Resilience and a relatively level playing field created great prosperity for the United States over the past 150 years. Resilience continues to be critical in nation wealth and growth, but the dynamics have changed. Nation states now align with enterprises and not all laws (which level the playing field) are adhered to globally. It’s time to update the resilience-based strategy, but it will take time.
The events of the last two years have made the intricate and sensitive nature of the global technology supply chain apparent. The worldwide economy absorbed the lessons of Adam Smith’s 250-year-old Inquiry into the Nature and Causes of the Wealth of Nations by moving each piece of the supply chain to the country where it could be accomplished most efficiently. For example, it took 40 years for semiconductor manufacturing to shift production from the United States, where semiconductors were invented and are still designed, to mostly East Asian countries, like Taiwan, South Korea, and Japan. Processors may be manufactured in Taiwan, memory in South Korea, screens in Japan, and batteries in China, where they are also often assembled. All are connected by tightly scheduled airplanes and ships, and are now disrupted by a global pandemic and political tensions. Smith’s treatise heralded an unprecedented globalization and distribution of work and increased prosperity to all and made East Asia the electronics manufacturing center of the world.
As the global economy has reawakened from its Covid-induced hibernation, companies are struggling with the uneven restart in distinct parts of the world, especially when only one missing piece influenced the entire process, which relies on a globally synchronized machine. The expression of the “weakest link” holds true today’s world. It takes time for the global conveyor belt that moves products from one part of the world to another to be back at normal speed. Pent-up consumer demand products, especially electronics, in the Western world, fueled by government programs – ranging from unprecedented unemployment payments to subsidies for companies – and a reduced ability to spend, created significant strain as companies slowed down production, planes did not fly due to the pandemic, and ships went idle. These factors forced company closures, leading to single points of failure. After more than a year of almost no Covid infections in China, the country leadership locked down several cities with more than 20 million people to prevent the further spread of the virus. As a result, factories in these cities have stopped operating again with the possibility of further lock downs and their negative side effects on the global supply chain.
Over the past 40 years, China has grown faster than any other part of the world. At times, China represented almost half of the global growth and has become the second largest economy in the world. It has prospered tremendously as it became the factory of the world. It has progressed to be one of the leading innovators in the world. Such economic growth leads to greater political and military power and China demands its concerns and claims to be heard. It is inevitable, that even in the best of times, a growing and increasingly more powerful China changes the power dynamics in the world as China wants to undo a “Century of Humiliation.”
What complicates the situation is that China is becoming increasingly unreliable and breaks its international treaties when it suits its purposes. Over the last decade, China has broken its treaty obligations and crushed democracy in Hong Kong by abolishing the One Country, Two Systems approach agreed upon in the Sino-British Joint Declaration that governed the return of Hong Kong to Chinese rule. The tenants of the Basic Law of Hong Kong were supposed to be valid until 2047. However, China implemented the 2020 national security legislation that, for all intents and purposes, created a one country, one system rule. Furthermore, the widespread suppression and what the United States calls the genocide of Uyghurs in Xinjiang is increasing tensions. While Western countries regularly trade with suppressive dictatorships – placing money ahead of moral standards – as long as they are reliable business partners, businesses are generally looking for alternatives when these countries become a source of instability.
China’s geographic expansion in the Pacific, where it builds islands and military bases in disputed areas and creates tensions with its neighbors, as well as the bullying of Australia, the detention of Western businessmen for leverage, the berating and coercion of foreign companies when they hold positions or make statements that do not please the rules in Beijing, and the repeated threats of forcibly reintegrating Taiwan into China by military force are increasingly making Western companies look for alternatives outside what China considers its sphere of influence. Meanwhile, China sees nothing wrong with its behavior, which only aggravates the situation.
Pandemic disruptions combined with the specter of war, and economic blackmail combined with the efforts of both the United States and the European Union to keep and expand their high-tech manufacturing base, are leading to the establishment of factories outside East Asia. Building new semiconductor fabs in Arizona is a step in that direction, but it is only a step. The next steps are much harder than the largely symbolic water-hungry semiconductor fabs in the Arizona desert: the entire supply chain that solidified in East Asia has to be replicated in the United States and Europe. Without such a gargantuan effort, replicating dozens if not hundreds of companies will be very difficult as it goes directly against the relentless drive of companies to lower costs through economies of scale.
Intel’s huge $20 billion investment in semiconductor fabs in Ohio is just a fraction of the total cost to bring the full supply chain for the Intel fabs back to the US. Building the fabs in Ohio, but leaving the supporting supply chain in East Asia, would be an ultimately futile gesture as when only one link in the supply chain remains in East Asia the entire production process is at the mercy of a stable and US-friendly environment in the region. Creating a non-East Asian supply chain will be expensive, leading to higher prices without a short-term benefit other than to say, “we are not dependent on China.” At the same time, when events go from bad to worse, it’s the only thing that will save us. The United States with semiconductors does not want to follow Germany’s path with natural gas of becoming ever more dependent on a less than benevolent dictatorship.
At the same time, the trajectory of China over the last ten years makes it much more likely that it will use its market power to exert more political influence. The writing is on the wall: China views the United States as a power in decline, withdrawing internationally during the last two administrations while being hobbled by internal divisions. China is filling the resulting power vacuum through unprecedented international aid through its Belt and Road Initiative, thereby creating third-world client states. The least important but most visible effect has been that China’s candidates are all winning multi-national leadership positions while the West’s are losing. The EU has largely been a pliant partner putting economic benefits over human rights, with only the tiny Lithuania standing up against China. It will be a test case for Europe’s “strategic sovereignty” if it backs EU member Lithuania against a China that probably will try to make an example of it. Meanwhile, China and Russia are increasingly cooperating against what they perceive as a common foe.
The worst-case scenario, an invasion of Taiwan by China, will rupture supply chains during and after the conflict and will put the West in the unenviable position of having to decide if they let another democratic territory fall in the hands of China or wage a war they might not win. Either way, post-invasion, Taiwan would be ravaged, its high-tech industrial base destroyed, and China would seek revenge by engaging in economic warfare.
All of this would likely create greater instability and makes a second non-East Asia supply chain an expensive but increasingly necessary insurance policy. Such a strategic decoupling could also lessen the chances of a so-called Thucydides Trap where the tensions between the established power and a rising power has frequently led to war. We need to prevent we relive what Thucydides aptly described: “It was the rise of Athens and the fear that instilled in Sparta made war inevitable.”
The strategic nature of the investment to prevent a war with China and its substantial size will require various governments to help with re-creating the supply chain in various parts of the world. Such an investment would be defense spending at its best and most productive. A more coordinated trans-Atlantic industrial policy with the G7 and the European Union at its core would help mitigate future supply chain issues and provide greater political flexibility as the dependency of the West on China would be lessened.
Roger Entner is the founder and analyst at Recon Analytics. He received an honorary doctor of science degree from Heriot-Watt University. Recon Analytics specializes in fact-based research and the analysis of disparate data sources to provide unprecedented insights into the world of telecommunications. Follow Roger on Twitter @rogerentner.