Supply Chain Risks and Rewards

Supply chains rarely received much attention in Washington until container ships started queuing outside the ports. Now, they’re a big deal. Even the White House is involved, first by appointing a supply chain “czar” and how by publishing a chapter on supply chains in the annual report of President Biden’s Council of Economic Advisers. The report reflects how much the conventional wisdom about supply chains has changed in just a few years — but it also reflects the bewilderment of government officials about what is basically a private-sector problem.

Much as I argued in Outside the Box, the CEA report asserts that the evolution of supply chains has “been driven by shortsighted assumptions about cost reduction that have ignored important costs that are hard to turn into financial measures.” In other words, the companies that forged supply chains have often failed to account properly for risk. The CEA’s economic analysis, which draws heavily on a recent paper on supply-chain risk by Richard Baldwin and Rebecca Freeman, is well worth reading.

The report goes astray, though, when it attempts to define an appropriate role for the government. This section underplays the complexity of modern supply chains; it highlights how the government resolved shortages by publishing data on hospitals’ stocks of personal protective equipment, but that doesn’t have much to do with industries in which the absence of some obscure component made far down the chain forces the final manufacturer’s production line to shut down. The report praises stiffer requirements for domestic content in federal purchases — a Biden Administration priority — but offers no evidence to support its claim that this will make U.S. supply chains more resilient.

The challenge in developing more resilient supply chains is that it’s not always in firms’ interest to do so. Imagine two competitors. One serves the global market from a single location, taking advantage of economies of scale to lower costs. The other spreads production of a critical item across three continents to minimize risks. Much of the time, the low-cost company will outperform the low-risk one. The resilient strategy will win out if a fire or an earthquake intervenes, but in most years that doesn’t happen. The CEA report does not address this reality.

Under pressure from customers and investors, many large firms have already taken measures to make their supply chains less fragile, from routing cargo through multiple ports to integrating vertically to control production of key inputs. The best way for the government to support such adjustments is by addressing distortions that lead to economically inefficient trade, such as by ending subsidies for freight transport and attaching a price to greenhouse-gas emissions in shipping (a subject briefly mentioned by the CEA). These sorts of actions are politically distasteful. But they might force companies to evaluate costs and risks more carefully when they decide what to make where.

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