22 October 2022

Supply Chain Sovereignty and Globalization

James Andrew Lewis

This commentary is part of Technology and Power, a series from the CSIS Strategic Technologies Program on the development and governance of key technologies and how they can be used to gain national advantage.

Supply chains are a focal point for tensions between the United States and China, and a central task for democracies is to reduce China’s role in international supply chains. Tensions over supply chains are also part of an increased desire for tech sovereignty. The supply chains constructed during the heyday of globalization were found to be fragile during the Covid-19 pandemic and a potential risk to national security. A reliance on imports and foreign producers is now seen in many capitals as a source of risk.

There is a growing preference for less reliance on imports and for expanding indigenous sources of supply. This can be called supply chain sovereignty. Sovereignty is the authority of a nation to govern itself. The general reassertion of sovereignty shifts policy toward increased national control—the abundance of data localization requirements exemplifies this trend—and sovereign control over important goods and services is also expanding. Globalization helps create the market for technology and supply chain sovereignty will shrink this.

The use of the term “supply chain” took off rapidly after 1992 as global political conditions changed in ways that encouraged transnational commerce. The spread of integrative technologies for communications and transportation, chief among them the internet, both reflected this political change and accelerated it. The end of bipolar conflict after 1990 expanded opportunities for cross-border economic integration. Cold War bifurcation was replaced by global connections among former opponents. Most importantly, the new connections gave a central place to China as a supplier and as a market. This made commercial sense at the time, but interconnection with China (and in some instances, dependence) has become the primary source of geopolitical risk.

Political risk runs counter to economic incentives. International supply chains, where customers seek sources of supply irrespective of national borders, can be more efficient at providing goods and services at lower cost. They expand competition, which drives improvements in price and quality. Companies depend on chains of specialized suppliers rather than a vertically integrated model of production, where one company performs most tasks. Despite the economic advantages of global supply chains, they are shrinking as international competition and the pursuit of sovereignty erodes the trust needed to sustain them.

Efforts by the European Union to reverse Europe’s long economic decline have led it to pursue digital or tech sovereignty, driven by a reluctance to rely on U.S. tech giants and a desire to rebuild the European tech sector. China has similar policies, to build indigenous capacity while at the same time pursuing globalization with Chinese characteristics. The political forces from these key actors fracture global tech supply chains.

China objects to Western-oriented globalization that has the United States at its apex. A number of important new powers such as Turkey, India, Brazil, are not fully invested in the institutions of post-1990 globalization. Major Western economies still support the liberal world order that allowed globalization, but some (like France) are tempted by nationalist solutions, and, as the calls for tech sovereignty illustrate, are themselves no longer comfortable with transnational supply chains organized under a Pax Americana. This is not just the result of the trade tensions between China and the United States or Russia’s dangerous actions, but reflects a decision by many countries to assert sovereign control over the shared digital technology space first created by the United States. The new competitors are attempting to build their own technology and are recasting the rules that govern it.

The political construct of concepts and institutions that allowed the United States and others to rely on multinational supply chains is losing support. This does not mean the end of interdependence, but more emphasis on indigenous production and regional supply chains. Concerns over supply chain security will drive an uncomfortable evolution in U.S. foreign policy. Policies based on the unipolar moment helped created stable global markets and served U.S. interests when they were widely accepted by other nations, but these concepts and institutions need to be reformed or replaced by something better attuned to a divisive global environment.

The current situation has only a few similarities with the Cold War, with its sharply bifurcated supply chains. This will not be a new Cold War, but an environment where suppliers doing business in other countries will face increased regulatory constraints. Many measures to build domestic supply chains, expand the use of homegrown technologies, and build national innovation bases can look suspiciously like protectionism. One result will be that the market for digital goods and services will shrink as growth in demand for integrative technologies is slowed by regulatory barriers and as new digital competitors (whether from China, the European Union, or elsewhere) appear to service protected markets. The resurgence of interest in export controls and foreign investment screening are other examples of this.

A limiting factor for the erosion of globalization is that no country can now depend on a national supply chain. The interconnections are too deep and the cost to build national alternatives to foreign suppliers is too great, even for China. China, the European Union, and the United States have identified key technologies like semiconductors or quantum computing and focus subsidies on them while allowing other goods and services to be provided by transnational supply chains.

Innovation is likely to remain transnational, since research, business, and investments that cut across borders are more productive, and led by the United States. The dilemma for Europe and China with expanded sovereignty is that the United States continues to lead in the innovation of new technologies. This creates a limit to how far Europe and China can disconnect without falling behind. The Chinese solution has been massive state investment and increased economic espionage, but political changes in China (intended to preserve the rule of the party and Xi Jinping) act to slow innovation.

The European response to build supply chain sovereignty has been to make symbolic investments in research accompanied by the extraterritorial application of its rules for digital services and data to equalize competition. How long this can be tolerated is an open question. European rules come with a cost to innovation that the United States would be unwise to accept. Adding more rules also does not address the chief problem for growth and innovation in Europe: the obstacles its regulatory culture creates for entrepreneurship. Nor can Europe turn to China, since increased reliance on China comes with increasing risk to European security.

The partial unraveling of globalization raises a number of questions about the direction of U.S. policy. Any unraveling will be incomplete, since globalization was the product of technology that make supply chain integration easy. While geopolitics has changed, the technology has not. Economies will still need to interact. The dilemma for policymaking comes from the tension between geopolitics, which is moving in the direction of greater fracturing, and technology, which continues to produce integrating forces.

The interim U.S. solution, while inelegant, is probably adequate for now. While proclaiming the importance of a liberal world order and defending the institutions that make it up, the United States is also creating alternate structures, with regional groupings and partnerships like the Indo-Pacific Economic Framework, the Quad, and the Trade and Technology Council. The United States has an advantage in building regional arrangements with trusted partners, given its shared values and extensive web of alliances. These groups are more exclusive than existing global mechanisms (like the World Trade Organization) in that they entail a commitment to the values and principles of democratic governance, respect of human rights, rule of law, and market-oriented economies.

The result for technology will be a strangely fractured digital environment, mixing global connectivity with regional arrangements. All will be loosely linked—the cost to complete bifurcation is too great—but connections will face new hurdles and constraints. Better technology cannot compensate for this.

Supply chains require both technology and trust to work, but global supply chains ultimately depend on shared and enforceable political understandings more than technology. Trust has eroded internationally, and technology cannot remedy this. The post-1945 liberal world, with its rules for trade and finance, remains a valuable guide point for policy, but in the near term, calls to defend and maintain it will be unpersuasive because they do not address the politics of national sovereignty and because of the reluctance of new powers to accede to what they sometimes see as an ancien régime.

While global supply chains are shrinking, it is in the United States’ interest for multinational supply chains to expand. This is best done by gauging dependence against the security risks of trade with another country. Risk is lowest with partners who share democratic values and respect the rule of law. A second tier of low-risk partners might be suppliers who are not hostile or active opponents. A third tier would be opponents who can still participate in supply chains when a transaction does not give them dangerous influence over the U.S. economy and does not contribute to their military capacities. A new globalization calibrated to political considerations and guided by shared values will need to emerge, and the contours of this new globalization will be shaped by politics more than markets or technology.

No comments: