Americans can be forgiven for thinking that every critical system we rely on is breaking down. The country—nay, the globe—has endured years of social, political, environmental, and epidemiological upheaval. Pick your shock: COVID-19, wildfires, George Floyd protests, climate change, January 6. They all seem like harbingers of a chaotic future.
But backlogs in Pottery Barn orders are when shit gets real.
From Bosch dishwashers to bucatini to chicken wings to pipette tips, the past year has seen a raft of press coverage about delays, price spikes, and other disruptions to the production and shipment of goods to the United States. Strains in the global supply chain caused semiconductor shortages and big price increases for used cars. Toyota, Ford, and General Motors have all scaled back production in recent months because of the dearth of computer chips. When the container ship Ever Given temporarily ran aground in the Suez Canal, the Financial Times asserted that the accident showed "the inherent fragility of tightly stretched global supply chains at the very moment when they are already being buffeted by a pandemic and in an era when the philosophical underpinnings of global trade are being challenged."
Journalists aren't the only folks freaking out. Less than six weeks into his term, President Joe Biden issued an executive order mandating that eight cabinet departments examine the resilience of U.S. supply chains, warning that "pandemics and other biological threats, cyber-attacks, climate shocks and extreme weather events, terrorist attacks, geopolitical and economic competition, and other conditions can reduce critical manufacturing capacity and the availability and integrity of critical goods, products, and services." More recently, Biden has floated multiple policy responses, including using the National Guard to untangle snarled supply chains.
The administration's concern about global supply chains fits in with the political elite's larger ideological pivot away from trade liberalization and toward a more mercantilist posture. Indeed, this is the area where the Biden and Trump administrations sound the most similar. Biden's U.S. trade representative, Katherine Tai, stated in a congressional hearing that trade liberalization and tariff reductions were no longer her office's principal goals. In June, Biden's National Economic Council director, Brian Deese, declared that "resilient supply chains must be at the center of a 21st century industrial strategy." One of Biden's senior directors at the National Security Council has told me that "the U.S. is not a trade-dependent nation." Another administration official questioned to me whether the notion of comparative advantage in trade still exists. Never one to be outdone in policy freakouts, Sen. Josh Hawley (R–Mo.) has introduced a bill requiring more than half the value-added of any critical good to be domestically sourced.
The recent convulsions in global supply chains do highlight ways the globalization of the past decade differs from the idealized models taught in introductory economics courses. Globalization has produced far more market concentration than would have been expected a generation ago. The tripling of the Baltic Dry Index (which measures the cost of shipping dry goods such as coal or steel between ports) and the quintupling of U.S.-China container shipping rates over the past year demonstrate that frictionless markets do not exist. Rising geopolitical tensions between the United States and China reveal the ways that great power competition will complicate cross-border exchange. And the pandemic showed how the global economy can be buffeted by shocks that textbooks typically do not discuss.
A closer look at global value chains reveals ways that both public-sector and private-sector actors have prioritized short-term efficiency at the expense of long-term resilience. But it also reveals a mismatch between a lot of overheated political rhetoric and an actual understanding of how the global economy works. Many of the past year's issues are temporary—and when it comes to strained global supply chains, globalization is more often the solution than the problem.
When Ford completed its massive River Rouge plant in 1928, it created a factory that controlled every facet of car production, including its own steel mill. Trade volume was high during this era, but very few intermediate goods crossed borders. In the time since then, the industrial organization of production has changed a wee bit.
Whereas trade a century ago was primarily in finished goods, manufacturing now has disaggregated itself into myriad chains of subcontractors. As one MIT Sloan Management Review article summarized the phenomenon, we have a "deeper tiering of supply chains whereby suppliers draw upon their suppliers who in turn draw on their own networks of suppliers in multistage production networks."
Why did this happen? The end of the Cold War eliminated most geopolitical concerns about where to locate production facilities. Basic trade theory meant an awful lot of facilities expanded in China, the low-cost manufacturing locale. The reduction of transportation and communication costs made it easier for production to be disaggregated and managed at a distance. "Just-in-time" manufacturing encouraged companies to hold minimal inventories and count on suppliers to respond quickly to fluctuations in consumer demand. Management consultants stressed the efficiency of offshore outsourcing.
The most widely cited example of the globalized supply chain is Apple's iPhone. Most people know that the iPhone is manufactured in China and exported to the United States. What is less well known is that China plays only a minor role in the creation of its added value. The iPhone's flash drive comes from the Japanese firm Toshiba. Samsung, a South Korean firm, provides the application processor. A German company provides the camera module, and a U.S. subcontractor provides the Bluetooth application. All of these parts are then assembled by a Taiwanese firm, Foxconn, with operations in Shenzhen, China.
The management consultants were right about the efficiency. While productivity in the service sector stagnated after the turn of the century, manufacturing productivity continued to soar.
The political economy advantages were also apparent after the collapse of Lehman Brothers. The last time a financial shock of that magnitude hit, the trade wars of the Great Depression began. 2008 was different. A World Bank study examined trade restrictions immediately after 2008 and found that "vertical specialization" was the most powerful economic factor that limited tariff increases. The more a country's economy was enmeshed in global supply chains, the less likely it was to raise barriers to trade. Global supply chains help explain why the Great Recession did not lead to trade wars like those of the Great Depression.
So these global value chains seemed like an unalloyed good. And then the 2010s happened.
As global supply chains grew more and more complex, there were signs of trouble on the horizon. In 2011, the Chao Phraya River floods in Thailand severely but temporarily constricted production of hard disk drives, because close to half of global output was sourced from Thailand. In 2017, U.S. hospitals faced an acute shortage of IV bags after Hurricane Maria knocked out a key production facility in Puerto Rico.
The 2011 earthquake and tsunami that hit Fukushima in Japan affected key nodes in global manufacturing. Some firms suspended sales of cars in certain colors because key ingredients were stored near Fukushima and inaccessible. An iPhone designer warned The New York Times that "there are all kinds of little specialized parts without second sources, like connectors, speakers, microphones, batteries and sensors that don't get the love they deserve. Many are from Japan."
These supply chain hiccups highlighted one underanticipated phenomenon of globalization: Rather than strengthen market competition, it strengthened market concentration. Consumer-facing firms from Walmart to Ford to Apple to Home Depot stressed cost minimization ubër alles. Firms that excelled at efficiently producing one part became near-monopolists for that component. This is how Taiwan Semiconductor Manufacturing Company (TSMC) became the dominant global supplier of customized semiconductor chips. Other chipmakers focused on design, subcontracting to the Taiwanese firm for the physical production. As TSMC accrued comparative advantages in chip production, even established competitors such as Intel struggled.
The return of geopolitical competition has also flummoxed producers. China is a critical node in almost every global value chain. Over the last decade, as Xi Jinping has consolidated his power, the Chinese state has taken a number of steps that have raised hackles in Western capitals. Some of these, such as the Belt and Road Initiative, have been overhyped. Others, such as the subjugation of the Uyghurs, repression in Hong Kong, increasing control over United Nations agencies, and the expansion of China's nuclear arsenal, have not. Xi's "wolf warrior diplomacy" has triggered evaluations in the United States, Europe, and Pacific Rim about just how vulnerable their economies are to disruptions from Chinese suppliers. The 2010 rare earth embargo on Japan in response to a territorial dispute in the East China Sea offered a warning about how China could weaponize the interdependence of global value chains; Huawei's dominance in 5G offered another. Erratic U.S. policies during the Trump administration served in turn as a warning about how Western governments could disrupt global value chains.
Finally, the COVID-19 pandemic exacerbated the problems of both market concentration and political whimsy. As China reeled from the pandemic's first wave, there were disruptions across the global economy. China exercised state power to seize domestically produced personal protective equipment and other medical supplies; the United States soon reciprocated. According to Global Trade Alert, 157 export controls on medical supplies and medicines were put in place across 86 jurisdictions in the first six months of the pandemic. U.S. leaders expressed concerns about vulnerability to China weaponizing its role in medical supply chains. So did journalists: In May 2021, 60 Minutes warned that "COVID showed that the global supply chain of chips is fragile." The Washington Post concurred: "The pandemic has exposed fragile global supply chains across multiple continents."
Countries exercised vaccine nationalism, stunting global immunization against COVID-19, which in turn facilitated the development of more dangerous variants of the novel coronavirus. The delta variant has penetrated Chinese port facilities, Malaysian chip factories, and Bangladeshi textile plants, leading to periodic shutdowns that have spiked container shipping prices and lengthened order backlogs.
Throughout all this, producers seemed to be stuck in quicksand. The past decade has not been shy in signaling to firms that there might be risks to increasingly disaggregated global supply chains. If natural disasters, pandemics, and geopolitical tensions were not enough, now management consultants are piling on. The same consultants who urged offshoring a generation ago are now telling firms to retrench from globalized supply chains. But most firms do not seem terrifically interested in changing their practices. Multinational corporations like Apple have not altered their supply chains in response to political pressure. Whether one looks at business surveys or journalistic accounts, the results are the same: Most U.S. firms do not plan on moving their supply chains away from China.
A world in which the distribution of goods is held up due to constant supply chain disruptions seems less than ideal. What can be done about it?
One thing that would be great is if everyone would acknowledge that a lot of the issues with global value chains right now have to do with demand more than supply.
When the pandemic began, there was an immediate and acute contraction of demand. Producers assumed that this would be the new normal and reduced their output. They were mistaken. The combination of emergency COVID-19 relief and the work-from-home phenomenon led to a resurgence of demand. The affluent class had considerable sums of disposable income. The pandemic made spending on services a less viable option, so instead they spent it on stuff: cars, furniture, home office equipment, gaming systems, house renovations, and so forth. The shortage of semiconductor chips was caused by the unexpected twin rebounds in demand for cars and consumer electronics. As one Federal Reserve analysis explained, "the pause in demand was much shorter and the rebound in demand was much stronger than anticipated." These demand surges surprised suppliers and led to the production bottlenecks that are currently seizing up Pottery Barn orders.
While demand has been stronger than expected, supply in critical sectors coped better than expected. The predicted pandemic breakdowns in supply chains for food and medical supplies proved to be overstated. Surveys of logistical firms last year revealed that the pandemic had minimal effects on their operational capabilities. Even when it came to medicines and personal protective equipment, there were only minor disruptions after the initial shock in March 2020. Claims that the global supply chain in medical products rendered states vulnerable to weaponized interdependence proved to be wildly exaggerated. The pandemic affected service sectors such as tourism far more severely than any manufacturing sector. Indeed, Slate's Jordan Weissmann pointed out recently that "imports were up 5 percent year-over-year in September, and up 17 percent compared with the same time in 2019." This happened despite the decline in air passenger traffic, which restricted yet another means of shipping goods by air. Supply has increased—it's just that demand has surged even more.
The private sector is responding to market signals by ramping up production and ensuring multiple supply lines. Intel, Samsung, and TSMC are all spending tens of billions of dollars to build new chip foundries in the United States. Skyrocketing shipping prices are incentivizing additional construction of new container ships. The Wall Street Journal reports that in the first five months of 2021, there were nearly twice as many orders for new container ships as there were in all of 2019 and 2020 combined. To ensure holiday inventory, large retailers like Walmart and Home Depot have chartered their own container ships. Container shipping rates have already started to decline from September peaks.
But these capital investments designed to boost resilience will take years to kick in. This time lag is one reason private-sector actors have been so slow to invest in resilient supply chains in the past. If disruptions are expected to be temporary, such investments might seem like overreactions. Given the billions of dollars at stake, this sort of risk aversion is unfortunate but understandable.
Long-term investments in resilience make some sense, but short-term investments in robustness make even more sense. Resilience is the ability to adapt in response to permanent shocks to the system. Robustness is the ability to maintain output levels in response to a short-term hit. The most obvious way that firms can enhance their robustness is to warehouse supplies of key components. Car manufacturers, for example, are pledging to ramp up their inventories of critical components to ensure a more reliable production stream.
Yet the auto sector appears to be the exception and not the rule in bolstering inventories. For most firms, increasing reserves of component parts is an expensive proposition. To a corporation, holding inventory is like holding cash: Why sit on an asset that yields no rate of return? Lean manufacturing was popular in the first place because it boosted profits.
Even as semiconductors have grown scarce, chipmakers and chip customers have battled over which firms will shoulder the costs of carrying greater inventory. Under the just-in-time system, the chipmakers had held the inventory. As one semiconductor CEO said earlier this year, the shortage has shifted the balance of power: "If they expect the semiconductor [suppliers] to be the bank, to keep having a big working capital to support them, they can forget it."
Bottlenecks in the global supply chain threaten the macroeconomic and microeconomic health of the United States. On the macro side, supply chain issues are driving fears of inflation; if not brought under control, this could cause the Fed to prematurely raise interest rates. A related problem is consumer panic over rumored shortages. See, for example, the effect of the ransomware attack on Colonial Pipeline—drivers panicked and went to gas stations to top off their tanks, temporarily worsening the problem.
On the micro side, the high price of inventories and shipping imperils market competition. Supply risks privilege larger firms over small and medium enterprises. Multinational corporations have the capacity to make large-scale investments in resilience and robustness. They are also able to use their market power to ensure continued access to scarce container billets in ships; your local bodega, by contrast, is unable to charter an entire container ship. The more stretched the global supply chain, the more sectors that look like monopolies rather than a competitive marketplace.
When it comes to fixes, there has been a surplus of really dumb ideas about what the government could do. Hawley's idea of essentially nationalizing supply chains stands out as the dumbest. Such a move would take well more than the three-year window he proposes to execute. Prices would permanently rise due to new inefficiencies. The opportunities for rent-seeking are legion; every sector would be lobbying Washington that what they produce is "critical." It is also worth remembering that Hawley's go-to policies of protectionism and immigration restriction shoulder much of the blame for the lack of truck drivers that have contributed to delivery delays.
The Biden administration's responses have run the gamut. White House Press Secretary Jen Psaki tried to laugh it all away by reducing the issue to "the tragedy of the treadmill that's delayed." That will not play well with a country used to just-in-time delivery and trying to move past the pandemic. Nor will Biden's proposal to open the port of Los Angeles 24/7 have much of an effect. While ports are currently jammed, there are also bottlenecks in railroad cars and truck drivers—both of which are issues that predated the pandemic. Even if the port gets unstuck, the traffic jam will just migrate to America's railroads and highways.
Looking at manufacturing more generally, some firms have acknowledged that they were unaware of the geographic distribution of their suppliers prior to the pandemic. This is one area where the Biden administration's efforts to collect data on supply chains could be useful.
If the federal government can identify (or even stock) priority components that would affect multiple sectors, those strategic reserves could theoretically bolster the robustness of the U.S. economy. But not if such investments become a stalking horse for protectionism.
All of the evidence of the past year suggests that globalization helps economies recover more quickly from supply chain difficulties than aggressive efforts at homeshoring. This is because most shocks are localized, and access to global value chains facilitates recovery more quickly. Indeed, protectionism is partly to blame for the current mess. As the Cato Institute's Scott Lincicome recently noted, the Jones Act, which mandates use of U.S.-built, crewed, and flagged ships to move cargo from one U.S. port to another, has raised the costs of coastwise shipping, putting even more pressure on truck and train transport.
Unsurprisingly, U.S. producers seeking relief from skyrocketing shipping rates have asked the Biden administration to reduce tariffs. Protectionism isn't the solution to these breakdowns in our supply chains; it's part of the problem.
The post Where's My Stuff? appeared first on Reason.com.
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