TheMarketForIdeas

The security of global supply chains is a topic that the global public is actively debating for the first time since the OPEC crisis of 1973.There have been incidents since then that have highlighted the vulnerabilities produced by this stage of globalization, but none with universal and widespread impact until the coronavirus pandemic, which was followed up by the war in Ukraine starting in February 2022 and the sanctions levied against Russia. Two contradictory phenomena occurred during the pandemic – on the one hand, border closures and measures to reserve domestic production of medical supplies and equipment produced supply crises. On the other side, when restrictions were eased, global transportation thawed and the economy recovered, several nations experienced a crisis in both domestic and global logistical capacity (the USA and the UK being the best-known cases). Notable recent examples from 2020-2022 include: the oil tanker crisis waiting off the US coast due to a lack of oil storage capacity in the context of declining demand (leading to negative oil prices in futures markets); the international freight transport capacity crisis; the semiconductor crisis, which forced production cuts in the automotive industry, including in Romania; the raw materials crisis for the pharmaceutical industry, felt for example in India; the plastics production crisis; domestic fuel and freight supply crises in countries such as the UK; US problems in unloading container ships and ensuring multimodal transport, etc. There are several causes for these events, including government restrictions, consumer elasticity, the influence of economic uncertainty on business decisions to cut back on transportation fleets (especially road freight), the pandemic’s effects on employee health, and more. They all have one thing in common: the pandemic’s role as a persistent source of uncertainty and a force disrupting international and domestic economic connections. 

From black swans to grey rhinos 

The global supply and production system that was developed solely on the basis of economic efficiency and profitability has proven to be fragile, inflexible, with limited capacity to adapt, low levels of redundancy (because implementing redundancy costs money and efficiency), tight couplings between the various global trade system components ensuring the rapid propagation of disruptions (including in financial markets) and limited resilience. What little resilience we had was due to idiosyncratic action such as individual state interventions for their own security, strongly contested at the time of their introduction (e.g.: the existence of emergency and costly stocks of materials, policies to subsidize productive capacity considered critical, or to legally restrict its relocation). All the concepts in the previous sentences (resilience, fragility, adaptability) are concepts in the field of critical infrastructure protection, which defines technical and organizational systems (infrastructures such as ports, oil pipelines, etc.) whose destruction or disruption would have a major impact at national and international level. If there was any doubt, recent events have demonstrated the critical importance of the global supply and production system and its extraordinary vulnerability, and many countries are considering ways to reduce their exposure to these risks.

World leaders, together with other stakeholders, need to prevent a far too strong and damaging response that would sacrifice the economic good produced by globalization and the global division of labour, but they also need to address the vulnerabilities highlighted by recent events that have long been known but ignored. The coronavirus pandemic and its economic effects were not the so-called black swan theorized by Nassim Taleb in his book on the 2008 crisis, but a grey rhino, a threat with high probability and impact. Many of the proposed solutions have been lumped together as “slowbalization” or “slow globalization”, but these often rely on the actions of individual states, with few supranational entities able to act as a forum for coordination (the EU being almost alone in the category). 

How are we handling regional and international initiatives? 

Furthermore, there is another complicating factor: many countries have come up with global integration initiatives, with infrastructure, technology, finance, and institutional components, as part of their strategy in an international environment where economic competition is omnipresent. What all of these initiatives have in common is the presumption that they will facilitate an increase in trade of all kinds (products, services, capital, technology, ideas, people-to-people contacts) that will generate new economic and productivity growth and deepen partnerships with the countries involved, resulting in (geo)political and strategic power for the initiating country.

The most advanced integration initiative of this kind, if we exclude the European single market, is the Belt and Road Initiative (BRI), backed by China as a strategic umbrella for a host of other regional (China-Pakistan Economic Corridor, 16+1 Initiative between China and Central and Eastern Europe) and sectoral (Digital Silk Road, BRI Spatial Information Corridor, Pandemic Health Silk Road) initiatives. According to REFINITIV, the Chinese government’s BRI project portfolio was worth $851.2 billion and that of private companies was worth $396.5 billion in the run-up to the pandemic, which also affected BRI projects.

The fresh investments mobilized are worth over $150 billion, and China has stated that it hopes to achieve $3-4 trillion spent in commerce and infrastructure, even though many existing projects have been included under the BRI umbrella and would have existed without the initiative. In response to the BRI, the European Union unveiled the Global Gateway proposal, which would replace the earlier Europe-Asia Connectivity Strategy by allocating $300 billion to infrastructure projects, while the US has prodded the G7 to create the G7 Partnership for Global Infrastructure and Investment.

Lacking the political capacity to mobilize such resources for foreign investment, regardless of profitability, the US is also cooperating with Japan and Australia to implement the Blue Dot Network, a governance initiative in infrastructure financing that would protect countries from economic predatory behaviour, labour exploitation, environmental abuses, etc. (and limit or condition BRI projects, essentially). There are also initiatives at a much smaller level, including the North-South International Transport Corridor being implemented by Russia, Iran and India, as well as older Eurasian integration projects such as those being implemented by South Korea and, in particular, Russia through the Eurasian Economic Community.

Given these interests, whose defining element is openness as a means of competition and growth, are at odds with reflex solutions to the threats to production and supply chains caused by globalization, closure, autonomy and autarky, can we reach a compromise that fulfills the security requirement? 

Sustainability and resilience 

On October 26^th, 2021, and November 16^th 2022, two editions of the Symposium off Think Tanks (research centres, especially in the soft and policy fields) from the countries of the 16+1 Initiative between China and Central and Eastern European Partners was held online (amid declining membership through the exit of the three Baltic states). The 2021 hosts were the Bulgarian Diplomatic Institute and the Chinese Academy of Social Sciences and the 2022 hosts were Institute of International Politics and Economics and the China Academy of Social Sciences. I was among the speakers from Romania and both times I addressed the issue of supply chain security. In the course of presenting a critical infrastructure protection perspective on the impact of the pandemic on BRI and other global initiatives, I put forward a number of hypotheses on how the situation will evolve and what could be point solutions to ameliorate the problems.

First, the sustainability of the BRI and of globalization in general cannot exist without the resilience of supply and production chains when faced with the impact of an increasingly complex, uncertain and challenging security environment. Resilience is the ability of a system to minimize the chance of a crisis occurring, to minimize its impact once it has occurred, and to return as quickly as possible to normal functioning or an acceptable level of functioning to prevent further problems. The era of irrational exuberance, during which only economic considerations were taken into account when deciding whether to outsource jobs overseas or internationalize businesses, as well as when the “animal spirits” of the markets were disregarded in favour of an ideology of self-correcting markets, has come to an end. Initiatives like the BIS must be robust by design and able to respond to unforeseen shocks in order to sustain their political and economic viability.

Without addressing the losses that can be caused by complex disruptive events (pandemics, cyberattacks, solar storms, hybrid warfare, etc.), the BRI and other global integration programs cannot fulfil their aims.

The security rationale will trump all others once states have experienced sufficient shocks, leading to attempts at autarky, with global fragmentation and losses of productivity and efficiency, reversing the conditions that have allowed the rapid advance of the developing world in recent decades.

At the same time, the main arguments made against the BRI in particular by the US, which pivoted towards a confrontation with China with its recognition as a major competitor during the Trump Administration, have evolved from countering China’s strategic interests for the sake of competition (an uninspiring rhetoric for many countries, including close allies in the Middle East) to the risks of participation in the BRI – environmental risk, financial risks, strategic dependency phenomena, excessive indebtedness, but also risk management of supply and production chains. Unsurprisingly, the major international reaction from the US (the trade war with China being mostly unilateral) has been the Blue Dot Network, a global investment governance project based on the G20 Osaka Summit’s Principles for Promoting Quality Investment in Infrastructure.

Therefore, the BRI requires visible and effective action to increase the resilience of the logistics system coalescing under the BRI and to address the risk asymmetries generated by the BRI for nations and small companies. Sustainability depends on improving resilience governance at multiple levels, but especially for high impact, low frequency (HILF) events. We have argued, repeatedly in such forums and meetings, that the European Union has tremendous experience in promoting and coordinating multilateral critical infrastructure protection for a diverse group of countries through initiatives such as the European Program for Critical Infrastructure Protection. Because there are crucial economic and infrastructural links that must be managed and whose risk (at all levels) needs to be mitigated, regardless of the political situation and geostrategic competition, this experience can become a significant part of cooperation with its economic partners (such as the US and China). The voting public will insist on it. 

Some proposals 

First, it should be emphasized that all global integration programs fundamentally favour bigger enterprises, who manage complicated supply chains and eventually become “too big to fail” (in the formula applied to banks during the 2008 crisis), notwithstanding the rhetoric of the world’s governments that is strongly pro-SME. Global supply networks are plagued by information, environmental, and operational process concerns. BRI and other efforts can shorten travel times, bringing marketplaces and players closer together, but long travel lengths throughout the supply chain raise additional risks for disruption or sustainability. These include emergency logistics management, a lack of integrated cross-border risk management for nations, a lack of transparency, uneven risk distribution, incompatibilities between governance structures and pervasive risks such as cyber-attacks on supply chains (a very fast-growing segment, according to Symantec’s annual Internet Security Threat Reports). And the pandemic highlighted the vulnerability of global supply chains, both at the start of the crisis and after the initial waves. Some of the possible solutions to this issue, especially when discussing integration initiatives with heterogeneous membership especially the developing world include:

- Integration of Western best practices into the Asian Infrastructure Investment Bank (AIIB) and other multilateral appraisal and decision-making mechanisms for BRI projects, in contrast to the current mechanism, which favours bilateral negotiations for projects. This was the argument put forward by Germany and Canada when they became founding members of the AIIB over the objection of the US. The AIIB is still responsible for only a minority of projects, although its funding will increase;

- Optimizing cross-border infrastructure connectivity;

- Greening supply chains for products such as agriculture, a term that refers not only to environmental risk management but to all risks that can affect supply;

- A greater focus on rail transport, consistent with EU priorities and often overlooked by the BRI and other infrastructure initiatives;

- Shift from competition between Chinese firms and local/national firms to co-opetition, a term that includes cooperation, aligning the profit sustainability strategy of Chinese companies with the environmental and security sustainability priorities of different countries.

Additional specific suggestions included the following: the creation of a production and supply chain security management educational component inside the BRI, with focused research activities (current efforts concentrate on cultural exchanges), and the creation of a supply chain security index as a required tool for businesses participating in the BRI (similar to financial ratings), development of standard certification mechanisms for supply chain security, and financial support to absorb the costs of eliminating just-in-time delivery-based methods of inventory management (a method pioneered by Japanese firms, which minimizes the cost of storage through strict and reliable delivery schedules, which can lead to major disruptions if there is a crisis somewhere in the chain).

Conclusion 

The pandemic has highlighted the true risks of globalization processes, resulting in chaos, uncertainty, and loss when economically optimized and vulnerable production and supply chains are removed from the normalcy and efficiency with which they operate. The global and individual state responses are still in the making, but they favour economically distorting solutions with unintended consequences as great as those of globalization.

We can develop strategies to reduce risks and improve the resilience and sustainability of supply and production chains within these very initiatives, including the largest and most significant, the Belt and Road Initiative, given the strategic calculus of states that have initiated or joined global integration initiatives. But to achieve this, there must be multilateral collaboration and a change in the security mindset of all parties involved – not only the participating states but also the businesses. 

(This article was first published in an earlier version, in Romanian, in the financial and banking magazine Piața Financiară. Translation by Ioana Adelina Gheorghe.)

Photo source: PxHere.