Why supply chain diversification isn’t all that easy

Hello from Brussels. Most of the economics-related excitement round here at the moment is in central banking rather than trade as such, with the European Court of Justice and Germany’s constitutional court slugging it out as to which of them gets to decide what. At stake is the ECB’s attempts to save the world economy, no biggie.

Today’s main piece in Trade Secrets is on whether it’s as simple as politicians say for companies to diversify their supply chains to build resilience against pandemics and the like. (No, it really isn’t.) Our chart of the day looks at how US soyabean exports to China are faring, while our Tit-for-Tat guest is Wendy Cutler, vice-president at the Asia Society Policy Institute in Washington DC.

The unchained malady of diversifying production

We’re not even full swing into the relaxation of the lockdown yet — the first lockdown, we should say — across much of the rich world. And already the putting-down-markers industry is, as they say, ramping up production about what a pandemic-proof global trading system would look like.

One thing a lot of policymakers are keen on is making supply chains “resilient” to shocks. Well, no argument there. No one’s against resilience the same way no one’s pro-crime. But how? The standard view seems to be diversification and in particular not putting all your money on red by sourcing only from China. Among the more unreconstructed politicians this also means bringing production back home.

In future newsletters we’ll get into exactly how governments might encourage this. For the moment, let’s have a look at whether diversification is remotely as easy for business people to do as for politicians to say. Guess what? No, it isn’t.

Here we’ll turn the mic over to John Neill, chairman and chief executive of the UK-headquartered logistics and supply chain business Unipart, which has, let’s say, a bit of experience here. In the car industry, which is where Unipart started out and still does a lot of work, a sourcing procedure for a new component involves doing a bit more than a search on eBay. (Our words, not his.)

For a product like fuel tanks, which Unipart supplies to the UK car industry, it takes months or years to find a supplier, discuss specifications, assess production quality and make sure their procedures are reliable and repeatable. “Let's say we wanted to reshore one of those components for fuel tanks to the UK,” Neill told Trade Secrets. “We would have to put them through a whole range of quality and safety tests to prove to our customers that they meet all their safety requirements. They are rightly incredibly risk averse on a safety-critical product like this.” 

By all means build in geographical diversification and spare capacity to be resilient against the next pandemic. You’ll probably go bust before it arrives. “Just imagine that you've decided to have three suppliers for a component,” Neill says. “You'd have three sets of tooling, three teams that need to go in and work with them and support them. The costs would be astronomical and those would make you uncompetitive. So you might have a more robust supply chain than the other guys but no one's going to buy your cars because they're too expensive.”

Another thing: what, exactly, is supplier diversification taking out insurance against? Sure, there have been country or region-specific shocks in the past, like the Fukushima earthquake in Japan in 2011, when many companies woke up to how much of the world’s silicon wafer manufacture was located in the area. Or the rare earths episode a year earlier, when China, a big producer of the minerals essential to manufacture many electronics, whacked on export restrictions to divert them to its own industry. The rest of the world, faced with shortages and rocketing prices, scrambled to reopen old rare earths mines and dig new ones.

But the pandemic is a global shock. Neill says: “I can't think of a single thing that we could have done if we'd known coronavirus was coming that would have protected us. Factories and operations all over the world have stopped. Let's say we were sourcing all our requirements in the UK. The government shut down various parts of the UK anyway. So we'd still be in the same position.”

Now, OK, we’ve picked a favourable example to our thesis to illustrate our point. Car supply chains are notoriously complex, with very low tolerance for engineering and logistical errors. It’s obviously easier to diversify supply of something cheaper and simpler than cars, such as clinical masks.

But still, the difficulty of re-engineering supply chains is an incredibly important point, to which we’re going to return. There are going to have to be some seriously hefty incentives to get a lot of manufacturing companies to diversify. And if it’s really going to be done across the board it will end up with products being much more expensive, or much less sophisticated, than before. And possibly not achieve resilience anyway. Careful what you wish for.

Charted waters

Robert Lighthizer, the US trade representative, and Steven Mnuchin, the Treasury secretary, held a conference call with Liu He, China’s vice-premier, on Thursday night to discuss the implementation of the US-China “phase one” agreement — and said that the pact remained on track despite rising tensions. China has agreed to buy a lot more soyabeans as part of the deal — but US soyabean exports tend to peak later in the year, giving it some time to catch up.

Tit-for-tat

Wendy Cutler, vice-president at the Asia Society Policy Institute in Washington DC, answers three blunt questions.

Is the current crisis an opportunity for the WTO to prove its relevance?

The World Trade Organization (WTO) was facing tough times before Covid-19, both on the negotiating and dispute settlement fronts. It was further marginalised when the United States and China took their trade war outside of Geneva. Covid-19 won’t make these issues any easier of course, but it could provide other opportunities. Specifically, a multi-country initiative to level the playing field in the trade of essential medical supplies could garner the support of many members now combating Covid-19. Such a negotiation could demonstrate the relevance of the WTO, especially in terms of preparing for future health-related global emergencies.

Will regional trade agreements become more attractive in light of Covid-19 as countries look to diversify trading partners and supply chains?

In my view, yes. Covid-19 has underscored the dangers of relying on any one country for needed inputs or final products. In particular, the supply chains in the automotive, electronics, and medical sectors have been hard hit. We can expect countries to put a premium on the diversification of their trading partners, while companies look to regionalise their supply chains. The Regional Comprehensive Economic Partnership (RCEP) and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) accession should see a boost in interest, and new regional groupings may emerge.

What can be done to get countries to lift and/or ease their export restrictions on medical supplies?

Over 70 countries, including the United States, Europe, and China, have imposed export restrictions on medical supplies and equipment. These restrictions are contributing to global shortages and higher prices for these essential goods. Countries should be urged to limit these restrictions to the minimal number of products, and to phase them out over a specified short period. The G20, WTO, and APEC can play a useful role by shining a spotlight on these countries and making sure they explain how they intend to do so.

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