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The Visible Hand

The Visible Hand

Global supply chains and geopolitics

by Etel Solingen

The relationship between eco­nomics and security has long been central for understanding international relations in East Asia and the Asia-Pacific. The two are inextricably bound. On the one hand, intra- and extra-regional trade, invest­ment, and other forms of economic exchange have expanded dramatically over the past several decades. On the other hand, there have been no major wars for many additional decades: Indochina has been at peace for forty years, maritime Southeast Asia for sixty, and Northeast Asia for seventy. Persistent historical, ethnic, religious, and territorial cleavages have been restrained, and major powers—most notably China and the US—have normalized diplomatic relations.

Contemporary developments, however, call into question the stability of what some had characterized as “Pax Asiatica.” Tensions in US–China relations, especially the trade-and-technology war, have already transformed the tenor of East Asia’s international relations as we have come to know them. Other regional worries have deepened, including the most serious deterioration in Japanese–South Korean relations in decades. Interactions among China, Taiwan, and Hong Kong have reached their lowest point in decades as well. And China’s activities in the South China Sea have escalated tensions with several Southeast Asian states over intrusions into their claimed territorial waters.

These and other frictions have unfolded against a unique economic infrastructure linking East Asian countries. Namely, at the very heart of this infrastructure lies a tangled web of interdependence generated by global supply chains (GSCs) that connect the region internally and with the rest of the world. Having transformed global economic interdependence and connected countries in entirely new ways, GSCs deserve more dedicated attention than they have received in the past in the broader field of international relations, beyond international political economy.

In a recent edited volume, Geopolitics, Supply Chains, and International Relations of East Asia (Cambridge, 2021), my colleagues and I argue that heightened attention to GSCs should address five distinct yet related points: First, the relationship between economic interdependence and interstate conflict and cooperation. This has a longstanding lineage in the theoretical and empirical literature in international relations, yet most work in that tradition has typically surveyed bilateral trade in final goods (gross trade), capital flows, and foreign direct investment (FDI) as standard variables of interest. We would do well to further concentrate on GSCs as a distinct, more complex, and perhaps unique mechanism of interdependence that has not yet gained adequate consideration in the analysis of broader patterns of interstate conflict and cooperation, despite the dramatic expansion of GSCs in recent decades.

Second, GSCs were at the heart of the Trump administration’s efforts to delink or decouple the US economy from that of China. Focusing on GSCs makes clear why, despite the Trump administration’s repeated pronouncements to the contrary, tariffs were rather tangential to its efforts to reduce US–China bilateral trade balances. Over half of China’s total exports include intermediate inputs that the US and the rest of the world exported to China in the first place, via GSCs. Beyond that, tariffs can have long-lasting implications for GSCs, which amplify the effects of tariffs. Escalating technology controls spreading throughout GSCs have been designed to hasten delinking.

Over half of China’s total exports include intermediate inputs that the US and the rest of the world exported to China in the first place, via GSCs.

Third, Western lead firms in GSCs are at the heart of China’s insertion in the global economy. The prospects of delinking have crucial implications for China’s continued economic wherewithal, for its ability to avoid a “middle-income trap,” and for the sustained viability of the political-economy model incepted by Deng Xiaoping, one that has yielded golden eggs to China’s Communist Party—economically and politically—up to the present day. This dramatic rise had tangible effects on China’s political economy, underpinning economic growth, job creation, wage increases, poverty alleviation, the emergence of a vast middle class, urbanization, welfare, and technological advancement. And yet, domestic bottlenecks and external geopolitical shocks, even prior to COVID-19, had introduced serious dilemmas for Chinese leaders regarding the future role of lead Western firms along GSCs in China’s overall grand strategy.

Fourth, beyond the direct implications of these shocks for China, their second- and third-order effects can be massively consequential, due to the very nature of GSCs. China has become less dependent on imported intermediates (backward linkages) in recent years, but the rest of the world has become more dependent on China’s exports of intermediates (forward linkages). And because China is also the largest trading partner for many East Asian states, this region is a pivotal arena for understanding the many facets of GSC interdependence. The density of GSCs connecting “Factory Asia” with itself, and the share of overall East Asian trade taking place within GSCs grew significantly over the last two decades. Now China is the largest GSC node connecting East Asia with itself, the US, and the rest of the world, but other East Asian relationships are also embedded in GSCs, such as those between Japan and South Korea, Japan and China, Taiwan and China, China and Hong Kong, Taiwan–China–South Korea, and North and Southeast Asian countries. The recent erosion of GSC interdependence has increased economic and political uncertainty not just in the East Asian space; its consequences for the future of the global economic system and international cooperation are far more widespread.

Fifth, GSCs are an especially versatile arena for understanding a phenomenon that spans different levels of analysis in international relations, from the micro to the macro levels, from lead firms and suppliers’ networks to sectoral and industry-level analysis; from political and business leaders and sub-national politics on GSCs to the role of GSCs at higher levels of aggregation including interstate political, economic, and geostrategic relations and transnational politics. Indeed, GSCs are a focal point in contemporary debates over de/globalization, triggered initially by the 2007–2008 Great Recession, and in major subsequent processes from Brexit to the election of Donald Trump and emerging geopolitics more broadly, including the geopolitical triangle linking the US, the EU, and China.

These five considerations elicit an array of pivotal questions regarding the relationship between economic interdependence and interstate conflict and cooperation in a world of GSCs: How have recent geopolitical shocks altered the extant GSC infrastructure in East Asia and the Asia-Pacific? Why might leaders in the US, China, Japan, South Korea, and elsewhere in the region pivot away from—or, conversely, buttress—the GSC-centered relationships that had hitherto yielded positive mutual benefits at aggregate state levels? How have GSCs, especially lead firms, responded to the US–China trade-and-technology war and to other geopolitical shocks in East Asia? How fragile or resilient have GSCs proved to be against geopolitical shocks across the region, and how did COVID-19 alter those outcomes? What are the distributional costs and benefits of geographic GSC redeployments within and beyond East Asia stemming from the trade-and-technology war? Or, in the classical formulation: Cui bono et cui plagalis? (Who benefits and who is penalized?). And what are the preliminary effects of all this on the broader texture of international relations across the region?

Why might leaders in the US, China, Japan, South Korea, and elsewhere in the region pivot away from—or, conversely, buttress—the GSC-centered relationships that had hitherto yielded positive mutual benefits at aggregate state levels?

This brief overview highlights why GSCs offer a sort of natural experiment for exploring the reciprocal effects between economic interdependence and interstate relations. International relations in East Asia face the most complex bundle of geopolitical and geo-economic threats in decades, including trade-and-technology wars; rising tariffs, export controls, sanctions, and protectionism; nationalism and populism; erosion of global trade agreements and WTO rules; tensions from the Korean peninsula to the South China Sea; corrosion of alliance commitments by the Trump administration; the so-called Thucydides Trap presumably fueling the US–China competition; domestic political polarization; deterioration in regimes governing weapons of mass destruction; and energy and environment-related rifts, among others. Unlike previous sporadic episodes of tension, this new array of geopolitical shocks can hardly be considered “accidental” deviations from an equilibrium that diplomacy can restore fairly rapidly.

Likewise, however, recent variation in rates of expansion and retraction of GSCs offer an opportunity for exploring the extent to which GSCs may have provided a more robust foundation for interstate cooperation than older forms of interdependence or, alternatively, whether GSCs amount to equally vulnerable targets of nationalistic and autarkic ambitions. It is also possible that GSCs may have indeed generated substantially consequential effects in taming interstate conflict for several decades only to succumb, ultimately, to more powerful forces of competition and rivalry. This calls for greater attention to the degree of resilience of GSCs or their relative ability to withstand and survive geopolitical and geo-economic shocks, a hitherto neglected topic in international relations, economics and business.

Some of the unprecedented challenges stemming from COVID-19—including finding alternative suppliers and facing tumbling demand—operated directly on GSCs, as they would have done even in the absence of geopolitical tensions. Other challenges triggered by COVID-19 operated indirectly, aggravating geopolitical tensions, tightening borders, and fueling mutual recriminations regarding the pandemic’s origins, and China’s putative hoarding of medical equipment in the early stages. COVID-19 brought public awareness of GSC interdependence in an unprecedented way as the US and others struggled to secure medical equipment and other technical components from quarantined Chinese suppliers. Such dependence powered renewed calls for severing GSC ties with China. Efficient “just in time” lean inventories and the dearth of substitutes exposed the downside of global sourcing, affecting access to ventilators, N95 masks, MRI machines, active pharmaceutical ingredients (API) relevant to antibiotics, and a wide range of other vital intermediate inputs from China. Yet critics of mercantilist policies warned that reshoring to the home market would only increase prices for US consumers, reduce competitiveness of US firms, and invite retaliation. Instead, creating redundancies in supply networks would circumvent bottlenecks and increase GSC resilience and security of supply. The restructuring of these GSCs, in this view, would entail not reshoring but rather diversification, especially in instances where China is the sole supplier to US firms.

Firm-level surveys confirm that the US–China trade-and-technology war induced great uncertainty. A US–China Business Council study reported that US–China trade tensions, the uncertainty of supply they created, and customers’ shifts to alternative suppliers affected 81 percent of US firms operating in China in 2019, rising from 73 percent in 2018. Concerns by China-based partners about doing business with US companies rose sevenfold from 2018 to 2019. About 30 percent of firms in another survey—twice as many as in 2018—reported slowed, delayed, or cancelled investment in the US or China due to rising costs and uncertainty generated by geopolitical tensions. Surveys by the American Chamber of Commerce in the People’s Republic of China found that the US–China trade dispute had affected the supply chains of 90 percent of large US companies. Over 61 percent of respondents were pessimistic or slightly pessimistic about US–China relations in 2019 and 51 percent in early 2020, with 37 percent in 2020 planning decreased investments or no further investments (the sharpest slowdown since 2013), largely due to US–China tensions and tariffs. The uppermost concerns of 60 percent of respondents regarding their supply chain operations in China over the next three years were a slowdown in global economic growth stemming from US–China trade frictions and a broader deterioration of bilateral US–China relations. About 66 percent of respondents deemed decoupling “impossible” in 2019 but only 44 percent thought so in 2020. Nearly 92 percent of US firms saw a quite likely or very likely escalation in US–China trade disputes over the next three years, although fewer firms were as pessimistic following the November 2020 US elections. A Baker-McKenzie 2021 study found 44 percent of 800 East Asian firms concerned with trade disputes and protectionism as the foremost macro risk driving GSC disruption.

Nearly 92 percent of US firms saw a quite likely or very likely escalation in US–China trade disputes over the next three years.

All these projections notwithstanding, China’s exports to the US rebounded in the second quarter of 2020. Furthermore, surveys also suggest that reshoring back to home states has hardly been the standard GSC response thus far. Many firms adopted “in China for China” strategies to mitigate the impact of the trade-and-technology war and 83 percent had no plans to relocate production or supply chain operations outside of China, even under COVID-19. Japanese, South Korean, Taiwanese, and even Chinese firms continued the trend that had originated in China’s rising labor costs over the years to relocate production and final assembly to Southeast Asia (especially Vietnam, Malaysia, Thailand, and Indonesia), Mexico, and India. Relative GSC resilience or vulnerability is a function of their structure, industry features, and availability of substitution among others. Typical measures designed to enhance resilience included reshoring, near-shoring production or suppliers, diversification or multiple sourcing within and across countries, building redundancy, buttressing inventories, regionalization, digitalization, and improving mapping, transparency, and visibility. Surveys suggest high levels of ongoing investment in diversification and in enhancing resilience.

The cumulative effects of geopolitical shocks, COVID-19, and rising inward-oriented hyper-nationalist models have indeed made GSCs more vulnerable than at any time since the beginning of their dramatic expansion in the 1990s. At least in the short term, COVID-19 has accelerated the potential for decoupling, for bolstering populism, and for exacerbating geopolitical tensions, providing yet another veneer of legitimacy to the purposeful disruption of flows of goods, technology, and people. But inflection points are not good grounds for extrapolating the future of GSCs. The ostensibly ongoing restructuring of GSCs suggests a potential decline in China’s status as factory of the world relative to the past, but hardly its demise.

GSCs were never an artifact of invisible hands, and the sinews of states were imprinted on their expansion or retraction since inception. The causally prior point of departure for understanding the role of GSCs thus requires a proper grasp of why and how they proliferated in East Asia to begin with. Lead firms may have been the more immediate agents in the expansion (or retraction) of GSCs. Yet the true architects of this and earlier forms of interdependence were political leaders and their supportive coalitions. The combination of the trade-and-technology shocks since 2018 and the economic, political, and social legacies of COVID-19 are likely to make states even more central to the redesign of GSCs. Yet, states reflect preferences that are not static or monolithic. Neither can those preferences be simply inferred from ill-defined measures of balances of power. Domestic political competition between outward-oriented and inward-oriented grand strategies, especially in the US and China, may be more consequential for the future of GSCs.

Photo: Jason Leung. Courtesy Unsplash

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