Global supply chains: why are they no longer working?

#CriticalThinking

Peace, Security & Defence

Picture of Jamie Shea
Jamie Shea

Senior Fellow for Peace, Security and Defence at Friends of Europe and former Deputy Assistant Secretary General for emerging security challenges at NATO

This is the week of the COP26 in Glasgow and the international media is dominated by the issue of climate change. Although this is also the single most important challenge facing humanity today, another topic has been getting the attention of global leaders this past week even in the maelstrom of other climate initiatives, whether on methane, forestries, steel production technologies or private sector finance, coming out of Glasgow: the issue of our current crisis in global supply chains.

Living in the United Kingdom, you rapidly become aware of this problem when you walk into your local supermarket, only to survey empty shelves and ‘out of stock’ stickers in the places where all your favourite products used to be. When supplies of milk, detergent or fresh salad arrive, they are rapidly depleted as no one knows how long it will be before they reappear. Just a few weeks back, British motorists queued for hours to fill up at petrol stations after a lack of tanker drivers disrupted fuel supplies. Around a dozen energy companies have gone bust, forcing their customers to switch to new suppliers. Pigs have been slaughtered on farms as farmers are unable to have them transported to slaughterhouses as again there are not enough drivers, or qualified butchers to do the job when they get there or warehouse staff to safely store the carcasses before they can be processed for delivery to the retail sector.

The UK currently has vacancies for hundreds of thousands of jobs in road haulage, agriculture, food processing and the National Health Service. After proclaiming its intention to ‘take back control’ and create British jobs for British citizens in the wake of the Brexit referendum, the UK government has been forced into an embarrassing U-turn, offering quick delivery visas and higher wages to lure Polish lorry drivers, Lithuanian butchers and Italian doctors back to Britain, even if only for the duration of the supply chain crisis. This all seems a far cry from just a decade ago when globalisation was at its height, global trade was growing at 5% every year, and people and goods were crossing more borders faster than ever before.

Central bank governors fear the return of inflation and higher interest rates in economies and households

The current situation in the UK undoubtedly has its own particularities, such as the Brexit impact and a major services sector traditionally dependent on low wage foreign labour and deregulated energy and transport sectors that, anxious to please shareholders, have not invested sufficiently to ensure resilience or spare capacity in national supply chains. Yet the UK government has been adamant that the supply chain crisis cannot be laid at its door, but is a global phenomenon. It gained some backing for this view at last week’s G20 summit in Rome when supply chains, together with the taxation of tech giants, were among the few topics to make it on to an agenda dominated by preparations for COP26.

G20 leaders were alarmed not just by rising gas and oil prices, but also by supply bottlenecks at ports, a global shortage of containers, and spiralling shipping and haulage costs. Many retailers fear that they will not have sufficient supplies to cover the busy Christmas period. Central bank governors fear the return of inflation and higher interest rates in economies and households carrying worrying levels of debt as a result of a COVID-19 pandemic that, according to the World Bank, has already sucked $15tn out of the global economy. These fears come on top of a global shortage of semiconductors and batteries that has held up car production in Europe and North America and follows a COVID19 crisis that has seen intense competition for vaccines, treatment drugs, hospital equipment and clothing supplies.

The United States was very much in the driving seat in addressing global supply chains at the G20. US President Biden reported that he had issued an Executive Order to release raw materials from the US Strategic Stockpile, managed by the Pentagon, to keep the US industrial base running. The US recently held a summit with the ASEAN countries where they agreed to simplify customs forms and clearance procedures to speed up the delivery of goods across the Indo-Pacific. The US announced that it was giving money to Mexico and Central American countries to improve their port infrastructure to take larger container ships and speed up incoming and outgoing container traffic.

In Rome, US Secretary of State Blinken and Secretary of Commerce Raimondo together announced that the US will convene a supply chain summit in Washington next year to see how global supply chains can be made more resilient in the face of climate change shocks and future pandemics. At COP26 the concern regarding supply chains has also been evident. India and the UK announced that they are leading a group of 140 countries to build a single global solar electricity grid that could switch supplies from one region to another to boost capacity and deal with power outages.

So what has brought us to this state of affairs?

Supply chains need stocks of products but also a rational, timely distribution of those products

In the first place, there has been the rapid recovery of the global economy as it emerges from the COVID-19 pandemic. For instance, here in the UK, economists a year ago were calculating that COVID-19 would cost around 6% of GDP. Now they have revised that figure downwards to a much more manageable 2% of GDP. Too much pent-up demand chasing too little supply has caused the current bottlenecks and put Asia in competition with Europe, particularly for liquified natural gas (LNG) supplies from the US or Qatar. Gas prices in Asia have traditionally been higher than in Europe where they have been tied to the oil price.

A second reason is a push towards greener economies. This has a major electricity and electronics dimension as we work more from laptops and tablets and store ever more data in electricity-cooled storage centres. Electric cars, although still only 5% of the global market, require lithium-powered batteries and ever more chips and semiconductors. Not to speak of a massive proliferation of charging stations. New grids to store and deliver solar and wind power across borders and over long distances become ever more urgent if we are to exit from fossil fuel use by mid-century. As climate activists call for a halt to mining for coal, the increased mining of the rare earths that are key to high-tech electronics, smart power grids and the ‘Internet of Things’ will be central to the green transition. As we are discovering with the current sharp increase in gas prices, getting the transition right is important for supply chain security. If we stop investing in domestic gas exploration, production and distribution before renewables can meet the demands of transport, household heating and industry, energy bottlenecks could be severe.

In third place is the COVID-19 pandemic. This has disrupted production and relocated labour to other jobs and destinations. Businesses during lockdowns cancelled key supplier contracts, unwisely it now turns out, as with rising business activity these contracts have to be renegotiated. The pandemic has also produced knock-on and cascading effects on supply chains. Greater injections of vaccines have now led to a 2bn shortfall of syringes. In India, the Serum Institute had to redirect its production of AstraZeneca vaccines from the European Union to the Indian domestic health service as COVID-19 infections rose rapidly in that country. This also had catastrophic consequences for Africa which has received only 2% of global vaccine distribution thus far. Only nine months later could the Serum Institute once more send its vaccines abroad. The US followed a similar ban for much of the first year of the pandemic. Supply chains need stocks of products but also a rational, timely distribution of those products that weigh the benefits and needs of its consumers and assesses their impact if they are to function optimally.

Finally, climate change last year and this year has been a causal factor. Massive forest fires, severe air pollution, extreme heat, droughts, hurricanes and widespread flooding in North America, Europe and Asia have all had their impact on infrastructure, production and transport. Major power cuts in China and India have shut down entire regions. Extreme weather events have stopped electronic components from reaching factories in Europe, as when Mercedes in Stuttgart had to close for several days because the plant supplying its dashboard control system in Thailand was flooded. Extreme heat over the summer has blighted vegetable, cereal and fruit production leading to a dash for more expensive and homegrown alternatives. 30% of the Brazilian coffee crop has been lost to an unusual frost in July, and US cotton production was reduced by a similar figure due to prolonged drought. Rising food prices due to supply shortages can push low-income families into poverty and towards charitable food banks. This in turn puts further strain on government finances as short-term subsidies for food and energy claw away money needed for the longer-term green transition.

Another useful tactic is to help the EU’s neighbours ramp up their own domestic production and supply chain security

So what are the policy implications of the supply chain crisis for the EU?

A starting point is not to turn our backs on globalisation. It has produced the cheap prices, the diversity of goods and services, and the abundant, resilient supply chains on which we have all come to rely. Moreover, lifting millions out of poverty in Asia, Africa and Latin America helps to create more markets for European companies, as well as more environmentally-aware local populations. Yet the lesson of the COVID-19 pandemic is that the EU needs to ensure adequate domestic production in a limited number of areas. For instance, in pharmaceuticals, these areas include smart grids, 5G telecoms equipment, microprocessors and conductors.

If European companies cannot invest in these sectors, the EU can induce vital foreign suppliers to set up production plants within the EU. The US recently revealed that TSMC of Taiwan, one of the world’s major producers of semiconductors, was opening two plants in the US. This would be a good strategy to follow. Reducing Chinese direct foreign investment in key European infrastructure in ports, railways, power generation and telecoms is all very well, but only if the EU has a range of alternative suppliers, both domestic and foreign. Diversifying from Russian natural gas means greater access to alternative supplies from Israel, Egypt, Turkmenistan, Morocco and Algeria.

Another useful tactic is to help the EU’s neighbours ramp up their own domestic production and supply chain security. Pfizer announced last week that it was going to build two vaccines plants in Africa. The EU should support these private sector initiatives and help EU companies to achieve the right investment climate. This is not only a worthy humanitarian cause, as the COVID-19 pandemic shows. It also promotes self-interest as the more Africa develops its own self-sufficient supply chains, the less the EU will need to come to its aid during a crisis and arbitrate difficult choices between domestic priorities and international solidarity.

Brussels needs to conduct frequent vulnerability assessments and identify choke points […] that could quickly derail complex supply chains

The EU also has to be mindful not to exploit the emerging African supply chains for its own benefit. For instance, last month Egypt concluded an agreement with Greece to supply it with solar energy across the eastern Mediterranean. Yet if Europe imports much of the renewable energy, pharmaceuticals, phosphates and organic foodstuffs that Africa may produce in the future, its own sustainable green transition will be held back. So as the US and EU develop their own Build Back Better World initiatives to offer a more sustainable alternative to China’s Belt and Road Initiative infrastructure and financing programme, a balance will need to be struck between what the EU puts into Africa and what it takes back out. The challenge will be to build supply chains across the Mediterranean that are complementary and mutually reinforcing rather than exploitative.

Storage and stockpiling also have their role to play here. One of the reasons for the high gas prices today across Europe is that EU member states allowed their gas reserves to run down over the summer and did not replenish them before the winter. So gas prices went up in anticipation of tightness in the market and future inflation. A cushion of reserves from which to release supplies onto the market, as the US has done periodically by dipping into its oil stockpile to undercut OPEC, can help to mitigate price shocks and buy time to develop alternative strategies.

The European Commission demonstrated during the COVID-19 pandemic that bulk purchases of vaccines by the EU can lower unit prices and ensure an equitable distribution of vaccines across the bloc. The Commission faced initial criticism for the slowness of its contracting and its vaccine rollout, often unfair as it was let down by vaccine producers that over-promised and under-delivered. Yet once the rollout got underway the EU rapidly caught up with other countries such as the UK or Israel. Recently the Commission has proposed to bulk buy and store gas on behalf of the member states. At the last EU summit, the bloc’s leaders declined to pursue this idea, but if gas prices do not go back down soon, the proposal may need to be revisited.

Certainly, the ‘just in time’ principle which has dominated the production flow of goods for several decades already will need to be rethought. Some years ago, the EU endorsed the Basel principles, which require banks to keep a certain percentage of their assets in reserves to cope with liquidity crises. These provisions are subject to stress tests from time to time to ensure that a financial crisis will not lead to a domino effect of bank crashes as happened after the collapse of Lehman Brothers in 2008.

Something similar is now required for those industries and companies that are critical to the EU supply chain. Brussels needs to conduct frequent vulnerability assessments and identify choke points, such as port capacity, shipping availability, manpower and skills shortages, that could quickly derail complex supply chains if they are suddenly placed under stress – whether from political crises or natural disasters. Tabletop exercises bringing together industry, EU governments and the Brussels institutions are a useful way of inducing key decision-makers to share information and experiences in a frank and open way and to identify glitches in reporting and early warning mechanisms. They help to build trust and to remove gaps or obstacles in common procedures for managing crises.

Storms, fires and droughts will wreak havoc on intricate and extended supply chains

In the short term, the EU should focus on stockpiling supplies of rare earths. China currently produces 80% of the global supply. It has restricted rare earth exports to Japan in the past to express its displeasure over bilateral disputes. Moreover, China will use a considerable proportion of its rare earths to fuel its own economic growth and transition to a carbon-neutral economy by 2060. So the EU needs to diversify its supply chain. Greenland is the obvious place to look as it has the largest discovered rare earth deposits outside China – perhaps the reason that former US president Trump was keen to buy Greenland four years ago. The melting of ice and permafrost has made mining of rare earths easier and more commercially viable. The US and Canada are interested in Greenland too. Thus exploiting Greenland’s resources in an environmentally-sound manner is a challenge for transatlantic cooperation in the years ahead.

It also helps to avoid self-inflicted wounds. Brexit has caused numerous trade frictions between the EU and the UK, more recently over the Northern Ireland Protocol and fishing rights in the English Channel. In recent days France has threatened to ban British fishing boats from offloading their catches at French ports and also to impose extra checks on British lorries entering France via Calais or Dunkirk. Already the additional paperwork and customs checks on cross-Channel trade have deterred many companies in the EU and UK from trying to export their goods.

Both Brussels and London have accused each other of not respecting the Trade and Cooperation Agreement that regulates the UK’s post-Brexit relationship with the EU. These frictions have been a reminder that the EU’s single market, whereby goods, capital, people and services move freely across the continent, is a crucial part of its supply chain security. So the EU has a major interest to uphold its free trade and common standards area, not only among its own 27 members but with important trading neighbours like the UK or Turkey. Admittedly, this is not always easy given fractious political relationships and national responses to crises. At the beginning of the COVID-19 pandemic, EU member states closed their borders reflexively, leading to massive traffic build-ups and delayed deliveries. This was a situation which again cried out for coordinated management from Brussels to establish filter arrangements for vital supplies.

The supply chain crisis is not going to be resolved soon. Economists believe that it will take until the end of 2022 to clear the backlog and return global trade flows to their normal rhythm. Yet when the supermarket shelves start filling up again and Amazon online orders go back to being delivered the next day, Europeans should not declare victory too soon. The extreme weather events of 2020 and 2021 were not the product of a freak 24 months, but very much the shape of things to come. Even if COP26 does succeed in keeping global warming to 1.5°C by the end of the century, storms, fires and droughts will wreak havoc on intricate and extended supply chains. Pandemics will send vital workers home or even take them permanently out of the labour market as lifestyles change.

The current crisis has underscored just how complicated and fragile the global supply chain is. The shortage of a 50-cent chip used in the seat heating system in an electric car can stop that $50,000 car from being exported from Asia to the US for months. Empty containers in the wrong locations and taking 100 days (rather than the normal average of 60 days) to be returned to their owners, or delays of over a year in the supply of microprocessors following an order, are enough to bring global trade to a near standstill. So the combination of inherent fragility and systemic shocks means that we will undoubtedly experience more supply chain disruptions in the future. It is time for the EU to learn to manage the consequences.

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