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How political risks are adding complexities to supply chains
In this episode of the NextWave Global Trade podcast series, EY Global Leaders Doug Bell and Courtney McCaffrey explore the US industrial policy and its impact on trade.
The COVID-19 pandemic has exposed the soft underbelly of global supply chains. To strengthen global supply chains, promote economic stability and improve national security, the US Government has announced a new industrial policy. Under the new policy, the Biden Administration will be focusing on two key areas: digital technology and climate crisis. There is likely to be an increased government involvement in promoting the domestic production of solar panels, wind turbines and energy-efficiency technologies. Such actions can help reshape global trade and set the stage for investment, infrastructure and innovation.
Key takeaways:
While some companies have developed resilient supply chains in response to the COVID-19 pandemic, others are still struggling. Political risks are making supply chains more complex.
Companies and governments will need to focus more on strengthening supply chains. The outcome of industrial policies will be a balance between policy goals and economic imperatives.
Future trade policies will be more targeted. This shift will be both good and bad for companies. It will be good because not many companies will get affected by new tariffs. However, those getting affected might suffer due to higher prices or reduced supplier options.
For your convenience, full text transcript of this podcast is also available.
Justine Greene
Hello and welcome to the podcast series from EY Global Services. I'm Justine Greene, and with global trade experiencing such uncertain times, we continue to look at how organizations can respond to, survive and grow. Our topic this time is the increase in industrial policy and its impact on trade. Joining us from Washington, DC, Doug Bell, EY Global Trade Policy Leader. Hello, Doug.
Doug Bell
Hi, Justine. Great to be here.
Greene
And Courtney Rickert McCaffrey, EY Global Geostrategic Business Group Insights Leader. Hello, Courtney.
Courtney McCaffrey
Hi, Justine. Thanks for having me.
Greene
Doug, tell us a bit about your background, which I understand includes time spent working with the US Government.
Bell
Sure, Justine. So, before joining EY as its Global Trade Policy Leader, I had a long career in the US Government in a variety of senior-level economic and trade policy positions. So, ranging across a couple of different organizations. So, I was at the US Trade Representative’s office, I was also at the White House from 2009 to 2011, and I concluded my career at the US Treasury Department.
Greene
And Courtney, what does your role involve?
McCaffrey
So just you know, I'm the Insights Leader for the EY Global Geostrategic Business Group, which means that basically I analyze the intersection between geopolitics, corporate performance and political risk management. So, my background is primarily in political risk consulting, macro trends analysis and strategic foresight.
Greene
Okay, well. Let's get into our topic for this podcast. Doug, why is government intervention in global trade on the up right now?
Doug
Well, you know Justine, that's a great question. I think there are a number of factors, it’s really been a combination of … I think I would start off by highlighting that there's really been just a broad-based decline in political support for globalization as it's been practiced over the last decades. You also see the rise of China and the challenge its heavily state-directed economy has posed in both economic and national security terms. And of course, we've seen the shock of the COVID-19 pandemic and the perception by political leaders that they really have lacked sufficient control of their economies to really address what they consider to be important domestic constituency needs. Lastly, I would just comment that we were also in a politically and in terms of national security, a period where the relationship between the major powers — the US, China, the EU and others — are really in flux. And frankly, those relationships have become more competitive. And, that really led to an increased role for the state to sort of address the big structural challenges, the competitive challenges that I think government leaders feel they're facing right now.
Greene
Courtney, give us some examples of how governments are getting more involved.
McCaffrey
Sure, Justine. So, I mean, the first thing I want to point out in terms of what governments are doing is that they're really focusing their involvement in two key areas, both of which are really seen to be crucial to compete in the 21st century economy. So, the first is digital technology, so that's things like artificial intelligence (AI), semiconductors, 5G wireless networks. Basically, all of the technologies that really make modern life work. So, one prominent example is semiconductors, which have really grabbed the attention of governments all over the world this year. So, you know, this is no surprise given the global shortage that we've seen, and the realization that the supply chain is extremely concentrated for these products. So now governments are crafting a variety of incentives and investments to try to get companies to produce semiconductors domestically. So we're seeing these policies in the works in the US, in Europe, in China, you know just to name some of the biggest players in this area. And, the second key area where we're seeing governments really get involved in their economies is technologies that enable climate change mitigation and adaptation. So, this is a huge focus for governments right now, particularly in the lead up to the Conference of the Parties (COP26) summit later this year. So, we'll see more government involvement in promoting the domestic production of solar panels, wind turbines, energy efficiency technologies and things like that. So, one really interesting example that we've been following closely of a sector where governments are getting involved in industrial policies is electric vehicle (EV) batteries, and the mineral supply chains associated with them. So, we've seen Indonesia ban the export of raw Nickel, which is a key component in EV batteries. They have also loosened some restrictions on foreign investment to try to foster its domestic battery and EV industries. And, we've also seen the EU approve US$3.5 billion in public funds to support EV battery manufacturing there. Last but not least, US President Biden's executive order on supply chains and the recent report with associated industrial policy recommendations — both of which include policies around mineral inputs and EV batteries. There’s a lot to cover on that aspect of the US industrial policy, so I'll leave it there for now.
Greene
Let's get both your thoughts on the impact of increasing industrial policy on supply chains. What are the key issues here? Doug?
Bell
The challenges, in many cases, are sector-specific. There are clearly areas, as Courtney noted, that are of a particular focus. But that doesn't mean other sectors aren't going to be impacted. And really, there's sort of these more indirect impacts, and I think that's going to become very apparent. The impacts also come with, I think, both challenges and opportunities. So, you know, clearly, there are industrial policies that are founded on what I would call incentives, or whether it's tax credits, subsidies, obviously for firms that create opportunities to take advantage of. But then they are also accompanied by coercive measures. So, trade and investment restrictions, the example that was used around Indonesia, those obviously create challenges as well. So, I think there's going to be sort of challenges that companies face really between sort of cost and efficiency, which is really driving globalization and supply chain thinking and lean supply chains versus sort of the emerging industrial policy supply chain policies that are really designed to promote resiliency, diversification and frankly have in many instances, sort of a domestic insourcing agenda.
Greene
Courtney, your thoughts.
McCaffrey
Sure. Well, I think Doug was just touching on a lot of the same things that I would mention, but probably the most obvious way in which these, you know, trade and investment protections affect companies is through their supply chains. So, greater trade and foreign direct investment (FDI) barriers increase the costs of cross-border operations for companies. This can tend to discourage the fragmented and geographically dispersed supply chains that have been so prevalent in recent decades. Another important impact is on companies’ investments, particularly mergers and acquisitions. So, companies really need to factor in greater scrutiny of FDI when they're considering cross-border mergers and acquisitions, and then exercise higher due diligence when considering those transactions and figuring out if they're viable or not. And then the final impact is one that I think is often overlooked, which is reputational risks. So, the rise of industrial policies is likely to re-nationalize the global economy, at least to some extent. This will lead to the creation of more national champions. Now those companies are likely to face increasing pressure to support their home governments, domestic and foreign policies, and to uphold the values of their respective governments and societies in their foreign operations. So, this has a tendency to elevate reputational and compliance risks for companies in both their home markets and in foreign markets.
Greene
All right, coming next, we’ll look at a new executive order from the White House for the US supply chain. Doug, what's the US Government trying to do with its executive order called America’s Supply Chains?
Bell
The first and foremost is to secure supply chain resilience in the sectors deemed strategic, so this is either for national or economic security or for public health. The subtext of that, of course, is that it really means trying to diversify away from countries where the US feels that it is overly dependent. It really is also designed to set the stage for investment, critical infrastructure and innovation. And then, it's also designed to use the power of public procurement to really change incentives and encourage the resiliency I mentioned earlier. But it is explicitly designed to address climate change and what are called equity concerns around labor, both of which are viewed critical to the long-term health of the US, and I would say, western economies by the Biden administration.
Greene
Courtney, can you take us through its key points?
McCaffrey
Sure, happy to, Justine. The full report is 250 pages long, so I'll try to be brief. In terms of the key points, basically there were two main parts of the executive order that Biden issued in February. An annual review of key sectors and industrial bases such as energy, agriculture and transportation and then a 100-day review of supply chains for four critical products: semiconductors, critical minerals, pharmaceuticals and active pharmaceutical ingredients (APIs) and large capacity batteries such as those used in EVs. So, I'm going to focus just on this 100-day review because that's the big report. It just came out in early June that Doug was just talking about. The report lays out a variety of policy priorities. One of the most important ones is that it lays out how to leverage government procurement and investment in critical industries to build more resilient supply chains for these products. The report also directs the Department of Energy and the Interior to develop a domestic battery supply chain, which is key because the demand for EV batteries and other high-capacity batteries is expected to skyrocket in the coming years with all the focus on climate change policies and mitigation efforts. The review also says the Department of Commerce should facilitate the information flow between semiconductor producers and suppliers and help fund innovation in semiconductors. Finally, it proposes creating a new cabinet-level supply chain and trade task forces.
Greene
Doug, how realistic do you think this review is from the White House?
Bell
Well, I think, for the most part, the analysis and the assessment of the challenge that the report goes through is pretty solid, assuming it's important for the US to have more controls over its critical supply chains. But the recommendations are clearly aspirational and, I would say, characterizes a bit of a wish list. Some of them require only executive branch actions and those will be much easier for the President to implement, but others will require congressional actions either through legislation that gives the executive branch authority or provides funding. So, those will be a much heavier lift. But I think what's really going to be important here is how well they're received by the business community. I think if the business community feels that the recommendations make economic sense and markets and companies see the value or more resilient supply chain, then I think these proposed changes become much more realistic and are much more likely to change behavior. If there's a gap, then it's going to be a bit more of a muddle between, you know, what the government is trying to incentivize and maybe even push versus where companies are willing to go.
Greene
What do you both think will be the effect of this executive order on trade, not only inside the US but also globally? Doug?
Bell
Well, I think there's no question that's going to have a global impact. I think, you know, let's look just at semiconductors. If we do see a restructuring of that industry’s supply chain, that'll have extensive impacts across not only semiconductors but across many different sectors that use those products. Many different companies will be having to sort of make adjustments to their logistical and procurement function. But there's also the whole area of like rules of origin, tax structure potential changes, where do you locate IP, transfer pricing, and so on. Those are issues that every company that uses semiconductors will have to grapple with, and also kind of layer in sort of competitive responses by China and the EU. It could really have a definite impact globally on trade and the movement of goods and services across borders.
Greene
Courtney?
McCaffrey
I think that these government actions coming out of this executive order in the US really have the potential to help to reshape global trade by making it more acceptable to use industrial policy. So, you know, basically, if the US is pursuing industrial policies so explicitly, then what's to stop other countries, you know, including China, from doing the same? And why wouldn't they do so? I mean, it could become hard to compete in the global market if your companies and strategic sectors aren't receiving some government support to put them on par with what American companies are receiving. So, this could even affect norms around industrial policy at the World Trade Organization, which could end up having an overall dampening effect on global trade growth in the future. I think, you know, the best-case scenario is that the US becomes a global leader in some of these critical products, similar to how the US Government investments enabled the development of the Internet and Global Positioning System (GPS) and other key technologies that have come to dominate life in recent decades. But whether this best-case scenario is achieved really depends on how current industrial policies are designed, and you know, as Doug mentioned, whether companies buy into what they're trying to achieve and can actually gain commercial value from them.
Greene
Okay, well, to round off next, let's say how organizations can respond to more government involvement in the trade. Doug, what should businesses be thinking about now to react to increasing industrial policy?
Bell
Well, I think there's a couple of things. I think, first companies really need to take a whole of company approach, certainly governments are. I think companies need to as well. So that means this isn't just an operational issue. There’s, I think hopefully as this conversation is highlighted, there are really issues of strategy, political risk, tax, finance, HR, just to name a few that really will be needed at the table to help make good decisions. You know both the EU and the US have formal procedures. I can certainly speak with some authority on the US side, everything I hear from administration officials as they want, they recognize they need input from the private sector. So, companies should not be shy about doing that, whether either directly or through their industry associations, about finding a way to help shape the direction of these policies. I would also just highlight the environmental, social and governance (ESG) concerns and how those are really affecting because the boundaries between these other issues, ESG for example, and “industrial policy” there really isn't one. It really will be important for companies to really just take that very broad, holistic approach and factor these issues into their decision-making.
Greene
Courtney, all supply chains agile enough to cope, or do they need to be more resilient?
Courtney
It's a great question, Justine. Actually, it’s sort of a difficult one to answer because it really depends on the company. So, we've seen that some companies have already developed fairly agile and resilient supply chains, in part because they began reorganizing them in response to previous shocks and policy shifts. But we find in our work with clients that a lot of companies actually have a lot more they could do to improve agility and resilience in their supply chains. In fact, we actually just released a survey of 1,000 global executives in which we asked them how trade protectionism and industrial policies will affect their company’s supply chain. The key finding is that these political risks are creating much more complex supply chains. So, in the next year, 46% more companies expect to diversify their supplier base compared to those who expect to consolidate suppliers. About one-third of executives say their company’s supply chains will become longer. Again, about one-third expect greater use of nearshoring or onshoring. So, my takeaway from all of these plans, strategy shifts is that as industrial policies continue to proliferate in capitals around the world, it seems global executives realized they need to do more to improve supply chain resiliency.
Greene
Finally, looking ahead, what are you both hearing from the policymakers about the degree and complexity of government intervention in trade? Doug?
Bell
I think it's clear to say that trade clearly has become a tool to address the challenges that we've started these discussions with. But it's also important to note that it's just not a US phenomenon. We’ve been discussing the US Executive order, but in the EU, you have an open strategic autonomy framework, and you know, China has articulated its dual circulation policy. So I hear policymakers clearly articulating that trade has an important role to play in supporting these broader industrial policies, and that the severity and the long-term nature of these challenges means this will be the case, for certainly, a while to come. And, I’ll also point out that this report we've just been describing is really just limited to four sectors. There’s an accompanying report that will come out in February 2022, which in the case of the US, looks at its industrial base and therefore will have a much broader coverage and sector implications. So, the outcome is really going to be a balance between the policy goals that governments are aspiring to and the economic imperatives that companies will face.
Greene
Courtney. Any insight on this from you?
McCaffrey
Yeah, I mean, I certainly agree with Doug that trade has become a sharper tool in many policymakers’ toolboxes. And I want to pick up on what Doug was saying about sort of the intention and the outcome because there's recognition among policymakers as well as the outcome of trade policy shifts doesn't always match their intended goals and objectives. You know, I think the most prominent example of this is that a lot of the tariffs that the previous US administration imposed have been paid primarily by US companies and consumers. The US trade deficit with China is still very large. So, there's a question of how to design trade policies better to actually achieve the objectives that they're set out to achieve. So, you know, given the recognition of these complexities, I expect future trade policies to be more targeted, so less of a machete approach, more of a scalpel. This shift will be good and bad for companies, I think. Good because fewer companies will likely be affected by any new tariffs, but those that are affected are likely to feel an even greater pinch in terms of higher prices or reduced supplier options.
Greene
Okay, well, it's been a really enlightening conversation. Thank you both very much for sharing your knowledge on this subject. Doug, thank you.
Bell
Yes, Justine. Thank you.
Greene
And Courtney, thank you.
McCaffrey
Thank you, Justine.
Greene
Do join us next time when we will continue to discuss global trade with our expert guests. Also, you can subscribe to this series, so you won't miss an episode. From me, Justine Greene, Doug Bell and Courtney Rickert McCaffrey, it’s thanks for listening and goodbye.
