Time to readjust global supply chains

Trade conflicts, the COVID-19 pandemic and geopolitical tensions have all had an impact on the global supply chains, necessitating a rethink on how these crucial production links are established and how they can be made more resilient.

One key lesson of the pandemic and subsequent supply and demand mismatches is that global supply chains are fragile. They have been struggling amid uneven economic recovery and trade conflicts between global heavyweights, and face geopolitical risks that are critically weighing on food and energy supplies.

Businesses, particularly those in manufacturing, are finding it difficult to source inputs and engage in seamless, multistep logistics and delivery management systems across borders. At the national level, this has resulted in shortages in key medical products and equipment during the pandemic, shipping and transportation costs going through the roof, and security concerns over the heavy reliance of critical goods and commodities from countries that could turn less supportive or even antagonistic in a volatile geopolitical environment.

As such, the time is right to rejigger global supply chains. According to one school of thought, there is a need to diversify those far away from places prone to disruptions due to economic, health, climate change and geopolitical issues. The other is to bring the production capacity back to the home country ("onshoring") or to countries nearby ("nearshoring"). The benefits of diversification transcend sheer cost minimization. They also involve gains from risk mitigation and securing back-up sourcing plans in case of a threat to existing supply chain security.

Nearshoring utilizes geographical, or even cultural and political proximity of neighboring countries for upstream or downstream segments of supply chains. Onshoring builds production capacity of goods at home, often intending to cover the end-to-end business streams of designing, sourcing, manufacturing, marketing, distribution, sales and post-sales services.

Regional trade blocs or agreements such as the European Union, the Regional Comprehensive Economic Partnership and the United States-Mexico-Canada Agreement support nearshoring. The Indo-Pacific Economic Framework is another example, although it can fall under the category of "friendshoring" as touted by some people, where the scope of "friend" goes beyond the geographical boundary.

Although concerns are growing about potential fragmentation of global supply chains based on a few trading blocs among allies, their future may not follow one common path, and will unfold differently depending on different countries' priorities and sectoral characteristics. It is also worth noting that a government's industrial policy can do only so much and the ultimate reconfiguration of supply chains is hugely dependent on how businesses take supply chain risks on board and how they respond to incentives provided by governments.

While supply chain risk management seems to have become part of operational decisions in many C suites, cost efficiency and gains from specialization and trade are something that businesses cannot entirely forgo. In this sense, reshoring versus further diversification of supply chains should not be viewed as an either/or choice, but as a strategy to be pursed correspondingly.

Some sectors will rely more on reshoring while others will focus on further diversification, subject to supply chain vulnerabilities and the expected gains from repositioning of management strategies.

In rejiggering global supply chains, governments should consider certain important factors.

First, they need to pursue reshoring in a selective and efficient way. No matter how ambitious a country might be, reshoring across broad industries is neither possible nor desirable given the additional cost implications and inefficiencies involved in bringing back home part of the supply chains.

Although we hear a lot about the need to rebuild production capacity of semiconductors in the United States and the EU, with their heavy reliance on East Asia for manufacturing (foundry), this doesn't mean they have forgone the sector entirely over time. They have rather become specialized in the high value-added, upstream segment of the chips supply chain such as electric design automation, and discrete, analogue, optoelectronics and sensors, relegating simpler manufacturing processes largely to Asian economies.

By encompassing the manufacturing segment, reshoring will certainly enhance supply chain security for this critical "new oil" of the economy, but with additional cost implications at least in the short term. This is where technological advances can play a role, and the level of technological sophistication vis-à-vis traditional foreign peers will characterize the efficiency of such reshoring strategies.

Second, reshoring strategy ought not to solely target outsourced production capacities of domestic companies. Attracting foreign investment could also be a part of the strategy to cope with short-term domestic constraints in human and physical capital mobilization. Domestically incorporated foreign invested enterprises will make no less contribution to expanding production capacity and job creation than local companies, let alone the expected technology spillovers.

Third, diversification motives should not be based solely on cost efficiency. Instead, they should consider risk management perspectives. For this, the offshoring of production to multiple sites with lower correlation of various supply chain disruption risks will help. This also corroborates the rationale that free trade agreements should be explored not only with geographical neighbors but with trade partners further afield, too, to expand the scope for such opportunities.

And fourth, while government incentives to rejigger supply chains could be effective in jumpstarting businesses' motivation to reshore or diversify, this may not ensure the long-term sustainability of such approaches, given that subsidies tend to ameliorate fixed costs, not operational costs, for investment or tax payment.

Incentives for export competitiveness could also have some implications on compliance with World Trade Organization rules and stoke retaliatory reactions from trading partners. So the success of such strategies will hinge on how well an eco-system can be nurtured to facilitate a virtuous cycle of outputs from newly expanded production or sourcing capacity being linked to robust demand base domestically and abroad.

Legitimate economic rationale and political motives for rejiggering global supply chains may not always ensure its success unless pursued with strategic thinking and practical implementation plans, which also need to be well aligned with business incentives. Rhetoric is one thing, but implementation is another. Only those that can wisely strategize its implementation will be able to reap the benefits.

The author is principal economist at Economic Research and Regional Cooperation Department, Asian Development Bank.

The views don't necessarily reflect those of ADB or China Daily.