Tensions mount between security and efficiency in global trade
Published 21 May 2020
The coronavirus pandemic has caused both governments and businesses to question some of the assumptions that have underpinned global trade for decades. In the balance between economic efficiency and security of supply, the pendulum may be swinging back toward security.
The coronavirus pandemic has caused both governments and businesses to question some of the assumptions that have underpinned global trade for decades. By the time the dust settles, the world’s approach to trade could look quite different.
Extended global supply chains brought unprecedented economic efficiencies generated by extreme specialization of production and the ability to reduce costs through just-in-time inventories. These benefits are now being weighed against the risks created by the lack of redundancy and the consequences of severe disruption when key suppliers are not available. Rising economic nationalism and strategic rivalries are prompting multinational companies to rethink their investment and production strategies.
Weighing security over efficiency
In the balance between economic efficiency and security of supply, the pendulum may be swinging back toward security. This shift will apply not only to essential medical supplies and medicines but across the full spectrum of trade. Many automotive production facilities in South Korea, Japan and elsewhere were forced to suspend operations at the onset of the coronavirus outbreak when the flow of critical components from China was interrupted.
Companies may not only rethink supplier relationships. They might also consider further diversifying their own production. Take for example the recently announced decision by Taiwanese semiconductor giant TSMC to build a US$12 billion production facility in the state of Arizona, which may represent an attempt to mitigate business risks emerging as a result of geostrategic rivalries, in particular between the United States and China. The compelling economic rationale for TSMC’s Arizona facility is not readily apparent. The costs of semiconductor fabrication are relatively higher when compared to TSMC’s facilities in Taiwan, where the bulk of its manufacturing is done.
Reducing over-dependence on Asia supply chains
The TSMC facility might represent an industry step toward a more US-based high technology supply chain. But there might actually be less to the proposed plant than meets the eye. By the time it is operational in 2024, it is expected to produce semiconductors based on existing (rather than next generation) technologies, and it will lack capacity to produce at a game-changing scale. The 20,000 silicon wafers the Arizona plant is expected to produce each month is only one-fifth the capacity of the larger Taiwan-based fabrication facilities.
However, as the Trump Administration has been vocal in its desire to repatriate elements of vulnerable supply chains wherever possible, the move could also represent an opportunity to hedge against the risk that more production of critical industrial products will be compelled to be manufactured and procured in the United States, something other governments are contemplating as well.
At the recent G20 Finance Ministers meeting in Riyadh, French Finance Minister Bruno Le Maire — a staunch advocate of deepening economic integration — posed a question which just a few years ago would have seemed inconceivable: “Do we want to still depend at the level of 90% or 95% on the supply chain of China for the automobile industry, for the drug industry, for the aeronautical industry or do we draw the consequences of that situation to build new factories, new productions, and to be more independent and sovereign? That’s not protectionism — that’s just the necessity of being sovereign and independent from an industrial point of view.”
Le Maire’s comment captures the policy debate officials around the world are wrestling with, even in countries that have traditionally been strong pro-trade and pro-integration advocates.
Doubling down on regional trade agreements
Broader strategic considerations were undoubtedly at play in the decision. Taiwan’s position as a global supplier of chips – as well as a highly sensitive flashpoint in US-China relations – means that TSMC is inevitably caught up in the technology and strategic rivalry between the US and China.
TSMC’s investment may not be a bellwether that US companies will re-shore or that multinationals will flock to the United States. More likely, companies will build more diversity into their supply chains with more emphasis on regional trade and less reliance on a single trade partner.
This could have big implications for the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Although neither China nor the United States are currently parties to the CPTPP, the agreement is a useful vehicle to achieve greater trade and investment diversification for its current members. As a self-selected, voluntary grouping of economies ostensibly committed to promoting trade and investment among members, the CPTPP could provide some degree of insulation against the surge of export restrictions.
With the CPTPP positioned to take on greater relevance in the post-Covid-19 world, Thailand, South Korea, Indonesia and the Philippines have indicated interest in joining. Japan seems to be the informal new member recruitment manager, with Japanese officials already working closely with their Thai counterparts on the mechanics of accession.
Japan’s role is not a matter of happenstance. Japanese officials understand the dangers of over-reliance on a single market. Japan relies on China for about 37% of its imports of automotive parts and 21% of its imports of intermediary goods overall. In light of the Covid-19 disruptions, Japan is making a concerted effort to reduce its supply chain dependencies on China. The recent stimulus bill passed by the Japanese legislature allocated US$2.2 billion to help Japanese manufacturers shift production out of China.
A lasting impact
The Covid-19 pandemic will recede at some point. But its impact on trade will endure. The world can expect to see less China-reliant supply chains and increased use of regional trade agreements, providing a particular boost to the economies of Asia that multinationals see as the alternative to China.