The Supply Solution to Stagflation Economics
This should worry us. Today’s global supply chains – made possible by reductions in tariffs and lower transportation and communication costs – have transformed production by allowing firms to manufacture goods wherever it is cheapest to do so. This has generally meant that while high-value-added inputs (such as research and development, design, advertising, and finance) are sourced in advanced economies, manufacturing moves to emerging markets and developing countries.
The benefits are obvious. Final products are significantly less expensive, so even the poorest people in rich countries can buy them.
At the same time, developing countries participate in the production process, using their most valuable resource: low-cost labor. As their workers gain skills, their own manufacturers move to more sophisticated production processes, climbing the value chain. As workers’ incomes rise, they buy more rich-country products.
By 2017, for example, China had more iPhone users than any other country. Knowledge workers in rich countries then earn higher incomes as the market for high-value products grows.
Of course, even though trade yields net benefits, the distribution of gains and losses matters. Trade is not simply “win-win.” Hollowed-out small towns in the American Midwest attest to the downside of offshoring production.
It has ever been thus: Across the advanced economies, today’s rust-belt towns and cities initially grew by putting traditional craft workers elsewhere out of work. With the right policy support, however, trade need not leave people or communities behind. In Scandinavia, firms constantly focus on upgrading their workers’ skills so that they are ready for change.
These are the basic, Economics 101 arguments in support of free and fair trade. But in recent years, global supply chains have displayed new vulnerabilities. In their desire to maximize efficiency, companies have sometimes overlooked resilience. Climate disasters (including floods, droughts, and wildfires) and shocks like the pandemic-induced lockdowns have highlighted “just-in-time” supply chains’ many chokepoints.
As a result, firms are now considering whether they should increase their inventories as an additional buffer. They are also looking for ways to reduce chokepoints by diversifying production locations across countries, and to increase flexibility by making inputs more substitutable. Such private-sector responses can preserve the viability of global supply chains.
But resurgent protectionism – cloaked and augmented by new geopolitical rivalries – constitutes a more dangerous threat. The tit-for-tat tariffs between the US and China during Donald Trump’s presidency were the opening salvos. The West’s subsequent restrictions on the Chinese telecom giant Huawei’s sales, and China’s restrictions on Australian imports, added more policy uncertainty to the mix. Now, Russia’s war of aggression against Ukraine has introduced the possibility of an angry public broadening official sanctions beyond what policymakers intend.
If all that is not sufficient to make corporate CEOs rethink the value of their global supply chains, government advocacy of friend-shoring certainly will. True, national security can never be taken lightly. It is legitimate for a country to ensure that goods and services essential to its national defense are produced domestically or by friendly neighbors. The problem is that “essential” is often broadened by protectionist interests to include even widely produced commodities like steel or aluminum.
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