Rebuilding the Chain

The emergence of COVID-19 in Wuhan, China, in early 2020 not only sparked a humanitarian disaster but also exposed major supply chain vulnerabilities for companies based around the world. As the global economy climbs out of its pandemic-sized hole, will companies reassess how and where their key components are made? In this interview with Asia Society Executive Vice President Tom Nagorski, Wendy Cutler, a leading trade expert who serves as vice president of the Asia Society Policy Institute, provides insights into why supply chains matter — and how they’re poised to change in a post-pandemic world.  You can listen to the full conversation in this episode of the Asia In-Depth podcast.

Tom Nagorski: Let’s start before the pandemic arrived, when global supply chains were functioning well. How does a good, seamless supply chain operate? And why is it so important for companies, consumers, and the whole global economy that they work well? 

Wendy Cutler:  Supply chains are the way companies organize their production. They're driven by a desire to promote low costs and efficiency. Companies find suppliers all over the world who can provide inputs on a timely basis that can be put into a finished product and forwarded to the consumer — whether it be someone at a store or an industrial consumer — as quickly as possible. 

We know that supply chains are working when we hear nothing about them. Even before COVID, they were beginning to come under stress, largely due to the U.S.-China trade war. But COVID has exposed new vulnerabilities, leading many companies to rethink their current supply chains in a variety of sectors. 

Global supply chains have contributed enormously to low consumer prices in the United States. One of the problems with “reshoring” — the drive to bring production back to the United States — is that prices on those products will likely go up because costs will go up. 

China is usually involved in any major global economic news story — as well as in any complex global supply chain. What advantages does China have that puts it in the middle of so many of these systems and networks? 

China has become the central force in so many global supply chains for a range of manufactured products, whether it’s electronics or cars or toys or textiles. It has so many advantages compared to other countries, including just its sheer size. Moreover, it has a skilled workforce and an efficient and extensive infrastructure that allows products to move very quickly within and out of the country. 

There are also other factors that companies take under consideration, including — though this has changed over time — China’s low-cost, low-wage workforce. As the wages for Chinese workers have gone up in recent years, we've seen companies move more of their production to Southeast Asia and South Asia, even before the U.S.-China trade war and COVID-19. Companies are adjusting their supply chains all the time. They need to balance all of these factors as they strive to be as cost efficient as possible.  

The pandemic hit China first, causing a near-total shutdown of its manufacturing capacity. What were the effects of this — and how quickly did it impact these global supply chains? 

Wuhan, where the virus started, is a central manufacturing hub for China. Companies in Wuhan produce automotive parts, pharmaceuticals, electronics, and electronic parts, among other products. 

The virus hit production lines very quickly. One of the first companies outside of China that felt the implications of COVID-19 was Hyundai in South Korea. Hyundai couldn't get one of the thousands of parts it needed for its auto production, and actually had to shut down some plants. This shows the vulnerabilities that were exposed when a company is reliant on one source of production for a key input. 

Hyundai was not alone. In fact, many auto companies either had to scale back or delay production until Chinese inputs could be provided. But by then, COVID was moving to Europe, so it became even more complicated. 

When you have an efficient supply chain, a company like Hyundai can’t just say: “Fine, we’ll just go and get those parts we need from another part of the world.” 

For the sake of a cost-effective supply chain, ideally you don’t want to have three different manufacturers of the same part because that's just more expensive. But indeed, that's what's going to happen. Companies are realizing their vulnerabilities and recognizing that just being cost efficient is not enough. They also need to diversify and build resilient supply chains. If their source for an input can no longer get their part to them quickly — because of a pandemic, another natural disaster, or some political event in that country — then they can turn elsewhere and not have to shut down their entire production. 

In the United States, there was already a push from the Trump administration to “reshore” production — or bring more manufacturing back to this country. What are other countries planning to do to respond to this broken global system? 

We’re seeing a trend where governments are trying to encourage their companies either to come home (as in the U.S.), or in the case of Japan, to leave China and go to Southeast Asia. Governments are providing incentives, such as tax breaks, to make their countries more attractive investment destinations. But we also may see penalties, particularly in the trade area, against companies that don't reshore to the United States.  

The president mentioned that he may even try and impose tariffs against companies that don't come back to the United States. His administration has also announced a policy of not awarding government contracts to companies that don't reshore. With other countries, it's not so much about returning production to their country — it’s about building more resilient, secure, and trustworthy supply chains. So, if there's another pandemic or emergency, they'll be better prepared. 

How are companies coping with these disruptions, especially if China is a link in their global supply chain? How do you build a trusted or a secure supply chain in this day and age? 

When companies make supply chain decisions — do they want to stay in China? Do they want to come back to the United States? Do we want to expand production in Southeast Asia? There are a lot of considerations. These include the economic growth rate of these countries, the level and types of regulations in place, tax rates, the quality of the infrastructure, and the sophistication and flexibility and cost of the workforce. 

I think one thing though is clear: If you look at the recent survey of over 100 companies issued by the U.S.-China Business Council this past summer, 70 or 80 percent of U.S. companies in China responded that they don't have any plans to exit China. Now, many of these companies are producing goods for consumption in China, so they're not there to export inputs into a broader supply chain. That said, China still has enormous advantages over other countries, even though places like Vietnam are implementing policies that will attract production from companies that are looking to diversify their supply chains. 

Is it possible that these recent supply chain movements away from China have just been just a blip? 

Many companies still look at the large and growing market in China and want to be there. They're willing to incur the cost and unpredictability and perhaps the over-dependence on the Chinese market because they think it outweighs the cost of moving to other destinations. 

Can what China’s done be replicated in other countries? Practically speaking, what would happen if a lot of companies moved to Vietnam, Bangladesh, or even Mexico for supply needs that are currently met by China? 

I think certain companies will move, but many others won’t. This will depend not only on the culture of the company and the kinds of risks they want to take, but also on the sector and which conditions they think are most important for the production of their product. 

Even if companies stay in China, many will still aim to diversify their supply chains, so if something else happens in China, like what we saw in Wuhan, they will have alternative sources for key inputs. I think that’s one lesson that companies have learned. They don't want to shut down complete production lines, and they're going to have to incur more costs for that diversification. 

But many will think that is well worth it, because shutting down a production line means no money's coming in from that line, and it means the workers that they need for that line’s jobs are jeopardized. Diversification and resilience is important, even for companies that choose to stay in China because of the advantages that China provides with respect to supply chains. 

And that's good news, right? It might mean we pay slightly higher prices, but the reduction of those shocks and vulnerabilities would, I assume, be a good thing. 

Absolutely. I think many companies got so fixated on efficiency and low costs that they didn't plan sufficiently for risks. They didn't fully think through their vulnerabilities, so this is a useful lesson. And frankly, in looking ahead, due to either climate change or other pandemics or unexpected weather occurrences, we can expect further stresses to supply chains. 

Some of the things you’ve spent your career working on — like free trade and globalization — have become, in some places, dirty words. I assume, though, that you’d argue that global supply chains aren’t going anywhere. They’re just ripe for change. 

Right. I think we're going to see important adjustments to supply chains, but globalization and intricate supply chains will continue. But we're not going back to where we were. And in fact, based on many studies, globalization peaked in 2008 and, since that time, you've seen supply chains start to move out of China. So again, adjustments have and will continue to be made, and they can be viewed as healthy adjustments in many cases. 

What I worry about though is that in this push for reshoring, the U.S. government doesn't think through which sectors are critical to have here at home and the impact on consumer prices. We have many allies and partners around the world that we could work with to set up trusted supply chains, as we advocated in our most recent ASPI paper entitled Reengaging the Asia-Pacific on Trade: A TPP Roadmap for the Next Administration.