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Why Free Trade Needs a Comeback

June 11, 2020
In a COVID-19 world, minimizing cost is no longer the top supply-chain criterion, and companies are re-optimizing accordingly.

The future direction of globally distributed supply chains has been a topic du jour for the better part of two years now, but COVID-19 has pushed the conversation in a different direction that could redefine manufacturing supply chains for the next 50 years.

The last 20 years have seen supply chains grow longer and thinner as they've spread around the planet and across country borders. Minimizing cost was a primary motivation for changes in supply chains in recent decades. But it wasn't only the cost of labor. Companies have long looked at the total cost of a good in its end-market, and as a result, companies have spread their supply chains across multiple countries for multiple reasons.  

In each country, they've sought to perform the needed transformations to achieve country-of-origin designations that enable products to be eligible for preferential tariff rates, and ideally free trade agreement rates. While moving a product's production across borders helps avoid the added cost of potential tariffs inflicted on consumers, it also makes supply chains longer and more susceptible to shocks, both within these countries and beyond.  

Supply chains have also grown thin because of the way our financial markets value companies. The financial metrics used to judge the best companies are driven by lean inventories and productive use of capital. These financial metrics reward companies that outsource capital-intensive activities or keep inventories off their books as long as possible to keep inventory turns high.  

Basic economics teaches us that there is value in national specialization, combined with international trade, especially if that trade is free of additional costs like tariffs. As a result, specialization has moved all kinds of production to manufacturing hubs around the world, while financial metrics have pushed companies to stretch supply chains beyond what they otherwise might be.  

In all these ways, supply chains have been optimized to produce the best results given market demands and the financial, regulatory and trade frameworks that have existed for years. 

That is, until pandemics shutter entire countries. The COVID-19 pandemic that started in China, and then tore across the rest of the world, disrupted nearly every supply chain. As a result, companies are revisiting what resiliency in supply chains might mean and how best to refine supply chains to reflect "the new normal."  

For many companies, minimizing cost is no longer the top criterion of their supply chains, and companies are re-optimizing accordingly. After all, supply chains are inherently risk-averse, and their biggest risk is being unable to deliver what customers have ordered. Recent events have driven that risk to unacceptable new highs. 

One strategy to combat this is carrying more inventory to guard against shocks. But the changes coming to supply chains go far beyond that.  

The COVID-19 outbreak has highlighted the susceptibility of globally distributed supply chains to "black swan" events. Global supply chains were already adjusting because of rising trade tensions and other geopolitical dynamics. Now supply chains are adjusting to minimize potential risks from events that impact entire countries and regions.  

This will likely accelerate a private-sector-driven shift to greater localization and regionalization. A recent IPC flash poll of electronics manufacturing executives found 64% believed a move toward regional supply chains is a long-term trend. Roughly one in three say they are investing in regional manufacturing networks. These new supply chains won't be free of risk. But companies may be better able to isolate risk to a single country or region, ensuring isolated disruptions don't lead to significant problems.  

Even as localized and regionalized supply chains are likely to play a more prominent role in the future of business, these supply chains may be more susceptible to national tariffs. To make all kinds of supply chains more resilient and secure, we need a return to broader free trade agreements, not narrower ones. We need both a free flow of goods and regionalized supply chains in critical industries like healthcare and defense.  

The COVID-19 pandemic has helped us realize the importance of freer, fairer and more resilient trade among nations; our response to it must protect these values in a way that braces them for similar shocks in the future. 

Shawn DuBravac is chief economist, IPC, a global electronics manufacturing association.  

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