There has been a lot of talk on how the Covid-19 shock would mean the end of global supply chains and accelerate the shift away from globalisation. Are we witnessing the beginning of a re-shoring of production for many sectors of activity? Are we moving from the era of “just-in-time” to the one of “just-in-case”, as the new buzzwords suggest? The key question is, to what extent what is going on with respect to supply chains is a direct result of Covid-19 and what reflects longer – structural – trends?
Globalised supply chains have been designed to source components from where it is most efficient to deliver these components at the time required, at the cheapest possible cost. This just- in-time model was already under stress before the pandemic with the emergence of new geopolitical risks, the impact of the US-China confrontation and the US-China decoupling, the rise of protectionism and the need to reduce the environmental footprint of business activities.
Covid-19 is a huge one-off shock, the perfect example of the “black swan”— an unpredictable event with potentially severe consequences, characterised by extreme rarity, and the widespread insistence they were obvious in hindsight.
Covid-19 highlighted the hidden costs of single-source dependency and the lack of resilience to sudden shocks. As a result, there is a lot of talk about bringing back home the production of pharmaceutical and medical devices, food items and goods deemed of strategic importance. But what is the real extent and the feasibility of this on-shoring triggered by the pandemic? Will people, insurance companies and governments accept the unavoidable increase that this on-shoring will entail at a time when developed countries are struggling to contain the rising cost of health care? Also, nobody has a clue about the nature of the next global crisis and when and how we will be confronted by it.
However, there will be some on-shoring of production of strategically important goods. But this will remain limited in scope. According to a study from the Rhodium Group, which specialises on China’s economic relations with the US and Europe, the re-shoring in Europe of these kind of activities would represent 5 to 10 per cent of the European Union exchanges. Hardly a radical reshuffling of global supply chains.
The situation is different when looking at the longer-term impact of structural trends such as the changes in the multilateral trading system, the deterioration of the geopolitical context, the evolution of economic conditions in China and the increasing US-China de-coupling.
What we see here is a trend of diversification away from one-sourcing base, i.e. China, towards other bases such as Vietnam, Indonesia or the Philippines. This trend is driven by the increasing perception of the risks associated with operating solely from China, as well as by the increase of production costs in the mainland and the pressure on companies to reduce their environmental footprint.
It affects especially high-tech companies. An illustration of that is Foxconn’s decision to invest
$1 billion to expand its operations in India — in addition to its existing operations in China.
However, for the large majority of business activities there is no across-the-board move out of China, no bypassing of China’s key position in supply chains in the foreseeable future. In most cases, alternative options don’t match China’s scale to support major relocation of activities. Many MNCs will be looking at diversification in terms of “China plus one” strategies, supplementing — when possible — operations in China with another Asian country.
According to a survey among the members of the EU-China Chamber of Commerce, the number of companies considering to move out of China has declined from 20 per cent last year to 12 per cent this year. The kind of ecosystem and scale that China offers for key industries, such as automotive, chemicals, heavy industry, would be very difficult to recreate in Europe or the US. And this would require a lot of money and time. As Jörg Wuttke, the head of the European Union Chamber of Commerce in China noted, the operations of the members of the Chamber “involve a lot of high-tech elements that are difficult to move. (…) Supply chain security is not their only concern. The location of future demand and markets is also a key point of consideration.” The situation is different for American companies impacted by the US-China de-coupling. Almost 40 per cent of respondents to the last survey made by AMCHAM China consider relocating — or have relocated — outside China. But those doing so move mostly to Southeast Asia or to Mexico. Less than 6 per cent would consider manufacturing in the US.
If Donald Trump is reelected president in November, we need to prepare for the emergence of an America-centric economic and technological region and of a China-centric one; Europe will presumably try to navigate between the two. In that scenario supply chains will become more and more regionalised. This will entail huge additional costs as investments in China and in countries aligned to it will have to be written off and there will be new costs for building new factories, new skills, plus the differentiated cost of production between operating in Asia and operating in Europe or the US markets.
It is also far less certain that the US will be the beneficiary of a full de-coupling with China. In fact, the reverse will most probably happen as China — with the depth of its market — will be the number one beneficiary of the relationship with Asean; the fastest growing region in the world will have no other choice than aligning itself even more with the Mainland despite its misgivings about Beijing’s policies.
If Joseph Biden wins the White House, there will definitely not be a full shift towards “back to business as usual” with Beijing. The anti-China mood is one of the very rare common points between Democrats and Republicans. However, one would expect a Biden administration to settle into a policy combining confrontation with Beijing on certain issues with cooperation on other ones. There will also be a greater awareness of the costs for the US of a full de-coupling with China. Then the picture will be a very dynamic mix of regional and global supply chains complementing one another.
So, even though diversification will be a key trend in the coming years, global supply chains will remain a key feature of the economic and business landscape. There will not be a shift from “just in time” to “just in case…” but the search of the optimum trade-off between efficiency and resilience.
The writer is president of Smadja & Smadja, a strategic advisory firm;
@ClaudeSmadja