Coronavirus, supply chains, sanctions: A new beginning or the beginning of the end?

The novel coronavirus is ravaging economies across the globe. An initial supply shock was followed by a mitigation-driven demand shock as stringent lockdown and social distancing measures were implemented to contain the health crisis. More specifically, COVID-19 is forcing states and multinational corporations to re-evaluate the intrinsic value of global supply chains. Heightened scrutiny isn’t unprecedented – similar sentiments were espoused in the wake of the SARS virus of 2002, the global financial crisis of 2008 and the Thai floods of 2011.

But why? Put simply, global supply chains are vulnerable. Their vulnerability stems from the fact that “just-in-time” cost-driven, lean manufacturing processes – while financially efficient –lack the operational resilience to withstand a global pandemic (or more benign trade wars). Productive manufacturing processes are being exposed as lethal vulnerabilities.

This became particularly evident when critical medical supplies produced by single-source providers, like China, failed to keep up with surging global demand, exacerbating fatalities and economic populism at once. Protectionism is therefore an unsurprising byproduct. White House trade adviser Peter Navarro argued that “if we learn anything from this crisis, [it is that] never again should we have to depend on the rest of the world for our essential medicines and counter-measures.”

Beyond critical medical supplies, supply chain vulnerability impacts more mundane goods. For instance, an iPhone is composed of parts supplied by over 43 countries. An estimate cited by The Economist suggests that over 18 countries are involved in the production of merely one cup of coffee. Natural disasters, public health crises, or even political unrest at any point of production can severely disrupt the supply chain at large, yielding a serial succession of ramifications not exclusive to your daily caffeine-kick. A recent survey by the Business Continuity Institute indicates that 56 percent of companies had suffered a supply chain disruption in the past 12 months, with 14 percent reporting losses of over 1 million euros. Instinctively, deglobalizing supply chains seems like the antidote. This begs the following set of questions: Will COVID-19 kill off global supply chains? How feasible is it to localize the global economy? And more importantly, are there unintended consequences associated with deglobalized supply chains?

The short answer is that it is much easier said than done. First, individuals and corporations tend to overestimate how crises fundamentally alter market behavior. This cognitive bias is coupled with the fact that modern supply chains retain a level of complexity and interdependence akin to biological systems. Second, the quest to ensure cost-effective production lured business executives to special economic zones with favorable tax rates and low labor costs, thereby forming highly specialized – yet increasingly vulnerable – manufacturing clusters, like that of China’s Hubei province. Over 50 percent of the world’s special economic zones are located in China, the epicenter of coronavirus. Third, deglobalizing supply chains is financially counterproductive given that free enterprise, competition, and minimal regulation reign superior in the broader global economic system. Fourth, the costs associated with changing or diversifying existing suppliers is subject to industry-specific variance, inexorably creating conflicting policy priorities. For instance, the automotive industry—with complex and expensive supply chains—is significantly less resilient than the food industry’s agile supply chains.

Deglobalizing supply chains entails significant – albeit unintended – geostrategic implications, particularly as they pertain to the efficacy of economic sanctions. Central to geopolitical stability and a rules-based global order, sanctions are used as a policy tool to deter or alter state behavior. Sanctions are therefore inextricably tied to the decision-making calculus of foreign leaders on critical issues such as the pursuit of nuclear weapons. In effect, sanctions leverage the threat of economic damage to deter states from engaging in destabilizing action or coerce states to undo an action already taken.

A deglobalized supply chain would significantly reduce the coercive and deterrent efficacy of sanctions as an instrument of foreign policy. For nations with the financial prowess to impose sanctions – like the US given the dollar’s status as the world’s dominant reserve currency – a less globalized supply chain means fewer points of leverage across the supply chain, limiting latitude for disruption through sanctions.

This curtails the sanctioner by reducing available points of leverage, the type of goods subject to disruption, and second-order effects of sanctions more broadly, or the reputational damage of being associated with the sanctioned. So far, a deglobalized supply chain sounds like music to the ears of North Korea’s Kim Jong Un, or Iranian regime, right? Not quite.

Those sanctioned are equally impacted: Not only do they lack the financial capacity to bring production home, sanctioned nations – like Venezuela or Iran – are plagued with dismal socio-economic conditions that render international trade an indispensable lifeline. Without the benefits of mass production and international trade, sanctioned nations would fall into the abyss of economic devastation.

Setting aside the soundness of deglobalized supply chains, a new supply chain paradigm is expected – one where resilient and diversified supply chains, premised on a “just-in-case” approach, take precedence over cost-driven “just-in-time” leanness. Decisions to reshore or diversify supply chains will likely vary based on the strategic significance of each industry. Policy makers will also have to grapple with the political dimension of those decisions and their potential to alleviate or exacerbate systemic issues of inequality and social stratification. Protectionist measures applied by one state have the potential to alter labor conditions and incentive structures in another, deeming multilateral coordination imperative in pursuit of greater supply chain resilience. Efforts to localize supply chains must also take into account the geostrategic implications for both the sanctioner and the sanctioned, and how second-order effects may impact geopolitical order more broadly.

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Sultan Althari is a Masters Candidate in Middle Eastern Studies at Harvard University’s Center for Middle Eastern Studies and Student-Affiliate at the Kennedy School's Middle East Initiative.