by manypre-existing structural trends, such as increased geopolitical and geo-economic tensions as well as the shift towards digital and low-carbon economies.
- While the private sector and public policy approaches have traditionally emphasized efficiency (for instance, by prioritizing low costs and speedof production), now the focus is on strengthening supply-chain resilience. This paper defines supply-chain resilience as an adaptive capability to prepare for, respond to and recover from unexpected disruption by returning quickly to normal operations. As a starting point, a resilient supply chain is one that is visible, agile, and sustainable.
- Governments have different – at times overlapping – rationales for supporting supply-chain As well as addressing market failures, these include: enhancing crisis preparedness and response regarding health and personal safety; strengthening national security; boosting industrial strength and economic competitiveness; creating domestic jobs; and promoting human rights and sustainability.
- Supply-chain resilience is ultimately strengthened at the level of firms, but governments play a critical role by encouraging or constraining the sourcing and production decisions of companies, and by being the primary actor in some areas, for instance regarding national This paper argues that a mix of public policy tools is needed to build resilient supply chains. Such measures should encompass limited reshoring and increasing domestic production capacity for essential products and sectors, the diversification of sources of supply, and the holding of strategic reserves. Even though domestic policies to foster supply-chain resilience are necessary, they are not sufficient. International cooperation at the bilateral, regional and global level is key to success.
- Given the position held by the US and Europe in international trade and the world economy, their recent resilience-oriented efforts will have wide-rangingimplications for global supply chains. Moreover, the US, EU and UK offer a natural starting point for strengthening supply-chain resilience by leveraging their partnerships with like-minded countries in the Asia-Pacific region as well as their role in international forums such as the G7/G20 and World Trade Organization (WTO). For the US and Europe, reducing global dependencies and increasing self-sufficiency do not have to mean dispensing with economic openness and international cooperation.
01 Introduction
With the COVID-19 pandemic and recent semiconductor shortages having put a spotlight on supply chains, the US and Europe are critical players in strengthening the resilience of global production networks.
Global supply chains have come under increased scrutiny in the light of the vulnerabilities which have been exposed by recent developments: notably, these include supply-chain disruptions related to the COVID-19 pandemic, geo-economic and geopolitical tensions between the US and China, semiconductor shortages, and a reliance on critical raw materials for the transition towards green and digital economies. These developments have raised concerns about excessive dependencies on foreign suppliers, and have given rise to calls for national
self-sufficiency with regard to essential goods and strategic sectors. Proposed solutions have ranged from reshoring production to diversifying supply chains and increasing stockpiles. Much has been made of the supposed shift in attitudes from ‘just-in-time’ systems of production to ‘just-in-case’ (meaning extra inventory and lead times) or ‘just-at-home’ models (focused on domestic manufacturing of critical products).1 This trend has been accompanied by a shift away from the decades-long focus on efficiency in favour of greater supply-chain resilience.
Many drivers and tools are entangled in the current debate and in countries’ efforts to achieve greater supply-chain resilience. A number of pre-existing trends have driven the reconfiguration of global production networks. These include national security concerns, increasing digitalization and a shift to services, a desire to change domestic income distributions and avoid distortions in global trade, and efforts to tackle issues pertaining to climate change and human rights. Although declarations of the ‘death of globalization’ are exaggerated, a new era of the global economy has begun – the hallmarks of which are an increased regionalization and a convergence of industrial, trade and investment policies.
1 A similar point was made by Dr Ngozi Okonjo-Iweala, Director-General at the World Trade Organization (WTO), in September 2020 when she was a candidate for her current role. Brookings (2020), ‘Ngozi Okonjo-Iweala’s vision for the WTO’, Dollar & Sense Podcast, 21 September 2020, https://www.bredu/podcast-episode/ ngozi-okonjo-iwealas-vision-for-the-wto/?utm_source=feedblitz&utm_medium=FeedBlitzRss&utm_campaign= brookingsrss/programs/global (accessed 6 Jul. 2021).
During its period in office, the administration of Donald Trump aimed at ‘decoupling’ the US economy from that of China. Trump’s successor, President Joe Biden, who was inaugurated in January 2021, has also vowed to bring production back to the US from China in a number of economically and technologically sensitive sectors.2 The Biden administration has outlined its approach to building resilient supply chains and revitalizing American manufacturing, affirming its desire to ‘work with America’s allies and partners to strengthen collective supply chain resilience.’3 For its part, the EU is currently pursuing a policy of ‘open strategic autonomy’, thereby retaining its commitment to open and fair trade while reducing its dependence
on external suppliers and strengthening the security of supply across key industries.4 China, meanwhile, is also seeking to reduce its dependence on overseas markets and technology. In May 2020, President Xi announced the ‘dual circulation’ strategy of economic development, which seeks to focus increasingly on ‘internal circulation’ – the domestic production and consumption of goods and services – while supplementing this with ‘external circulation’, based on Chinese exports.5
The current focus on supply-chain resilience can help to find a new balance between globalization and sovereignty. This research paper seeks to contribute to the debate by focusing on the role of governments and international forums
in strengthening supply-chain resilience. The future of supply chains is considered within the broader context of what has been termed the ‘new nexus’ of economics, national security and technology.
The paper focuses specifically on the US and Europe, and on opportunities
for transatlantic collaboration to boost supply-chain resilience, as well as on the hurdles faced. Decisions taken by US and European policymakers and industry leaders will have implications for global supply chains. Together, the US, the EU-27 and the UK account for close to one-third of world GDP (in terms of purchasing power) and for roughly the same share of global trade.6 US–European supply chains are deeply intertwined, given the high proportion of transatlantic trade that takes place on an ‘intra-firm’ basis (i.e. transactions occurring between
a parent company and its affiliates, as opposed to those occurring ‘at arm’s length’ between independent parties). It is estimated that intra-firm trade accounts for one-third of total trade between the EU and US. During past economic shocks – such as the Asian crisis of 1997 and the global financial and economic crisis which began in 2007 – intra-firm trade has been the more resilient of the two. Thus, transatlantic policymakers will be able to expand on this inbuilt resilience.
2 Biden-Harris campaign platform (2020), ‘The Biden Plan to Rebuild S. Supply Chains and Ensure the U.S. Does Not Face Future Shortages of Critical Equipment’, https://joebiden.com/supplychains (accessed 12 Feb. 2021). 3 The White House (2021), ‘Building Resilient Supply Chains, Revitalizing American Manufacturing, and FosteringBroad-Based Growth’, 100-Day Reviews under Executive Order 14017, June 2021, https://www.whitehouse.gov/ wp-content/uploads/2021/06/100-day-supply-chain-review-report.pdf (accessed 6 Jul. 2021).
4 European Commission (2020), ‘Europe’s moment: Repair and Prepare for the Next Generation’, Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, COM(2020) 456 final, 27 May 2020, https://eur-lex.europa.eu/legal-content/ EN/TXT/PDF/?uri=CELEX:52020DC0456&from=EN (accessed 12 2021).
5 Pettis, (2020), ‘The problems with China’s “Dual Circulation” economic model’, Financial Times, 25 August 2020, https://www.ft.com/content/a9572b58-6e01-42c1-9771-2a36063a0036 (accessed 12 Feb. 2021).
6 Hamilton, D. S. and Quinlan, J. P. (2021), The Transatlantic Economy 2021: Annual Survey of Jobs, Trade and Investment between the United States and Europe, Washington, DC: Foreign Policy Institute, Johns Hopkins University SAIS/Woodrow Wilson Center, https://transatlanticrelations.org/wp-content/uploads/2021/03/ pdf (accessed 6 May 2021).
Moreover, the transatlantic partners are leading players in key structures for global economic governance, such as the G7 and G20 forums of major global economies, and the World Trade Organization (WTO). If the US and Europe threw their combined weight behind improved international coordination efforts and the development of an updated global trade ‘rule book’, they could boost attempts to build resilient supply chains. Similarly, because both partners share the same broad approaches towards the governance of emerging technologies that can promote supply-chain resilience, enhanced transatlantic cooperation in this space is a natural starting point. The US and Europe can leverage their own (at times overlapping) security and economic partnerships to encourage supply-chain resilience. Thus the transatlantic partners would be at the centre of a hub-and-spoke network to strengthen supply-chain resilience that encompasses advanced industrial democracies around the world.
A mix of efforts to increase local production of critical goods, combined with the reinforcement of the international trade system, offers the best opportunities for the US and Europe to contribute to a strengthening of supply-chain resilience.
In particular, the purpose of this paper is to offer useful insights into how the US, the EU and the UK can better harness the opportunities offered by globalization by providing legitimate protection to strategic supply chains without sliding
into protectionism. The paper presents a definition of supply-chain resilience, discusses the long-term structural drivers behind supply-chain reconfiguration and analyses supply-chain vulnerabilities and government objectives for boosting resilience. Based on an assessment of both the public policy instruments available and existing supply-chain resilience efforts, the paper develops a set of principles and recommendations that should guide government action at the domestic, regional and global level.
A mix of efforts to increase local production of critical goods, combined with the reinforcement of the international trade system, offers the best opportunities for the US and Europe to contribute to a strengthening of supply-chain resilience.
02 Global supply chains: Definition, trends and misperceptions
The COVID-19 pandemic has accelerated structural trends driving the reconfiguration of global supply chains. A new balance is emerging between efficiency and resilience as well as between globalization and national self-sufficiency.
Global supply chains – sometimes called global value chains7 or global production networks – have become a key feature of the world economy. In fact, approximately 70 per cent of international trade is for the purpose of production in global supply chains, whereby intermediate goods and services are exchanged across borders before being incorporated into a final product which can be delivered to consumers around the world.8 Supply chains are actually more regional in character than the term ‘global’ suggests: they are often structured around intra-regional links
7 While the literature does identify some differences between these terms to focus on a particular feature, they are often used interchangeably. The concept of global value chains tends to emphasize the process by which a firm adds value to a product, and includes aspects such as product design, manufacturing, marketing and distribution. Global production networks emphasize the non-linear aspects of the dispersed production structure. This paper does not take a strong view and thus generally treats these terms as synonymous. The author generally applies the designate ‘supply chains’, except when using sources that specifically employ an alternative term.
8 Trade in finished goods and services accounts for the remaining 30 per cent of global Organisation for Economic Co-operation and Development (2020), ‘Trade Policy Implications of Global Value Chains’, Trade Policy Brief, February 2020, https://issuu.com/oecd.publishing/docs/trade_policy_implications_of_global (accessed 12 Feb. 2021).
and are mostly clustered around Europe, North America and Asia.9 These major supply-chain blocs interlink, with a significant degree of interregional production-sharing. Despite the rise of China, the US and Germany remain the most important hubs in complex global production networks.10
Since 2011, the expansion of global value chains has slowed, according to the Organisation for Economic Co-operation and Development (OECD).11 In other words, even before the rise of economic nationalism (or protectionism) and the outbreak of the COVID-19 pandemic, the reconfiguration of supply chains has been driven by several structural factors in the last decade. These factors include:12
- A slowdown in growth of trade volumes, relative to the growth in global GDP, following the global financial and economic crisis which began in 2007, as well as a shift in orientation by China away from exports and towards supplying its domestic market;
- Diminishing labour cost arbitrage, as wages have risen in many emerging countries and the differential between countries in terms of labour costs
has become less important as a determining factor for locating production;13
- Increased political risk and trade tensions, with firms facing higher costs as a consequence of the imposition of tariffs and policy uncertainty;
- A higher frequency of business interruptions stemming from natural disasters or other disruptive events such as the COVID-19 pandemic;14
- Shifting social values and consumer preferences, including popular demands for a more sustainable and responsible sourcing of products;
- The rise of the so-called ‘service economy’ (which often implies production closer to consumers) and the ‘servicification of manufacturing’ (which means that firms are increasingly reliant on services as inputs, or are producing services that are bundled with the goods they sell);15
9 World Bank, WTO (2019), Global Value Chain Development Report 2019: Technological Innovation, Supply Chain Trade, and Workers in a Globalized World, http://documents.worldbank.org/curated/en/384161555079173489/ Global-Value-Chain-Development-Report-2019-Technological-Innovation-Supply-Chain-Trade-and-Workers-in- a-Globalized-World (accessed 12 2021).
10 Ibid
11 OECD (2020), ‘Trade Policy Implications of Global Value Chains’. In calculating global import intensity of production, the OECD ‘takes into account all trade flows of intermediates inputs used in any stage of the value chain, and expresses their overall value as a share of the final output’.
12 The literature covering these trends is extensive: it includes the reports by the OECD and WTO cited above, and private sector reports, such as: Lund, , Manyika, J., Woetzel, J., Bughin, J., Krishnan, M., Seong, J. and Muir, M. (2019), Globalization in transition: The future of trade and value chains, McKinsey Global Institute, https://www.mckinsey.com/featured-insights/innovation-and-growth/globalization-in-transition-the-future-of-trade-and-value-chains (accessed 12 Feb. 2021); and Fan, I., Holzheu, T. and Wong, C. (2020), De-risking global supply chains: rebalancing to strengthen resilience, Swiss Re Institute, sigma No 6/2020, https://www.swissre.com/ dam/jcr:cff737e5-ac7f-4d67-b0cc-6634fe378feb/sigma-6-2020-en.pdf (accessed 12 Feb. 2021).
13 For instance, a report by the McKinsey Global Institute finds that the share of trade based on labour-cost arbitrage declined from 55 per cent in 2005 to 43 per cent in 2017 for labour-intensive goods such as textiles and See Lund et al. (2019), Globalization in transition, p. 36.
14 According to a report by the McKinsey Global Institute, disruptions lasting a month or longer now occur every 7 years on average. See Lund, S., Manyika, J., Woetzel, J., Barriball, E., Krishnan, M., Alicke, K., Birshan, M., George, K., Smit, S., Swan, D. and Hutzler, K. (2020), Risk, resilience, and rebalancing in global value chains, McKinsey Global Institute, https://www.mckinsey.com/business-functions/operations/our-insights/risk- resilience-and-rebalancing-in-global-value-chains (accessed 12 Feb. 2021).
15 Miroudot, (2020), ‘Reshaping the policy debate on the implications of COVID-19 for global supply chains’, Journal of International Business Policy, 3: pp. 430–42, doi:10.1057/s42214-020-00074-6 (accessed 12 Feb. 2021).
- Technological change – for instance, the increasing availability of 3D printing and robotics technologies, allowing production facilities to be located closer
to the end-consumer and reducing cost arbitrage between countries (by means of automation, which has reduced the contribution of labour in the production process). At the same time, however, cyberattacks have become a source
of supply-chain vulnerability.
The COVID-19 pandemic has given added impetus to many of these trends. Resilience has become the new buzzword in relation to supply chains: however, there is no agreed definition.16 Some authors distinguish between resilience (returning to normal operations post-disruption) and robustness (the ability
to maintain operations during a crisis).17
For the purposes of this paper, supply-chain resilience is defined as an adaptive capability to prepare for, respond to and recover from unexpected disruption by returning quickly to normal operations.18
The coronavirus pandemic has also given rise to some common misperceptions. First, while it highlighted the pressure points on global production networks, supply chains were able to adapt to the stresses of the pandemic, proving to be quite resilient. Imports and increased domestic production helped to overcome initial shortages and supply-chain disruptions for personal protective equipment (PPE), food products and other goods. And while discussions around an over-reliance on imports for COVID-19-related products have mostly framed the latter as a problem specific to China, the information available points to a more complex picture (see Box 1).
Second, there seems to be a false dichotomy between efficiency and resilience. While it is true that companies have prioritized efficiency in recent decades (for instance, by optimizing both the cost and the speed of production) and have paid less attention to potential vulnerabilities, the two objectives are not necessarily mutually exclusive. Some scholars have argued that both efficiency and resilience need to be maintained for companies to survive in the long term.19 In the short term, tensions certainly exist between the two. This does not mean that companies need to focus solely on one or the other: rather, they need to balance the two objectives, and manage any resulting trade-offs.