International Finance
Industry Magazine

Restructuring global supply chains: Good, bad & ugly

ifm-Restructuring-global-supply-chains-image
The fact that many firms are shifting from efficiency to resilience is an indication that there is a vast build-up in precautionary inventories.

The pace of economic integration was stalled in the 2010s due to the financial crisis that throttled companies across the globe. A rebellion was out in the open against then US President Donald Trump’s trade war, due to which the flow of goods and capital stagnated.

Many big shots postponed important decisions, especially with respect to investments abroad as they did not know whether globalization was facing a blip or extinction.

But now years later, even as everyone are still battered over the damage caused by the COVID-19 pandemic and the Ukraine war, the people in governments and boardrooms are reinterpreting the impact it could have on global capitalism.

Across the globe, supply chains are being transformed. From USD 9 trillion in inventories, stockpiled as insurance against inflation and shortages. As there is a requirement for a large workforce, many firms have shifted from China to Vietnam.

The wave of globalization is not about work efficiency, but about security. The priority lies in people with whom you can rely and do business. This also indicates that your government needs to have friendly tie-ups with counties where you are doing business.

It could result in worsening inflation, protectionism and big government. But at the same time if the companies and politicians show restraints, it might lead to a change in the world economy for the better. The fall of the Berlin Wall in 1989 is one such prime example, where efficiency was key to globalization during those difficult times.

The companies initiated productions that were low in cost. The investors deployed capital which resulted in higher returns. The governments were keen on treating every firm equally regardless of which part of the world they were from. They also kept both democratic and autocratic counties on the same plate and struck deals with them.

As an end result, two decades later this gave rise to sophisticated value chains that accounted for 50% of all trade.

This kept the prices at a low cost for the consumers and also pushed one billion people out of extreme poverty, thanks to the industrialization taking shape across the world including China.

But globalization also had its own set of issues. Flammable capital flows led to the destabilization of financial markets, which ultimately results in blue-collar workers in rich countries losing out. Now, two others worries have also become a huge concern. The first one is that some lean supply chains do not have a good value as they appear. They end up kept at a low cost, but when they break, the bill can be adverse.

Today’s bottlenecks have ended up reducing the global GDP by at least 1%. Both shareholders as well as the customers have taken a hit. Since the production of cars has been stalled due to the chip shortages, there has been an 80% year-on-year drop in the cash flow of the carmakers.

Apple CEO Tim Cook stated that such disorder could reduce sales by up to USD 8 billion, or 10%, this quarter. The COVID-19 was unexpected but extreme weather, wars, or even another deadly virus could easily rattle the supply chains in the coming years.

The second problem is that the single-minded pursuit of cost advantage has led to a dependency on autocracies that abuse human rights and use trade as a means of coercion. There have been hopes that economic integration would lead to reform but that has been dashed as autocracies account for a third of world GDP.

Russian President Vladimir Putin’s invasion of Ukraine has exposed Europe’s reliance on Russian energy. McDonald’s in Moscow which has been there since 1990 was restarted this week under local control.

Meanwhile, China has a trading footprint seven times as big as Russia and many counties rely on various products of theirs.

The fact that many firms are shifting from efficiency to resilience is an indication that there is a vast build-up in precautionary inventories. The biggest 3,000 companies in the globe have risen from 6% to 9% of world GDP since 2016. Many of them have been adopting longer-term contracts and sourcing.

In the multinational investment sector, the pattern has also changed. Companies, instead of sending their capital abroad, 69% comes from their local subsidiaries. This situation is similar to what happened during the 1930s when international firms decided to make subsidiaries abroad more self-sufficient.

The industries that are feeling the heat have already started reinventing their business models. Governments from Europe to India have put their weight behind these industries which are keen on ‘strategic autonomy’.

The car industry is also up for a new revolution as they have been heavily influenced by Elon Musk’s Tesla and are working towards vertical integration where one gets to have control over everything be it nickel mining or chip design.

Meanwhile, Taiwan’s electronics assemblers ended up downsizing their share of assets in China. From 50%, it has gone down to 35% since 2017 as prominent clients like Apple demand diversification.

In the energy sector, the West is seeking long-term supply deals from its allies instead of being dependent on spot markets dominated by rivals, which is a major reason why it is having close ties with gas-rich Qatar. With renewable energy, the power markets will become more regional.

The risk is that an objective quest for security will degenerate into widespread protectionism, job-creating programmes, and massive industrial subsidies costing hundreds of billions of dollars. This would increase volatility and fragmentation in the short term, driving prices even higher. US President Joe Biden’s consideration of additional solar panel tariffs, which he put on hold this month due to shortages.

If supply chains were to be randomly duplicated, there would be significant long-term inefficiency. The additional annual operating and financial expenditures required could surpass 2% of global GDP if you replicated a fourth of all multinational activities.

So, exercising restraint is essential. Governments and businesses must keep in mind that diversity promotes resilience rather than domestic concentration.

Based on their exports of items for which they have a dominant market share of over 10% and for which substitutes are difficult to obtain, autocracies control just around a tenth of world trade.

The solution is to mandate that businesses diversify their suppliers in these sectors, then let the market adjust. Will modern governments be able to handle the job? There is a lot of myopia and isolation.

However, if you are a consumer of global goods and ideas or a citizen of the globe, you should desire that the next stage of globalization has the highest level of openness. A new equilibrium between security and efficiency is a reasonable goal.

Mineral Shortages Could Disrupt Global Supply Chains
Vital mineral shortages received media attention last year after automakers revealed supply chain problems for semiconductors, which depend on critical minerals like lithium and cobalt.

Fewer automobiles were available for purchase as a result, and many consumers were forced to wait for automakers to finish their backlogs.

Over the ensuing decades, dependence on essential minerals is anticipated to rise, particularly as the globe moves toward renewable energy technology.

Companies Rethinking Their Supply Chain Networks
The global supply chains now need to be sourced from a variety of locations in order to reduce shipment and manufacturing disruptions during the COVID pandemic.

Over the past two years, port operations all over the world have been in disorder, with containers stacking up at terminals due to a lack of employees to reload them and truck drivers to transport them anyplace.

Shipping costs reached historic highs in 2021 as exporters in Asia competed for the limited ship space available to ship their goods to clients in the US and Europe.

Supply chain crisis continues to reverberate through global economies
University of Rochester economist George Alessandria during an interaction with Rochester Education pointed out how supply chain issues continue to reverberate through the American and global economies.

Regarding the current situation of supply chain shortages, he said, “This is the worst that it’s been in 50 years—and it’s probably getting worse, considering that China has been shutting down cities and production facilities. The massive lockdowns in Shanghai and Beijing will eventually ripple through the system again.”

He also blamed the COVID-19 pandemic for the crisis that the supply chain industry is facing now.

Alessandria said, “It all started with COVID-19 and the shutting down of ports and factories, which slowed down the movement of goods around the world. And then it just became hard to partially reopen the economy, since public health issues remained in play. That’s why we saw periodic closures of facilities and ports around the world all through 2021.”

Alessandria noted that the bounce-back in consumer demand was much stronger than what was anticipated.

“On top of that, the bounce-back in consumer demand has been stronger than what was anticipated. It’s like trying to push more and more stuff through a straw that shrank. It just doesn’t work well. While the supply chain shortages started with COVID, they’re also due to increased consumer demand, which was fueled by the federal stimulus checks that we probably didn’t need to keep the economy recovering. We just didn’t understand how consumer demand was going to shift, once the pandemic began to ease,” he added.

Vehicle shortages in US as supply chain woes deepen
Meanwhile, analysts have forecasted that there will be vehicle shortages in the US as supply chain woes deepen.

With analysts at Cox and Carmax-owned Edmunds.com indicating that supply chain problems will continue for the foreseeable future, Cox Automotive cut its projection for US auto sales in 2022.

Cox’s full-year projection was lowered from 15.3 million vehicles to 14.4 million vehicles, but still predicted a modest month-over-month increase in sales in June.

According to Edmunds, second-quarter US vehicle sales will be better than in the first quarter, but they will still fall short of the weak number from the previous year.

Edmunds’ executive director of insights, Jessica Caldwell, said, “A recovery in vehicle production in 2022 seems highly unlikely at this point (but) profit margins are staying high and pent-up consumer demand will only continue to build as shortages continue.”

Cox Senior Economist Charlie Chesbrough said, “Even though economic conditions have worsened in the past months, the lack of supply is still the greatest headwind facing the auto industry today.”

Lack of supply chain resilience the reason for inflation
Oliver Chapman, CEO of supply chain specialist and UK’s No.1 fastest-growing company OCI, blamed the lack of supply chain resilience and redundancy for the rise in inflation.

He said, “Supply chain shocks, possibly in combination with too loose monetary policy, are the underlying cause of the current inflation surge, but the worst effects of this crisis could have been avoided if organisations had put in place basic procedures in understanding and improving their supply chain.”

“Lack of resilience and redundancy embedded into supply chains, encouraged by too much complacency, helped make the supply-chain crisis much worse than it needed to be,” he added.

He stated that the supply chain operation was taken for granted and people assumed that things would turn out fine.

“For too long, the supply chain operation has been taken for granted and ran on the assumption everything would go just right, with every interweaving part of the supply chain fitting just right, all the time. Now we are paying the price for such complacency. If supply chains had seen more redundancy and resilience built into them in the first place, there would still be a rise in inflation, but it wouldn’t have been so severe. To defeat inflation in the medium and longer-term, we must avoid second and third round inflationary effects,” he concluded.

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