Global supply chains used to be the last thing policymakers worried about. For a long time, it was almost exclusively economists who were concerned with the potential efficiency gains and potential risks associated with the interrelationships. Although the Japanese nuclear catastrophe in Fukushima in 2011 clearly showed the negative impact of interruptions in supply chains on the global economy, few politicians suspected that this could become a central problem.
Today it is very different. The current supply bottlenecks for semiconductors, for example, accompanied by corona-related disruptions in transport routes, impede production processes, support inflation – and are now occupying political decision-makers all over the world. The administration of US President Joe Biden has recognized that functioning supply chains are a key to future economic security.
In February 2021, Biden directed several federal agencies to secure and strengthen American supply chains. And in June the White House released a 100-day report on “Building Resilient Supply Chains, Revitalizing American Manufacturing and Promoting Broad-Based Growth.” There are many important proposals in the report – such as raising the skill levels of the American workforce and improving the ability of the economy to innovate.
It also addresses the impact that the dependence of the defense industry and other critical industries on imported intermediates has on national security. Most important, however, is the realization that global supply chains have also created immense social costs – for the American losers of globalization. The report begs the question of whether hyperglobalized supply chains are the ultimate wisdom.
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The common answer of economists is: “Yes, they are.” If two companies conclude a deal in which both gain something, it is not only good for the companies concerned, but also for the rest of the economy, as it increases efficiency and benefits Cost cutting is coming. From the point of view of these scientists, it seems irrelevant whether this is a US manufacturer who outsources the production of preliminary products to a Chinese company.
In the worst case, domino effects arise
However, supply chains can pose a major threat to economies, with economic risks increasing the more complex supply chains become. Even the interruption of a link can affect the entire chain and drive up prices if there are sudden bottlenecks. In the worst case, domino effects arise that not only bring companies to their knees, but also paralyze entire industries.
The parallels between the real economy and the financial industry are obvious: the bankruptcy of the investment bank Lehman Brothers in 2008 caused a tremor in the international banking sector that brought capitalism to the brink of collapse. Of course, companies always consider such risks when making decisions about building supply chains. Most of the time, however, only from their respective individual perspective.
Systemic effects of disruptions, on the other hand, are often ignored – such as the risks that they impose on other companies or even on the entire economy. In addition, even small price advantages from foreign providers are often considered attractive in the short term in global competition because they help reduce costs. Leading company managers collect lavish bonus payments if they increase their profits in this way. In the medium and long term, the much higher costs of non-functioning supply chains or corporate bankruptcy often have to be paid for by the state or taxpayers.
Another, more subtle, way companies are stretching their supply chains is no less important. The problem, according to the White House report, is that “the United States has viewed certain characteristics of global markets – particularly fears that businesses and capital will flee to where wages, taxes and regulation are lowest – as inevitable” .
It’s not just about trade and services
This statement reflects the forward-looking observation of Harvard economist Dani Rodrik that globalization is not just about trading in goods and services, but also about sharing profits (rent-sharing). The globalization of supply chains is thus also an essential part of the shift in the relationship between capital and labor.
The simplest mechanism is the relocation of production factors abroad. Managers can use this threat to keep wages low. US companies, for example, counter wage demands from their employees by including countries like Vietnam in their supply chains, where pay is of course much lower.
Fragmented supply chains make it difficult for workers to push through higher wage demands in collective bargaining. In addition, companies even get tax benefits from globalizing their supply chains if it allows them to transfer profits to countries with lower taxes.
This reason is also particularly problematic for the US economy. It suggests that managers tend to globalize their companies’ supply chains, even if it isn’t more efficient. It is enough for them if profits made in this way are shifted from employees to shareholders without anything in return. This not only leads to overstretched supply chains, it also changes the distribution of income – especially at the expense of workers with low and medium qualifications.
It takes fundamental changes
What lessons can be learned from all of this? The White House report suggests keeping a greater part of the supply chain in the US going forward, especially manufacturing. But how can that be achieved? A two-pronged approach would be most effective: First, there must be, for example, tax incentives for companies to invest in their domestic supply chains.
This could remove the tax benefits of moving production abroad and override its adverse effects on the relationship between employers and employees. Second, more fundamental changes are also required.
The disruptions in global supply chains should be an incentive for the USA, but also European industrialized countries, to discuss who should actually benefit from the economy. As long as top managers benefit from the short-term stock market performance, the problem of overstretched supply chains will hardly be able to get under control.
The Author: Daron Acemoglu is a professor of economics at the Massachusetts Institute of Technology.
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