Risk reduction is in vogue. At the recent World Economic Forum in Davos, both European Commission President Ursula von der Leyen and French President Emmanuel Macron spoke of the dangers of “over-reliance” on global supply chains. Policymakers may now talk about risk reduction rather than decoupling, but the goal is unchanged: self-sufficiency within the global value chain (GVC).
A goal that could have a price.
The search for security within the supply chain is understandable, especially in light of geopolitical tensions, particularly the rivalry with China, and international supply chain disruptions resulting from the COVID-19 pandemic and the war in Ukraine.
The key is how it’s made. There is a right way and a wrong way, and most countries choose the latter.
The US – and soon Europe – decision to use technology export controls in China is clearly on the wrong track. They are self-destructing, perversely accelerating the development of China’s technological capability, clearly evident in the cutting-edge Kirin semiconductor used in Huawei’s latest smartphone. Such controls also deny U.S. companies, such as Intel, the opportunity to grow through exports to China. And they force countries like Indonesia, Thailand, and Vietnam to make the invidious choice between U.S.-centric and China-centric supply chains.
Massive state subsidies are equally problematic, distorting international competition to the detriment of poorer developing countries. They disrupt the international trading system and run the risk of being subject to regulatory constraints as companies benefiting from subsidies become dependent on them.
Nor is supporting friends a clear path forward. The ultimate logic of trading with friends, however defined, would divide the world into rival trading blocs. Recent research by the International Monetary Fund and the World Trade Organization highlights that such a division would lead to serious financial fragmentation and serious losses in terms of GDP, up to 12% in some regions.
So what is the right path to address supply chain disruptions and vulnerabilities? There are two indications.
The first is to recognize that the World Trade Organization, despite efforts by Western governments and other countries to obstruct it, is still the best place to address supply-side concerns related to China’s practice of state capitalism. Under the auspices of the WTO, Beijing could agree to end subsidies for state-owned enterprises operating in foreign markets, in exchange for greater tolerance towards those who provide public services in China.
Countries can also build on cooperation under the WTO negotiations on electronic commerce, covering issues such as data protection, which brings together key players, including the United States and China, providing a welcome opportunity for constructive engagement between Washington and Beijing. (We may expect progress at the WTO ministerial conference, which begins on February 26)
The second and perhaps more critical indicator is the need for comprehensive national policy frameworks that generate genuine resilience to shocks by promoting innovation and export diversification.
The feasibility of implementing good domestic policies can be usefully demonstrated by considering countries engaged in the Supply Chain Resilience Initiative (SCRI), a trilateral effort by Japan, India and Australia – and potentially the United States – to protect supply chains and reduce dependence on China.
Instead of picking winners, SCRI countries need to get the foundation right. For Japan, this includes rebuilding fiscal space by raising the consumption tax while improving productivity – the lowest among all G7 economies – through better corporate governance; for India, improving health and education infrastructure, modernizing labor laws to eliminate disincentives for businesses to create jobs, and further reducing trade restrictions; for Australia, avoid overly rigid production systems based on the worst and least frequent events; and for the United States, a return to more open policies of technological development, which allow it to “run faster” instead of trying to impede the opposition.
What these policies share is their focus: not narrow, seeking to challenge comparative advantage through targeted and misplaced trade-distorting interventions in the name of self-sufficiency, but broad, addressing economic fundamentals to promote true resilience.
In other words, countries seeking greater security within the global value chain should focus above all on getting their economies in order.
Ken Heydon is a former Australian government and OECD official and visiting fellow at the London School of Economics. He is the author of The Trade Weapon: How Weaponizing Trade Threatens Growth, Public Health and the Climate Transition.
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