It’s About Time to Build Regional Supply Chains

It’s About Time to Build Regional Supply Chains
Industry Week February 2022
By Christopher S. Tang

How will the U.S.-China trade war end? When will the COVID pandemic end? What will happen when the Russia-Ukraine war ends?

I do not know the answers, but I do believe most global supply chains are going to end. They had a good run over the last few decades, enabling Western companies to grow profitably and helping developing countries alleviate poverty. But concurrent and unprecedented events have blown apart their cost efficiency. To offset increased tariffs on imports from China, U.S. companies have raised their prices, hurting American consumers.

Global Challenges

Disrupted operations at Chinese factories and ports, triggered by China’s zero-tolerance COVID policy, are creating logistical challenges for port and freight operators in the U.S., making product availability even more uncertain. Disrupted exports of fertilizers, wheat, corn and oil by the ongoing war in Ukraine and sanctions against Russia are fast turning into a global food crisis, especially in developing and low-income countries.

Making things worse, the conflict between Russia and Ukraine will prolong ongoing semiconductor shortages as Intel, TSMC and Global Foundries work to expand their production in the United States. This is because Ukraine supplies more than 90% of the U.S.’s semiconductor-grade neon, a gas integral to the lasers used in the chipmaking process. Russia supplies 35% of the U.S.’s palladium, a rare metal for producing semiconductors. Finding alternative raw material suppliers will also take time.

These unprecedented events are creating a perfect storm of escalating inflation and product shortages.

To ensure sustainable supply of materials and goods, in 2021 President Joe Biden ordered a review of America’s supply chains in 100 days, focusing on four sectors: semiconductors, large-capacity batteries, critical minerals and pharmaceuticals. Also, Biden signed the highly anticipated $1.2 trillion bipartisan Infrastructure Investment and Jobs Act, including $300 billion to boost the struggling U.S. manufacturing sector and $50 billion for semiconductor production and research.

The historical $1.2 trillion infrastructure bill is necessary, but not sufficient.

Short Lived, or Sustainable?

Decades of outsourcing and offshoring have hollowed out the U.S. manufacturing sector. Building domestic supply chains in the U.S. can be time-consuming and cost-ineffective. For example, the severe shortage of N95 masks in 2020 created investment opportunities for domestic PPE production. But the sky-high sales of those high-priced masks was short-lived when China resumed its export of N95 masks.  The American Mask Manufacturer’s Association estimates that up to 10 of 29 domestic mask manufacturers are facing bankruptcy risk, and the group is appealing to President Biden for government support.

To develop financially sustainable and operational resilient supply chains in the U.S., I have two suggestions.

Focus on North America

First, the U.S. government must strategically work with the private sector to develop cost-effective regional supply chains by leveraging the USMCA, the updated version of NAFTA. A U.S. firm can conduct more labor-intensive operations in Mexico, tariff-free and with lower labor costs, then perform final assembly operations in the U.S. The U.S. government can further encourage this regional development by offering expedited processes for cross-border customer clearance.

Ultimately, a U.S.-Canada-Mexico supply chain can monitor and respond to changing needs quickly and accurately.

To ensure financial sustainability, such regional supply chains must be agile and flexible. They must be able to produce certain ordinary products in normal times, but also pivot quicky to produce critical products within the same category during a crisis.

For example, iHealth Labs, the California-based subsidiary of Chinese manufacturer Andon Health, produced $1.8 billion of at-home COVID test kits for the U.S. government in 2022. Headquartered in Tianjin with an annual revenue of $315 million, Andon Health was producing electronic blood pressure monitors, blood glucose meters and forehead thermometers in China. How could a small company in China with a subsidiary in California, within a few months’ time, pivot to producing COVID test kits that are worth more than five times its annual revenue? The secret lies with Andon’s flexibility and capability to mobilize its regional supply chains in China.

Ease the Regulatory Process

Second, to expedite the process of building regional supply chains, the Biden administration must cut red tape, reforming and simplifying the Federal Acquisition Regulations (FAR), a set of intricate regulatory procedures that will guide much of the spending of the $1.2 trillion infrastructure bill.  As it stands, FAR deters many firms from submitting proposals for federally funded projects because it entails a complex and tedious contracting process with many clauses nearly impossible to implement.

Cutting red tape can breed success. FDA’s expedited emergency-use approval process, for instance, has enabled Moderna and Pfizer to launch their COVID-19 vaccines much sooner than expected. Also, it has given Andon the flexibility to produce a massive number of test kits by subcontracting to other manufacturers.

Easing regulations in a crisis can pave the way for U.S. firms to share their capability and capacity and reduce financial risk. Investing in production capacity to produce the COVID vaccine is highly risky. Demand can drop suddenly when vaccine efficacy falls with new variants. Therefore, it is prudent for pharmaceutical companies to invest less capacity to avoid overproduction. To ensure sufficient capacity, instead of direct government subsidy, it is more cost-effective to allow competing firms to share their production capacity for emergency use. For example, after Merck failed to develop its own COVID vaccine successfully, the Biden Administration authorized Merck to manufacture Johnson & Johnson’s single-shot vaccine in 2021.  Competition in normal times, and cooperation in crisis, can increase supply of critical products in need.

The current crisis exposed the vulnerability of global supply chains, but it presents an excellent opportunity for developing regional supply chains that are more resilient. It’s about time.

Christopher S. Tang is a University Distinguished Professor and Edward W. Carter chair in business administration at the UCLA Anderson School of Management.