Rewiring Supply Chains Based on Trust in Laws and Institutions under the U.S.-China Confrontation - Discuss Japan
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No.65, Economy  Sept. 1, 2021

Rewiring Supply Chains Based on Trust in Laws and Institutions under the U.S.-China Confrontation

Tomiura Eiichi, Faculty Fellow and Program Director at the Research Institute of
Economy, Trade and Industry (RIETI), Professor
at the Faculty of Economics,
Hitotsubashi University

 

Prof. Tomiura Eiichi

It is difficult to grasp the whole picture of a cross-border supply chain based on publicly available statistics. However, according to a list of suppliers (e.g., parts manufacturers) disclosed by Apple Inc., for example, the supply chain for the company’s products extends across as many as 30 countries/regions.

In addition to “snake”-type supply chains, under which long lines of production processes are located across many countries, there are “spider”-type ones, under which intermediate goods are collected from suppliers in many countries. This classification of supply chains was proposed by Richard Baldwin of the Graduate Institute of International Studies, Geneva, and Anthony Venables of Oxford University in the United Kingdom.

Many countries have enjoyed the merits of combining the low-cost labor in developing countries with advanced technologies in developed countries. However, in recent years, globalization, including the trend of operating cross-border supply chains, has been seen less favorably. According to a survey of around 10,000 people conducted by the author and other researchers at the Research Institute of Economy, Trade and Industry (RIETI), opposition to globalization has spread beyond workers in industries facing competition from imports and has become widely observed among the general population based on deep psychological factors, such as fears about changes to the status quo.

This article will examine the future course of global supply chains while discussing global trade trends.


Global trade has recovered from the rapid shrinkage that was observed in the early stages of the COVID-19 pandemic. Under the COVID-19 crisis, it is difficult to foresee whether global trade will continue growing. However, attention should be paid to the fact that global trade had been stagnant before the COVID-19 crisis. Since around 2018, the uptrend in global trade, including Chinese trade, had halted (see the figure below).

 

 

In Japan as well, the long-term uptrend in the ratio of overseas production has plateaued, while the share of overseas outsourcing out of the total value of outsourcing of manufacturing processes has stayed at slightly over 10% (statistics compiled by the Ministry of Economy, Trade and Industry). Global foreign direct investment (outward investment, on a flow basis) has also remained stagnant since peaking before the Global Financial Crisis in 2008. The share of domestic value added in gross exports, which was on a long-term downtrend, has taken an upward turn (surveys by the United Nations and the Organization for Economic Cooperation and Development).

Although it is difficult to strictly identify the factors behind those changing trends, we cannot ignore changes in China as well as the effects of the worldwide wave of protectionism, as was pointed out by the World Development Report by the World Bank (2020 edition).

The working-age population stopped growing and started declining in China. Also, state-owned enterprises there have become powerful and the government has taken measures to close the Chinese market to the outside world, including prohibiting transfer of important data out of the country. The positive effects of integrating China into the global economy following the country’s shift to the initiative focusing on reform and opening-up through the 1980s and 1990s have presumably been exhausted for now.

As indicated in the review of overseas production over the past three decades contained in the World Investment Report (2020 edition) by the United Nations Conference on Trade and Development (UNCTAD), global supply chains may be considered to be at a turning point. Against the backdrop of robotization, some people expect that the reshoring trend will grow.

However, in Japan, concentrating production within the country is very risky given the estimated 70-80% probability of a Nankai Trough Mega Earthquake within the next 30 years, which is expected to cause greater damage than the Great East Japan Earthquake. Japan needs to be prepared to accept price increases with respect to domestic production of goods for which even temporary supply disruptions cannot be allowed for national security reasons, and it is also necessary to forge a national consensus on bearing the future fiscal burden of subsidies for domestic production of such goods. Even so, it would be too costly to duplicate all supply chains, for example, by moving some production operations from China to another location.

According to the latest edition of the White Paper on Manufacturing Industries (Monodzukuri), only around 10% of Japanese companies have identified the whole of their procurement routes traced back to the sources of raw materials. This situation could lead to problems such as human rights violations, or application of civilian goods to military purposes by sub-suppliers far upstream in the supply chain. In light of the situation, it is risky to diversify supply sources indiscriminately without identifying the activities not only of direct suppliers but also of the supply chain as a whole through the use of big data.

For developing countries that intended to achieve development by being a part of global value chains, the trend of increased rigor in selecting suppliers presents a difficult challenge. Even though the diversification of production operations now concentrated in China may create favorable opportunities for them, those countries will be forced to change their development model because of the negative impact that robotization will have on their advantage in the form of low domestic wages.

While there has been a sea change in the underlying trend of ever-expanding global trade, cross-border flows of data continue to grow. According to another RIETI business survey conducted by the author and others, companies that transfer data across borders have high productivity. Although supply chains have become international in line with the spread of the internet, it is possible to develop supply chains that maintain high efficiency despite geographical dispersion if firms adopt new technologies such as big data and blockchains (decentralized ledgers).

Such supply chains will be smart and resilient “spider”-type supply chains equipped with the capability of restoring damaged sections of the chain based on the understanding that links between suppliers could be broken in an unforeseen emergency. If more and more countries rebuild supply chains based on digitalization, it will help to put global trade on a new path of expansion.

For such advanced supply chains, a framework that enables free cross-border transfer of industrial data while protecting personal information is important. In relation to that point, Nadia Rocha, Senior Economist at the World Bank, and others, have pointed out that it has become important not only to liberalize trade across national borders but also to deeply integrate laws and institutions beyond borders. This argument suggests that in line with the expansion of the role of data, an important criterion in selecting suppliers for global supply chains is shifting from low-cost wages to reliable legal institutions.

In this respect, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (TPP11) serves as a pioneering case. In the future, it may become possible to create supply chains that link together market economies that have compatible institutional systems in terms of the protection of intellectual property and privacy rights, an independent judiciary, and respect for rules-based international order.

However, unlike spot-market transactions, transactions conducted via supply chains require continuity. Even if companies are shaken by economic shocks, they tend to maintain trade relationships with existing partners and adjust trade volume, rather than switching from current to new suppliers. It has been confirmed that even at the time of the Great East Japan Earthquake and the Global Financial Crisis, when trade volume changed drastically, companies realigned suppliers only to a limited degree. Global trade’s rapid recovery from the COVID-19 crisis also indicates the resilience of existing networks of trade.

Even so, existing relationships do not last forever. After the previous U.S. administration of President Trump raised tariffs against China, some firms relocated production bases for export to the United States from China to Vietnam and other countries. Previous studies also confirmed that trade behavior reacts more strongly to the conclusions of free trade agreements, which are considered to have long-lasting effects, than to fickle exchange rate movements.

Japanese companies established production bases for export to continental Europe in the United Kingdom and for export to the United States in Mexico. However, when they did so, they likely did not anticipate events like Brexit and the arrival of the Trump administration, but expected that the economic integration of Europe and North America would remain intact. In other words, if a new institutional framework involving a long-lasting, irreversible commitment is developed, companies are likely to realign supply chains in response to the confrontation between the United States and China.


However, the current impact of the COVID-19 crisis, like the Global Financial Crisis and the Great East Japan Earthquake, is insufficient to cause a realignment of supply chains. Such a realignment will occur only if the new framework is projected to be as long-lasting as the situation of the EU before Brexit or the trade regime under the North American Free Trade Agreement before its revision by the Trump administration.

Translated by the Research Institute of Economy, Trade and Industry (RIETI).* The article first appeared in the “Keizai kyoshitsu” column of The Nikkei newspaper on July 16 2021 under the title, “Beichu bundanka no Kyoukyuumo: Saikochiku, hooseido heno shinrai jiku ni (Rewiring Supply Chains Based on Trust in Laws and Institutions under the U.S.-China Confrontation).” The Nikkei, July 16 2021. (Courtesy of the author)

*RIETI: http://www.rieti.go.jp/en/index.html

 

Keywords

  • Tomiura Eiichi
  • Research Institute of Economy, Trade and Industry
  • RIETI
  • Hitotsubashi University
  • global supply chains
  • snake-type supply chains
  • spider-type supply chains
  • low-cost labor
  • advanced technologies
  • overseas outsourcing
  • global trade
  • COVID-19 crisis
  • China
  • White Paper on Manufacturing Industries
  • TPP11
  • FTA
  • NAFTA