Rethinking the supply chain: Economic factors to keep in mind

Caroline Freund of the World Bank writes at Barron’s about factors nations and companies will consider in the debate over the future of supply chains.

Some economists are asking whether deep economic integration has been shortsighted, with too many companies chasing supply-chain efficiency gains rather than focusing on resilience. Business leaders in developing countries worry that advanced countries will relocate production closer to home.

Policy makers are taking note. Japan’s Covid-19 response provides subsidies for companies to bring manufacturing home. The European Union has rejected calls for “self-sufficiency.” U.S. officials have noted that “reshoring” could happen naturally as businesses reconsider the risks of participation in global supply chains.

Should supply chains be shortened? Given the current crisis, is a government nudge even required to bring them home?

It is unlikely that natural forces will induce significant reshoring. A reversal could be achieved through government policies, with long-term costs for economic growth and prosperity. This is particularly true in developing countries, where global value chains have played a large role in boosting incomes, creating better jobs, and reducing poverty. Consider four factors.

First, reshoring will not reduce supplier risk. The principle that diversification is the best strategy to reduce financial risk applies with equal force to trade. A better strategy to reduce the risk of potential supply-chain disruption would be for firms to reduce dependence on any individual supplier. …

… Second, production costs determine where businesses will locate. Firms will reshore if it is more profitable and less risky to produce close to the market.

One way that would happen is if domestic production costs fall relative to foreign costs. …

… Third, trade costs also govern location decisions. Firms will reshore if transport costs and tariffs are higher and more unpredictable due to the pandemic.

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