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“Governments need to incentivize supply chain diversification”

Gregory Shaffer, Chancellor’s Professor, University of California, Irvine School of Law, opines that while the COVID-19 pandemic has brought the importance of supply chain diversification to the fore, companies may be compelled to choose efficiency due to competitive pressure and stakeholder demands. This may necessitate government intervention.

Gregory Shaffer

TPCI: How has the COVID-19 pandemic impacted global value chains for businesses? And what is your view on the prospects of restoration of these value chains post-pandemic?

Prof. Gregory Shaffer: COVID-19 created significant demand and supply shocks for global value chains. Since China was the manufacturer for the world and Wuhan a node for supply chains, the lockdown in China triggered supply challenges. When lockdowns spread globally, demand plummeted. It is too early to tell the future for global supply chains, but five trends will likely deepen.

First, COVID-19 is having a major impact on foreign direct investment, which already was declining in response to uncertainty catalyzed by the US-launched trade war. In late March, UNCTAD estimated a 30-40% reduction in global FDI in 2020-21. Second, the WTO predicts that trade will fall by double-digits, and up to thirty percent in 2020, as countries face severe recessions. Third, there will be an enhanced push for new technologies to replace human labor through robotics and software solutions. In some cases, technologies can spur increased localization of production capacities, such as through 3D printing. In others, they could facilitate further outsourcing, such as for services.

Fourth, business is being incentivized to diversify and simplify supply chains to manage supply risks. Companies will used digital technology to enhance the visibility of supply chain risks. However, competitive pressure could still press managers to privilege efficiency over supply chain diversification to reduce costs and boost shareholder value. Thus, governments may need to intervene to incentivize supply chain diversification and some local production of “essential products.”

Fifth, the pandemic plays into current nationalist political trends in the United States and elsewhere that will spur new governmental measures to relocate at least some production domestically. How this will unfold, however, is difficult to predict. Companies nonetheless will take these factors into account in supply chain management.

TPCI: There is a sudden obsession across the world with respect to reducing dependence on China as a sourcing destination. How feasible is this and to what extent? Also, what should be the strategic approach for countries looking to do so?

Prof. Gregory Shaffer: Companies already were diversifying, or planning to diversify, supply chains out of China before the pandemic struck. COVID-19 has accelerated these trends. Nonetheless, China will remain an important node for global supply chains for multiple reasons. First, China has a skilled labor force, first-rate infrastructure, and advanced and reliable internal supply chains. Chinese suppliers have become part of trusted supply chain teams. Alternative supply locations do not offer these advantages and the transition costs can be significant. Second, China is leading in the development of robotics, artificial intelligence, and other technologies to reduce reliance on labor and so is well-positioned for companies responding to the pandemic by enhancing automation. Third, China has a huge and growing internal market and Asia has been the fastest growing region in the world. Market forces will continue to press companies to include China in regional and global supply chains. The main reason that companies will relocate out of China will be a function of government policies.

Governments may create incentives or requirements for companies to leave China out of security concerns, such as by limiting access to key technological inputs to those that produce in or source out of China. Relatedly, governments may create new requirements and incentives to diversify or localize production of “essential products,” ranging from medical supplies to key industrial inputs to reduce dependency on China. China, for example, has been the major supplier of key ingredients for the pharmaceutical industry. Governments will aim to reduce China’s ability to leverage trade as a coercive weapon, as well as its ability to engage in surveillance in a data-driven economy involving the Internet-of-Things.

TPCI: What will be the major challenges for businesses looking for relocation in the aftermath of COVID-19? How should they address these challenges?

Prof. Gregory Shaffer: Relocating supply chains can be quite costly and time-consuming, involving training, and acculturating a new production force, adapting to new regulatory environments, and responding to new challenges and possible bottlenecks. The more complex the product, the more time it will take for a new team to get up to speed. Most importantly, the local knowledge of long-time workers and managers will be lost. Trust will need to be developed. Communication may take place under a new language, potentially impeding efficient supply chain management. In addition, import and export restrictions may differ, as will labor, safety, and quality standards. Industrial machinery will need to be relocated and serviced locally, and alternative suppliers, including local suppliers, found.

TPCI: What will be the important considerations of companies while choosing their relocation destination in terms of factors like business environment, policy orientation, infrastructure, labour laws, market, etc?

Prof. Gregory Shaffer: Overall, many considerations will be the same as before (i.e. labor skills, labor relations, infrastructure, business and regulatory environment, intellectual property protection, and so forth). Nonetheless, US tariff, rules of origin, and export regulations will rise in salience as they expand to cover a broader range of products produced through supply chains based in China. For products subject to strict regulatory requirements in destination markets, such as pharmaceuticals, quality control will play a central role in location decisions.

TPCI: What are the key learnings, according to you, from the present crisis wrt management of global value chains by companies in the future?

Prof. Gregory Shaffer: The key takeaway will be supply chain diversification. According to a PricewaterhouseCoopers survey, the share of CFOs that expect to diversify their supply chains rose from thirty percent to forty-two percent between just March 11 and March 25 of this year. Concerns over supply chain diversification, complexity, and risk visibility should become more central in supply chain management.

TPCI: How do you expect global trade dynamics to change post-pandemic? What could be the top barriers with regard to policy environments across countries – protectionism, regulation, non-tariff barriers, port closures, etc?

Prof. Gregory Shaffer: First, consumption and work patterns will change. People will increasingly rely on e-commerce and electronic services for consumption. In parallel, people will increasingly work remotely. Companies that harness these trends will benefit over those that don’t. These trends could enhance the cross-border provision of many services. Second, companies will move toward greater automation of manufacturing to reduce dependence on labor. Technologies such as 3-D printing could spur greater localization of production. Third, the political response to the pandemic will likely spur a greater focus on resilience to reduce the risks that supply chains pose when they become too complex and tightly coupled, which creates risks from the weakest links. Fourth, protectionists politicians could harness concerns over globalization to incentivize local production and secure “good jobs,” while consumers may respond to “buy local” initiatives.

TPCI: How will the crisis change the approach of countries to bilateral and regional trade agreements? What agenda points could get more prominent during negotiations?

Prof. Gregory Shaffer: Bilateral and regional trade agreements should continue to grow in importance as the WTO declines (possibly significantly) as a forum for negotiations and dispute settlement. Such regional and bilateral agreements will overlap and compete. Countries will aim to enhance their position within regions, as China is doing with its web of free trade and investment agreements that complement its Belt and Road Initiative, which could give rise to a new Chinese economic order. India will continue its Act East Initiative. Depending on the results of the US election in November, the United States could become even more active on this front as well. E-commerce, services, data localization, data privacy, and intellectual property will be key issues in negotiations.

Gregory Shaffer is Chancellor’s Professor of Law and Director, Center on Globalization, Law, and Society, University of California, Irvine School of Law. Professor Shaffer writes theoretically and empirically on international economic law and law and globalization. His publications include seven books and over one hundred articles and book chapters. The work is cross-disciplinary, addressing such topics as transnational legal ordering, legal realism, hard and soft law, comparative institutional analysis, public-private networks in international trade, the rise of China and other emerging economies, and the ways trade and investment law implicate domestic regulation and social and distributive policies.

Professor Shaffer’s book Emerging Powers and the World Trading System: The Past and Future of International Economic Law is forthcoming with Cambridge University Press (2021).