TheMarketForIdeas

The recently resolved Suez Canal incident was the second high profile crisis in global logistics since the beginning of the pandemic. It underscored the significant vulnerabilities of an interdependent world in which supply and production chains are distributed over vast distances and are reliant on the near perfect and constant functioning of a complex transport apparatus through vulnerable bottlenecks. The Suez incident was caused by a super large container transport vessel becoming lodged in a sandbar and blocking the Suez Canal itself in one of its narrowest points. Until traffic could be restored, hundreds of ships were stationed outside the canal, waiting for their opportunity to cross, while racking up billions of dollars in global economic losses and contractual fines. More than 10% of global container shipping passes through the Suez Canal, which links the important Southeast Asian and East Asian producers to markets in Western Europe. It is also an important highway for energy transport, though land routes have been coming online to diversify these flows. The crisis came at a moment when the Egyptian Government is busy upgrading the Suez Canal, to enable it to accommodate 50% more traffic than it did in 2014. The growth in the intensity of the use of the Suez has several consequences – more traffic tolls for Egypt, greater importance for Egyptian ports and their attendant production and storage capabilities, greater geopolitical importance for the Suez Canal, which was the site of an attempted takeover by British and French forces within living memory. 

Globalization – the god that failed 

The Suez Canal incident, along with the sanitary products and materials crisis in the beginning of the pandemic illustrate the significant vulnerability of the global production and supply chains. These incidents, and their seemingly growing frequency, should be an opportunity for decision makers to reconsider the direction in which the global economy, with its attendant legal and economic incentives, has been heading. There are signs of a gradual awakening to the risks involved, but this has mainly been seen in the energy sectors (where diversification is the main option, rather than insourcing, with the US as an exception) and in the health product sector (personal protective equipment, vaccines, medical equipment, etc.). The siren song of the vast profits and efficiencies realized from a truly global division of labor has been too strong to resist, and, prior to the pandemic, only the security establishment and the populist forces in various countries mounted any significant opposition to this trend.

The issue is not the transport of final goods from factory to international markets. Complex products (sometimes even simple ones like the humble bread) end up featuring multiple instances of international logistics for components, raw materials, sub-assemblies and more, before the finished product is even ready to be ordered. Each step along the way creates an international sourcing risk, associated with delays in crossing border, delays in long distance transport, natural disasters, etc. These risks mount and the finished product therefore contains numerous instances of possible disruption, making an eventual problem almost inevitable in the long-term. It has been estimated that an iPhone contains materials and components from over 50 countries.

This complex system is superbly efficient economically when it works well, but it lacks the underlying resilience to systemic shocks. It becomes heavily centralized as suppliers monopolize markets for specific goods (examples are forthcoming), it incentivizes the minimization of inventory in favor of just-in-time management and it promotes the fragmentation of supply chains based on cost criteria, leading to incremental disruption risk. Such efficiency turns out, therefore, to be the antithesis of resilience.

The world found this out during the pandemic, which married a self-induced economic shock to a life-threatening health crisis, and politicians are still reeling from the very visible proof of national weaknesses. While the EU has proposed insourcing policies that make the specific problems that occurred this time around far less likely to occur in the future, it cannot address the underlying issue because of the costs it would entail and the influence groups arrayed against it. Faced with moralistic cries against not closing up to the world, which also accompanied the beginning of the pandemic and aggravated the spread of the novel coronavirus, Western countries are currently content to carve out exemptions from the all-consuming grasp of globalization on national security grounds, whether in health products or in vital dual-use electronics. Their current performance is not significant, and the battle seems more like a rear-guard action, rather then the offensive against globalization which ideologues and states like China, which is directly affected by any potential downturn in the globalization trend, see behind every policy paper and political declaration. The EU itself spent much of the pandemic negotiated ways to increase the mutual dependencies with countries such as China and other potential partners for cross-border investment and free trade. 

Lessons from the Suez Canal incident 

We can extract numerous insights from what happened in the Suez Canal. These are just some of the most salient not only from a security standpoint, but also from the perspective of public policy.

Globalized entities 

Globalization has also created hyper-globalized entities that could not exist in their current shape except in the most open environment possible. These entities are both efficient and fragile, which, should anyone factor in these risks of expected disruption into the efficiency calculus, would result in much lower efficiencies. They are also a ready-made lobby group in favor of greater globalization. The ship responsible for the Suez Canal blockage is a case in point: built by a Japanese shipyard, owned by a Japanese shipwright, leased to a Taiwanese company with German owners and with an Indian crew. All that is left is to find out that the capital for its operation came from New York from Middle Eastern Sovereign Wealth Funds and the global village is complete. 

Bottlenecks 

There are three types of bottlenecks hampering global transport chains. The first are geographic, like the Straits of Malacca. The second are infrastructural, like multimodal node capacity to unload and offload goods, to pass them through customs while maintaining safety, etc. The third are a mix of the two, such as the Panama Canal, the Suez Canal and the proposed Thai Canal, which take advantage of geography to place man-made infrastructure that facilitates the flow of goods. Without the Suez Canal, ships would have to either round the Cape of Good Hope, which many of the largest actually do, or their goods would have to be transported overland, at far greater cost.

The problem is that the Suez Canal was built in the 19^th century and has seen only partial upgrades since then. The largest upgrade is now underway. This means that the infrastructure itself is exploited to its maximum safe capacity and beyond, in order to maximize the economic gain it produces. The growth in trade far outstrips the growth in trade infrastructure, as the latter takes decades to build and recoup costs, while the former may result from global market processes. This means that there is a tendency to overexploit infrastructure that may lead to incidents like the one in the Suez Canal and many others that we never hear about. 

There is a visibility problem 

Problems in global transport and logistics are perennial. They crop up from the normal operation of the system. The global public has a bias in favor of discussion and drawing conclusions only from those events which achieve notoriety through media coverage. Recent examples include the Suez Canal incident, the health product crisis and the oil storage crisis in early 2020, when the futures market had negative oil prices because of lack of storage capacity. But there are many other mini-crises that do not necessarily make it into the public consciousness or end up on the radar of policy makers:

- The ongoing semiconductor crisis forcing the slowdown or closure of many factories in the automotive industry;

- The plastics crisis caused by extreme weather in the Gulf of Mexico, where numerous resin production facilities are located;

- The transport shortage caused by the Chinese export boom, which leads to shippers being paid a premium to send containers back to China even empty, while other clients cannot ensure enough transport capacity for important but low added value goods like foodstuffs;

- A decade ago, flooding in Indonesia affected the only global producer of a particular type of ball bearing used by every hard drive producer in the world, leading to an industry crisis. 

The incentive structures are anti-resilience 

The Western model in which private companies make decisions and are regulated by the state has been enormously successful, but it features a series of key blindspots which may lead to disaster:

- Discounting “high impact, low frequency” events – these are called “gray rhinos” in the current parlance. The maximization of profit is partly achievable through the minimization of costs, including security costs. One way to minimize them is to underinvest in events that take place rarely, but have a high impact;

- Companies rarely face full liability for the losses incurred by their inappropriate security frameworks and considerations. Proving negligence is often difficult, if even attempted, and criminal liability is almost always never pursued unless it is in high profile cases such as oil spills, and not even then. A cynic would even notice that the banks whose financial shenanigans caused the 2008 crisis were rewarded with bailouts and indirect government support of asset prices through monetary policy;

- Negative security outcomes from business decisions guided solely by economic criteria. It becomes possible to plan in the short term, to outsource important company functions, to allow subcontractors to subcontract some of the work and so on;

- Companies are generally powerless to affect the wider security environment, and so lack incentives to act individually to improve it incrementally if doing so places them at a competitive disadvantage. There is a role here for state regulation, by placing an equal burden on the entire sector in order to pursue a socially desirable goal such as environmental protection, thereby creating a level playing field. It is much harder to define the scope of the problem and how to regulate it when it comes to globalization;

- The interdependencies that have been created globally, based on asymmetric commercial relationships, make disruptions or even the gradual change of the status quo very difficult to achieve. World trade is dominated by a handful of highly productive surplus nations, such as China, Germany, Japan and South Korea who are dependent on access to foreign markets on favorable terms in order to continue their model. The imbalanced system is more likely to be affected by crises, as seen also during the financial crisis. The countries themselves lobby for globalization, as seen when China championed it and multilateralism in the wake of former President Trump’s attempted implementation of a nationalist economic agenda. Other interdependencies that resist correction are the asymmetrical relationship between permanent debtor and creditor nations (such as Germany and fellow Eurozone countries, China and the US, etc.). 

This is not the end of globalization 

There was an attempt in the wider media to make ratings by proclaiming a profound policy shift towards “strategic autonomy” in various fields. This is incorrect, since even if such a political will existed, the means by which the shift could be effected, i.e. pre-existing scalable infrastructures and organizations, are often missing. Rather, we may be entering a phase of “slowbalization”. This implies a chilling effect on future free trade agreements, or a reorientation of priorities during negotiations towards the protection of national security related sectors. The impact of reshoring will be limited, because states will resist losing supply and production chains, especially those states which have created a comparative advantage out of integrating them in proximity to one another, like China. 

The world is too complex 

The Suez Canal incident, with its myriad consequences that we have yet to quantify or even identify, proves that the globalized world has become too complex for total management. A complicated system gives hope that, with sufficient effort, it can be understood, measured and predicted. A complex system, however, cannot be adequately measured and it defies full understanding. The interactions between its components, especially under crisis conditions, leads to unanticipated events and behaviors that sometimes defy immediate explanation. The organic growth of the system is one of the reasons for its accumulated vulnerabilities. 

Resilience must be a focus 

While re-shoring may be applicable in certain instances, certain economic arrangements will prove to be lasting, or at least not amenable to top-down restructuring at the behest of governments. Resilience must still be pursued and it can be done in multiple ways. One of these is to coordinate globally the passage of legislation harmonizing liability rules for preventable crises. This can also be done through adjustments to insurance for business losses. If companies are simultaneously incentivized to maintain adequate inventory of components, parts and raw materials, then, the spiral of minimizing costs in these areas can also be attenuated, with attendant security benefits. The prospect of having their neglect of security issues factored into their insurance premia can also motivate companies, whether it regards their behavior or their choice of suppliers.

The biggest benefits, however, will stem from state-led resolution of underlying infrastructure issues, whether through the building of new infrastructure or the exploration of alternative routes to diversify logistics chains. One such possibility is the opening up of the Arctic routes that connect China to Northern Europe and North America, which can cut down significantly on the travel time from Shanghai to Rotterdam and elsewhere, while also reducing the burden placed on the Suez Canal. The development of Eurasian land routes by road and rail, as well as port facilities providing alternative multimodal routes bypassing important bottlenecks for economic and also geopolitical reasons, is part of China’s plan under the Belt and Road Initiative project. 

Conclusion 

The successful resolution of the Suez Canal incident should not lull us into a sense of false security. The globalized production and supply chain system which has been set up over recent decades lurches from crisis to crisis, most often below the visual range of the global audiences, but always with a quantifiable impact and an unheeded lesson regarding the inherent vulnerabilities of complex systems. The simultaneous manifestation of several such crises could lead to a significant economic hit, with security implications for countries reliant on this system for food, energy or medicine. The fewer planned adjustment take place to reduce these risks and increase resilience, the more likely it is that a “perfect storm” of crises will cause significant damage and spur governments into knee-jerk reactions such as vaccine nationalism, confiscation of supplies and other such actions. And this is without get into the issue of deliberate threats, such as cyber and electromagnetic attacks targeting shipping.