Supply chains aren't broken, have evolved for the better in some places

The world is fretting over the demise of global supply chains and the threat of deglobalization, with the US trying to lure manufacturing activity back home — or at least closer.
 

Yet supply chains have actually evolved for the better in some places — particularly in Asia — despite all the challenges since 2020 as Covid roiled global trade. 

The issue isn’t that large industrial companies’ long-globalized operations have fallen apart or that a decoupling of trading partners is under way, or that China is just looking out for itself. It’s that businesses in Asia have done better at weathering shifts in geopolitics, concentrating instead on building up the inventories they need and diversifying their products, while maintaining smooth trade ties. The dismal state of American manufacturing combined with resilient Asian supply chains has brought into focus the crucial global role of industrial giants like South Korea, China and Japan. 

The flow of high-tech products, industrial machinery and capital goods between South Korea and China topped $300 billion in 2021, the most since the two countries forged an economic relationship back in 1992, according to Bank of America Corp.

For US companies, it’s not been such plain sailing. Since late 2020, a slew of S&P 500 firms have consistently complained about supply-chain pressures in their earnings calls and reports. As recently as this month, executives at American conglomerate Dover Corp. said that they’ve prepared their customers for delays “on a lot of deliveries in terms of supply chain.” 

Its peers in Japan and South Korea brought the issue up far fewer times over that period. Hitachi Ltd., one of Japan’s biggest industrial companies with a huge business in China, noted in its latest earnings call in July that there was “no supply-chain disruption” in the first quarter. Other large firms have spoken of steps they’ve taken to reform or re-engineer trade flows.

As the scale of trade in Asia has risen, interdependence has, too. Raw materials, components and processed and consumer goods are flowing freely and in large amounts between countries. And as Chinese demand for higher-value products grows, its trading partners have changed what they export. The Herfindahl-Hirschman Index,a measure of market concentration, shows that South Korea has been sending greater volumes of specialized goods to its giant western neighbor. Industrial equipment, precision machinery and semiconductors made up almost 40% of South Korea’s exports in the first six months of this year. Japan’s exports of machinery and electrical equipment to China have also increased.
 

The reality is supply chains don’t come and go; they expand and deepen. They work best when economies of scale kick in as manufacturers produce more and better goods — as has happened in China, Japan and South Korea. Industrial companies specialize products over time as the needs of their trading partners evolve, more suppliers and countries get drawn in and different wares are traded. 

Ultimately, businesses want to do business, not geopolitics. The opportunity costs of acting on mercurial political rhetoric by changing production lines and moving factories is far too high. That’s part of the reason why we continue to see what should have been short-term snarls in the supply chain morph into prolonged ones — companies aren’t making huge long-term changes based on the latest political pronouncement.

But firms — especially in Asia — are choosing to adapt, adding product lines and cutting back others, among other measures. Few are actually reshoring because it doesn’t “address most risks,” as the Asian Development Bank’s annual report on global value chains notes. The strength of supply chains lies in their ability to adjust to changing macroeconomics — as they always have. 

For the US, hoping that one day the great American supply chain will emerge is misguided. The Biden administration’s Inflation Reduction Act and Chips and Science Act are aimed at supporting efforts to build manufacturing capabilities at home. Yet the US risks isolating itself from large swaths of global suppliers and creating a greater dependence on its North and South American trading partners. It would be wise to court its Asian friends, too: their supply chains can extend a little further.