Penn on the World after COVID-19 The Geopolitics of Post-COVID-19 Supply Chains
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April 30, 2020
Regina M. Abrami | Penn on the World after COVID-19
Penn on the World after COVID-19 is a joint project of Penn Global and Perry World House. We've asked some of Penn's leading faculty, fellows, and scholars to imagine what the global pandemic will leave in its wake.
Regina M. Abrami, a Senior Lecturer in Political Science and Senior Fellow at the Wharton School of Business, is the Director of the Lauder Institute’s Global Program and Head of its International Studies faculty.
President Donald Trump’s early April public spat with 3M Corporation’s CEO Mike Roman put a spotlight on the geopolitics of global supply chains. “P Act all the way!” Trump threatened, referring to the U.S. Defense Production Act. Roman responded that banning the export of 3M respirators would only hurt the United States if old-style tit-for-tat trade politics took hold. China is, after all, the world’s leading exporter of personal protective equipment (PPE), accounting for nearly 75% of face masks imported by the U.S. 3M’s Shanghai-based factory, as such, is not the problem according to Roman, but rather part of any solution to the public health crisis unfolding in the United States.
Still, it would be foolhardy to think that the U.S. and other governments are not rethinking the strategic risks of economic interdependency. China has in fact been a leader in doing so. Its 2006 “Medium and Long-Term Strategy for Science and Technology Development” made explicit that state planning and indigenous innovation, not free trade and foreign investment, were the key to global competitiveness. The subsequent 2015 “Made in China 2025” strategic plan called for the enhancement of domestic (“Chinese”) content of domestically-consumed goods and designated strategic sectors like telecommunications.
COVID-19 has broadened the debate over globalization beyond trade and economics to encompass public health and other second- and third-order globalization effects. Even so, there’s little sign that rising nationalism and emboldened mercantilists will win the debate on how best to ensure a country’s economic resilience. This conversation is more complicated than that and includes an array of voices, including Roman’s. To understand the role multinational corporations like 3M will play in the world and debate after COVID-19, we need to look at what businesses were already doing during the recent U.S.-China trade war.
Businesses hedged where they could. A first wave, which included makers and assemblers of low value-added goods, moved to parts of Southeast Asia in response to rising Chinese wages. A second wave, which included some of the electronics sector, favored a “China+1” strategy which aimed to demonstrate continued loyalty to the China market, while testing out nearby outlets. Even greater shares of global electronics production shifted out of China in the third wave, which kicked off in late 2018-early 2019. Tariffs, not wages, drove these late investment decisions. Most U.S. small firms could not absorb the additional costs, while large firms such as Apple, advised their Tier 1 suppliers, including Foxconn and Pegatron, to consider shifting additional production outside of China.
Changing patterns of global trade, in other words, were already underway in the run-up to COVID-19. Importantly, these early shifts were the outcome of price-driven decisions, and not borne of fear that state borders might shut indefinitely. COVID-19, however, has made clear that the Westphalian system and the borders that define it is alive and kicking. The Chinese government shut down businesses and banned exports in an effort to stem a worsening public health crisis within its borders.
The global ripple effect was felt almost immediately. Microsoft and Apple warned consumers to expect delays to market of best-selling products. Amazon declared it would stall restocking non-essential items, while the U.S government set up a webpage to track and explain drug shortages. Chinese firms also sought protection against contracts that they could no longer fulfill. Force majeure certificates were estimated recently to be equal to nearly US$73 billion in lost or delayed business.
In a snap, the long, lean, just-in-time production systems so integral to Chinese business structure appeared to be the weakest link in global supply chains. The country’s multi-tiered sub-contractor networks and competitive pricing, however, make quick exits difficult. If anything, additional tariff reductions initially linked to China’s 2001 accession to the World Trade Organization (WTO) further accelerated foreign direct investment. In turn, China’s share of PPP-based global GDP jumped from 8% in 2001 to 20% in 2020.
In a world riddled with COVID-19, we’re seeing foreign companies attempt to build on these investments, not dump them, by shrinking their China footprint while still engaging in trade. Already, Japan included in its economic stimulus funding for Japanese firms to make an exit from China. Larry Kudlow, Director of the U.S. National Economic Council, was quick to favor the idea for U.S. businesses. It does indeed take money to move production elsewhere. The United States, however, is not likely the next place for American companies departing China.
Southeast Asia, India, and parts of Latin America will gain, but picking spots is going to depend on the nature of trade agreements already in place between individual countries and their export markets. Vietnam is looking especially promising in this respect, with close proximity to China, membership in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or CPTPP, and a recently ratified European-Vietnam Free Trade Agreement. Chinese firms have not missed this cue either, with foreign direct investment into Vietnam sharply on the rise. At the same time, U.S. accusations of Chinese transshipment violations through Vietnam are increasing.
Taken together, these global shifts suggest that international businesses are going to go back to get ahead in a post-COVID-19 world. We will see the rebirth of supply chains similar to the patterns generated by the Multi-Fiber Arrangement, which drove businesses from 1974-1995 to disperse across the globe to arbitrage tariff restrictions. Back then, production networks were regionally dispersed hub-and-spoke formations, nothing like the long line that took us to China and back again over the past two decades. Resilience, in other words, is going to start to look a lot like it did before China’s 2001 WTO accession.
Companies will be driven toward redundancy to hedge political and economic risks to their supply chains, something which likely translates into higher costs. Depending on the industry, holding extensive inventory might again become common practice. Governments wishing to influence how these patterns emerge already have policy tools in hand. We can expect a continuation of preferential trade agreements and expanding pursuit of bilateral trade agreements, a tactic already favored by the current U.S. administration. Government buyers and major corporations will also be doing greater due diligence into supplier contingency planning.
Right now, however, when it comes to post-COVID-19 trade patterns, the cards are still very much in China’s hands.
The views expressed in Penn on the World after COVID-19 posts are solely the author’s and not those of Penn, Penn Global or Perry World House.