Paper #25. Supply Chain Competition: Protecting Globalization v Globalizing Protectionism

  • Thomas A.Drohan, Ph.D., Brig Gen USAF ret.
  • Commercial, Security, Strategy
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Supply chains are most efficient and vulnerable when globalized. How can we integrate them in the global information environment and protect them from discriminatory competition and outright threats?

Globalization and Protectionism

There have always been fundamental disagreements over how globalized and how protectionist an economy should be. The benefits of globalization today fit the post-World War II order erected by a relatively un-ravaged United States at the time. The two founding principles of this liberal economic order are:

  • Non-discriminatory free trade: the World Trade Organization lists fundamental principles for multilateral trade based on agreed rules. These are: (a) equal opportunity for most-favored nation status; (b) freer trade via negotiation; (c) predictable, transparent commitments; (d) fair competition; and (e) development with reforms to accept the preceding obligations. Discriminatory actors, on the other hand: (a) grant favors to selected trading partners outside free trade agreements; (b) construct non-negotiable barriers to competition such as quotas and tariffs; (c) conceal policies, practices, prices, and promises; (d) export below cost; (e) accept trade concessions without reforming.
  • Fixed parity among dollar-based currencies: the dollar-based, convertible-to-gold standard that emerged in 1945 (Bretton Woods) was replaced in 1973 by a more flexible arrangement (Jamaica Agreement) to permit limited government interventions yet prohibit predatory manipulations. Today’s mix of free-floating, managed-floating, and fixed-peg currencies includes the International Monetary Fund’s basket for special drawing rights on its international reserve—the US dollar, euro, Chinese renminbi, Japanese yen, and British pound sterling. Strong currencies attract foreign investment; weak currencies promote exports.

International institutions such as the International Monetary Fund (IMF), the General Agreement on Tariffs and Trade (GATT) which became the World Trade Organization (WTO), and the World Bank (WB) promote these principles of cooperation. The institutionalized rules nourished unprecedented global economic growth and increasing interdependence. With that came a host of inequalities and issues. These include job gains and losses, domestic market access, investment transparency, environmental protection, health and welfare, and intellectual property enforcement. Discriminatory competition was one way to deal with such changes.

Protectionism arose from these concerns under a banner of national independence. This occurred despite memories of the confrontational protectionism that proliferated between the two world wars with tariffs, quotas, trade blocs and trade wars. Distrust among rivals reinforced desires for self-sufficiency. We see eruptions today in contested sectors as comparative advantage shifts to different areas. In a competitive and liberal economic environment, climbing up the value ladder requires more integration and more responsibility to the customer. In an environment protected from competition, the initiative to integrate and serve customers depends on leadership and organizational culture. We see this type of constrained competition today in critical economic sectors such as agriculture, national defense industry, and lately—health. 

Protecting self-sufficiency, however, incurs cost. The reason developed countries pay less for consumer goods is due to outsourcing labor, inventory, and production to less expensive locations. Forcing low or high-end products and equipment to be “made in the USA” is generally more expensive and may not necessarily result in higher quality. We do that for clear and not so clear national security purposes. For a clear case, see the recent warning by US General Accounting Office about getting replacement parts for the Joint Strike F-35 fighter due to reduced credibility (induced by Russia) of a NATO supplier (Turkey). Not so clear cases are those that mandate made in the USA — which supplies, food, raw materials, energy sources, and so forth?

In a competitive global environment filled with companies and governments seeking profit margins, market share and influence, businesses have to adapt. They create partnerships, invest in technology, move production and services, and hire and fire labor. Protectionism would have businesses maintain legacy partners, satisfice with good-enough technology, keep production and services at home, and retain existing labor.

Discriminatory competitors have a solution to this predicament: reap the rewards of interdependent globalization and independent protectionism at the same time. Some competitors discriminate a bit more systematically than others—such as transnational criminal organizations and other networks of state and non-state actors. When does illegal competition become warfare?

When Competition Becomes Warfare

Some actors threaten others’ acquired values well beyond the scope of internationally accepted economic relations. When competition becomes a matter of national security, mutual legitimacy is replaced by mutual threats. Threats to national and international security wage warfare broadly. The weapons are diplomatic, informational, economic, military and social (DIMES). Their combined effects can be cooperative and confrontational, often at the same time: persuadedissuade; inducesecure; compeldeter; coercedefend.

Mutual threats are not identical threats. So, combinations of the above effects impose dilemmas that are not recognized as threats by the “when deterrence fails” military approach to warfare prevalent among western democracies. This broadening of national security has made the globalization or protectionism debate academic.

The real issue now is how to protect globalization without globalizing protectionism.

We will focus on official (single-Party or government-run/supported) China and Russia as complex threats, for three main reasons:

Since joining the WTO as a developing country in 2001, China insists on retaining that status which confers special and differential treatment. Beijing eschews much of the preferential treatment to fashion a leading identity: a developing economy that aligns similarly victimized followers. Such a group includes seven of the ten most wealthy countries by per capita GDP and purchasing power parity—Brunei, Hong Kong, Kuwait, Macao, Qatar, Singapore, and the United Arab Emirates. Now the second largest economy in the world, what model does China offer the world?

China uses: (a) large-scale industrial policy to enforce modernization priorities, state-owned enterprises and banks to consolidate control in key sectors; and (b) government-guided investment funds to leverage private capital. This approach has led to regional alternatives without global responsibilities. The New Development Bank (Brazil, Russia, India, China, South Africa) and Asian Infrastructure Investment Bank (AIIB) have forced the IMF and WB to accept more representation from emerging markets. The NDB and AIIB operate according to an opaque mix of relationships and rules. The NDB rules by an equality of shareholding and voting to represent emerging markets, with China as the largest contributor. China‘s banks hold more assets than US and Europe combined. Its international lending accounts for 16% of cross-border lending, a 10–year doubling. China, however, provides 2/3 of the credit extended to emerging markets (”Credit Clout,” Economist, 7 May 20). The AIIB operates by consensus…with a China veto. The China Development Bank (CDB), established in 1994, is the world’s largest lender for development projects. CDB loan financing serves the Belt and Road Strategy that aims to connect China across the Eurasian continent.

China‘s benevolence toward developing countries is betrayed by its flouting of international norms in obvious ways. Human rights abuses in China are brutal, particularly for ethnic minorities and religious groups. Beijing refuses to abide by the Permanent Court of Arbitration in The Hague that rejected China’s claim to 85% of the South China Sea in favor of the Philippines. Six other claimants, five of whom are WTO developing countries, dispute China’s re-expansion of imperial boundaries. China’s government and Party secrecy that perpetuates its authoritarian political system was and is on display during the COVID-19 pandemic. Authorities in Wuhan, the apparent origin of the virus, covered up the outbreak. Beijing authorities locked down China but not international flights, allowing the virus to infect the world. The ongoing deception committed by officials and state-run and sponsored media is tracked by Hamilton 2.0.

As a fellow authoritarian traveler on the UN Security Council, Putin’s Russia also claims to represent developing countries while perpetrating human rights violations (see Human Rights Watch 2019), inciting divisiveness in other’s territorial disputes, and using its limited economic leverage for geopolitical advantage (see Carnegie paper by Julia Gurganus and Eugene Rumer).

Since the dissolution of the Soviet Union, Russia has intervened or supported several ethnic enclaves in other states: Transnistria, a self-declared Russia military-occupied state in Moldova; Abkhazia, a self-declared Russia military-occupied state on Georgia’s Black Sea coast; South Ossetia, a self-declared Russia military-occupied state on Georgia’s northern border with Russia; and Nagorno-Karabakh, a self-declared ethnic Armenian state in southwestern Azerbaijan.

State-owned oil companies Rosneft, Novatek, Gazprom and Sistema are more internecine than China’s, but rely on personal connections with the Putin regime to obtain monopoly rights on exports to different areas. Compared to China’s organized protectionism, Russia’s creates chaos. Moscow’s use of force (Georgia, Ukraine), strategic loans to Euro-skeptic politicians (Moldova, France, Austria), and state-owned energy deals in Europe, Turkey, Egypt, India, Vietnam, Venezuela, and the Russian Far East (Power of Siberia pipeline) seek to divide or block rivals.

Supply Chain Integration

In this context of contested international rules, supply chains have become more horizontally integrated. By integration, we refer to cooperative competition among producers, storage facilities, and transportation networks that are not of the same firm (vertical integration). Horizontal supply chain complexity is enormous, consisting of many various interconnections among production orders, inventory levels, capacity and utilization, deliveries, revenues, and lead times. In every sector, companies and governments want more supplier visibility to grasp what an integrated supply chain looks like.

Many supply chains have become more globalized with respect to cross-border trade, investment flows and labor markets. In response, China and Russia have nationalized supply chains to create leverage.

Government subsidies add to that leverage with unfair pricing (a reason the US still regards China as a non-market economy). China leveraged that position in February 2020 by threatening to cut off medical supplies and pharmaceuticals to the United States during the pandemic that started in and emanated from China. In March, the state-run Xinhua news media warned of banning medical supply exports to the US. In May 2019, the state-run People’s Daily outlet threatened to cut off rare earth minerals to the US to leverage trade negotiations. Recall that China slashed exports of rare earth minerals to Japan in 2010 in the context of a territorial dispute over the Senkaku Islands (Diaoyutai, according to Beijing). 

For its part, Russia seeks lower oil prices to prevent US shale oil from gaining market share. Russia’s economy is otherwise anemic. So, Moscow routinely conducts cyber, disinformation, and sabotage operations to harm economic infrastructure, among other targets such as media outlets and government institutions. Threats to cut off oil or natural gas are usually aimed at isolated and heavily dependent targets such as Ukraine in the past, and Belarus now. Putin’s attempt to reverse Saudi Arabia’s reduction of oil supply during the pandemic’s drop in demand failed, driving government revenues downward and losing market share.

Both states’ willingness to use trade dependencies to compel foreign policy behavior reflects a common confrontational strategy to supply chain integration. China subsidizes, directs or pressures large-scale Chinese public enterprises (China National Petroleum Corporation), banks (China Development Bank), and private companies (Huawei) to support domestic policies and foreign priorities. State-owned enterprises that are privatized or transitioned to mixed ownership have boards of directors under the influence of Party and government officials.

Most countries pursue protectionism to defend sectors against attack. China and Russia use protectionism to threaten attack.

Protectionism in a general sense seeks to restrict all of the above: trade; investment; labor; and disease. It’s impossible to have all of that without inhibiting the free flow of information. Democracies value freedom of speech and press, so the process that secures protectionism for particular goods, services and people is more transparent. Authoritarian states restrict speech and press, so protectionism is more directive and opaque. Everyone wants economic growth, but China and Russia operate according to authoritarian rules. There are differences, such as China’s supply chain integration appearing to be more organized than Russia’s. The question is, where is integration heading? Let’s look at incentives and disincentives.

Incentives & Disincentives

Incentives and disincentives for integration are largely political-economic and technological, both of which are influenced by culture and historical experience. 

Political-economic incentives boil down to increasing one’s relative power and prosperity. For authoritarians, the purpose is to create a “stability of limited or non-opportunity” that leverages elites. In pluralistic political systems, stability is a dynamic of providing more opportunity to a wider variety of actors. We define “stability” opportunistically here to specify its meaning in terms of what to cause and what to prevent.

In many authoritarian cases, increasing power and influence also means reducing that of one’s rivals. In areas that China and Russia regard as strategic–such as territorial disputes and industrial policy priorities–advantage is not a win-win proposition:

The state-run media claims win-win by defining mutual gains in terms of disinformation-distorted interests. Note the Russia disinformation in the “power lines through the Kerch Strait” citation above, which refers to a coup d’etat and a wildly popular referendum. Another view may be found here. In addition, the assertion that “The Crimean bridge was built to connect the peninsula with continental Russia“ ignores: (a) Moscow’s illegal use of the bridge in violation of the United Nations Convention on the Law of the Sea; and (b) Moscow’s design and use of the bridge to constrain freedom of navigation.

Supply chain integration is politicized by state-owned enterprises and subsidized private conglomerates. Information about supply schedules, inventory management, and distribution networks tends to be unclear. Transparency that does exist is a veil that obscures power brokers and real contract preferences. For a business trying to do business, the challenge is to discern the informal relationships driving decisions and constituting trust. Given the coverup of information relating to the origin and spread of COVID-19, there are concerns about repeats in the future. Foreign businesses are looking to diversify manufacturing and perhaps component sourcing elsewhere where lower wages and skilled labor is available—Vietnam, Thailand and India.

Technological incentives of supply chain integration are clearer. The digitization of information expands connections and enables economic efficiencies such as reduced transportation costs. From containerization (The Box, Marc Levinson) to real-time tracking and predictive delivery, e-commerce and intermodel transfers are integrating Eurasia (Super Continent, Kent Calder). Automation of routine tasks such as inventory management, and the sharing of information such as departed-enroute-arrived enhances functional integration. No country in Asia except India can compete with China in terms of total labor, but automation can boost productivity.

The same technology that enables instant communication across widely distributed supply chains also invites information that exploits vulnerabilities. Businesses must deal with an explosion of threats such as cyber and disinformation attack, outsider-becomes-insider, and theft of financial assets and intellectual property. Non-disclosure agreements and government standards/best practices (such as the US Cybersecurity Maturation Model) can reduce but not eliminate the attendant risk of depending on technology and ultimately, the integrity of information.

Political & Technological Change

The degree to which China and Russia have sought supply chain integration for broader advantage may be further understood in terms of their post-Mao and post-USSR efforts to reclaim territory and status.

China’s post-Mao modernization has achieved unprecedented growth while struggling to maintain single-Party control. All the while, Beijing has waged complex warfare of coercion, compellence and inducements to reclaim imperial borders and suppress human rights. For a sample of evidence, consider China’s actions in and around Tibet (forced incorporation), Burma – Myanmar (forced border), Xinjiang (Uighurs), India (Aksai Chin, Kashmir), Russia, (Ussuri River), Pakistan (trans-Karakoram), Vietnam (invasion, maritime seizure of territory) , the Philippines (maritime incursions and seizure of territory), Taiwan (missile firings and airspace violations), Japan (Senkakus and airspace violations), Indonesia (maritime intrusions), Tiananmen Square (massacre of students), and Hong Kong (broken agreement).

The aggressive territorialism fueled by economic growth and military capabilities mocks liberal economic norms and creates problematic issues at home. For China, nationalism can quickly and on a massive scale backfire on the Communist Party of China, which few citizens trust to tell the truth. For Russia, militarist territorialism’s lack of respect for self-government has led to democratic protests and a declining lack of trust in Putin.

Russia’s political rearrangement of borders has become more aggressive: political and economic coercion; cyber and information attacks; and physical invasion.

In 2008 after a period of Russian and proxy provocations, Georgian forces assaulted South Ossetia to re-take territory from Ossetian separatists supported by Russian peace-keeping forces (see CAIRN paper by Tracey German. Russian forces counter attacked in strength, halted for the NATO-initiated ceasefire, and recognized Abkhazia and South Ossetia as independent states.

In 2014, Russian forces invaded eastern Ukraine to re-install a pro-Russia government that had fled due to large-scale demonstrations. Russia subsequently annexed Ukraine’s Crimea peninsula. In both cases and continuing today, cyber attacks on government institutions, media, and military forces are part of Russia’s DIMES-wide complex warfare.

The territorial and economic expansion of China and Russia have created a wariness among businesses seeking customers in growing markets.

Beijing appears to struggle at times anticipating how domestic politics play out in more democratic systems. Increasingly, domestic politics do not stay domestic. One example is the China Greece Serbia Hungary high speed rail initiative. A year after China initiated its 16+1 initiative toward central and eastern European states (becoming 17+1 with Greece) with a supply chain from Kazakhstan through Greece, EU and Russia involvement derailed the plan for high speed freight.

Russian operatives know how domestic politics play out, perhaps because there are vestiges of post-USSR liberalization. Also, Moscow is confronted by states in various stages of their post-Soviet freedom. These states are more able to balance NATO and EU ties against Russian economic and political-military pressure. For instance, the attempt by Putin to “securitize” the Eurasian Economic Union against Chinese and Western influence is undercut by Russia’s increasing trade and financial dependence.

Politics complicate supply chain integration, but what about changes in technology?

China’s access to foreign-sourced resources are enabled by advances in technology that reduce transportation costs but require information sharing. To deal with the growing complexity of supply chains, artificial intelligence, 5G networking, and quantum computing offer solutions. All of them require decisions about how much control over information should be allowed and by whom.

This is where political systems cannot be separated from the use of technology. The 2015 Agreement between President Obama and Chairman Xi and endorsed by the G-20 prohibited spying that benefits companies and commerce. As information technology expands China’s massive domestic surveillance, that agreement favors China. Internal controls over citizens and foreign businesses are not considered state espionage in China. National pride is at stake. Recent concerns by the Federal Bureau of Investigation and Department of Homeland Security that Chinese hackers and researchers were attempting to steal coronavirus vaccine information was rejected by China’s Foreign Ministry. In the same breath, official China claimed to be in the lead of vaccine research and development.

China’s Block-Chain Services network promises to “change the world” by managing information securely with transparent, trusted information. Given the massive information surveillance and disinformation of the Communist Party of China, will non-China trust this technology for their supply chain portion? There will not likely be a choice inside China where a huge domestic market with mobile apps and cooperation with Russia and India provide alternatives to US-centered international banking transactions based on SWIFT—the Society for Worldwide Inter-Financial Telecommunication. Will Beijing pressure business partners to adopt China-monitored apps (WeChat, AliPay, etc.) while banning technologies with uncensored search engines? We expect so.

Technology that affects Russia and China include the European Union’s Three Seas Initiative (3SI: Baltic Sea, Black Sea, Adriatic Sea) and and a Baltic-Black Sea Waterway. Twelve states comprise the 3SI (Austria, Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia). New liquid natural gas terminals, Romanian gas reserves and connections among highways, rail and water corridors involve improved intermodal connections, autonomous transport, and electromobility. A host of cyber upgrades rely on fiber optics, 5G technology infrastructure, cloud computing integration, and data islands.

https://www.google.com/search?q=three+seas+initiative+2020&tbm=isch&ved=2ahUKEwiUq4KE_NTpAhUY0qwKHat8DSAQ2-cCegQIABAC&oq=three+seas+initiativr&gs_lcp=ChJtb2JpbGUtZ3dzLXdpei1pbWcQARgBMgQIABANMgQIABANMgQIABANMgQIABANOgQIIxAnOgUIIRCrAjoHCCMQ6gIQJzoECAAQQzoCCAA6BggAEAgQHjoECAAQGFDGygNYh_8DYLKEBGgBcAB4AYABmgKIAchAkgEHMC4yMC4yMZgBAKABAbABBQ&sclient=mobile-gws-wiz-img&ei=HtnOXpSkOpikswWr-bWAAg&bih=911&biw=1366&prmd=nmiv&rlz=1C9BKJA_enUS732US732&hl=en-US#imgrc=KA9nA7RjfaSHyM

The Baltic to Black Sea project, E40, would bypass Russia and involve deepening existing waterways and building new ones. Opposed by Moscow, E40 would enhance Ukraine’s transit position for China’s BRI and orient Belarus toward the EU.

https://www.seanews.com.tr/viking-box-train-adds-georgian-railways-linking-baltic-to-black-sea/147285/

To what extent can we expect Beijing and Moscow to weaponize supply chains against rivals? That question includes Beijing v Moscow. China uses the Eurasian Economic Union (EAEU) created by Russia to reshape its own supply chains with selective free trade zones. Moscow’s bilateral trade within the Union is being outpaced by China’s. It’s easy to envision Russia’s Internet Research Agency (troll farm) hacking into China’s digital currency and trading partners for espionage, theft, ransom, and leverage to reduce China’s gains. With China’s rise, Russia is becoming a country of transit points servicing the China market.

http://greater-europe.org/archives/6813

Technology, governments, and businesses have a way of creating alternatives. Citing national security concerns, the US Government permitted a subsidiary of Google to open a direct underwater cable connection that avoids rather than includes Hong Kong – China. Cyber security laws in China, Russia and other states prevent the free flow of data, requiring in-country storage to enforce what is private and what is not. Based on that and ongoing Chinese and Russian information operations, foreign businesses have good reason to expect continued state-sponsored intellectual property theft.

Other tech trends affecting the integration of supply chains access to energy or information are advances in tracking goods and services, and the containers in which goods arrive and depart. More visibility can enable businesses to prevent some of the surprise stack ups in ports during the coronavirus pandemic. The ability to get information into more aspects of multiple supply chains can help develop multiple sources of supply. This insight, however, will not erase the costs incurred when sourcing from production or labor locations that are not lowest cost for the right match of product and labor expertise.

This brings us to the question, can we integrate and protect supply chains against entrenched discriminatory competition?

Integration with Protection

Discriminatory practices are not unique to China and Russia, but they are less negotiable. Constitutional legitimacy is weak, yet single-Party elites in China and statist elites in Russia manage to crush enough individual rights to stay in power. Some background on Xi and Putin is appropriate to appreciate the continuity of entrenched discriminatory competition and threats.

Xi was “elected” unanimously by the National People’s Congress, a formality eliminated by a change to the Constitution in 2018 that allows him to serve for life. His selection as Party Chairman by the Party’s Central Committee in 2012 guaranteed the Presidency anyway. Xi also holds the position of Chairman of the Central Military Commission. Putin’s elections as President are more legitimate in terms of democratic process. Putin was President Boris Yeltsin’s Prime Minister, then acting President, upon the latter’s resignation in 1999. He was elected in 2000 and 2004, then Prime Minister to due to the 8-year term limit, and elected again in 2012 and 2018. Russia’s Constitutional Court cleared the way for Putin to serve until 2036. Putin is losing legitimacy as he regularly imprisons, harasses and eliminates opposition leaders.

Protecting individual rights leads to democratic competition and a common basis for property rights that undergird legitimate economic competition. Protecting authoritarian rights leads to coercive competition at home, and stealing property (including territory) abroad where power vacuums permit. While Russian protectionism sputters against resistant neighbors, China’s strategic protectionism and infrastructure-driven development is uniquely transcontinental in scale (coined as ”distributive globalism” by Kent Calder in Super Continent, 107).

A liberal hope is that authoritarian powers become more pluralistic, whether they are a rising China or a declining Russia. The roots of protectionism offer potential solutions but the actionable options depend on many factors. The proximate causes of protectionism include nationalism, predatory trade and finance, uncompetitiveness, disadvantaged workers, and more broadly, societal differences in values and capabilities to adapt to change. Globalization based on agreed non-discriminatory practices is precisely the kind of change that authoritarian protectionism seeks to prevent. We see this play out in the incentives for integrating supply chains.

Supply chains that are regarded as legitimate competition generally operate according to economic incentives—profit, market share, and added value. In China and Russia these factors are more easily manipulated in non-transparent ways to achieve national advantage: enhancing corporate pricing with subsidies, foreign-targeted taxes and beneficial land-use policies; compelling foreign firms to divulge private intelligence and technology; coercing board of directors members; and inducing key executives’ resignations with anti-corruption charges. Where judicial systems are not independent of the executive branch, rule of law becomes elite rule by law.

A related liberal hope is that more authoritarian membership and leadership positions in international institutions will have democratizing effects. Perhaps time will tell. For now, having Chinese officials in senior posts for instance at the World Bank, Interpol, United Nations Educational, Scientific & Cultural Organization (UNESCO), and International Civil Aviation Organization simply serves authoritarian control:

Multilateral institutions and arrangements designed to protect a country or region against outside competitors are vulnerable to China and Russia when divided. With capital assets, China buys out the membership’s debt then acquires assets. Russia creates compromising information (kompromat) or energy dependencies with which to promote loyalty. We see this in ASEAN and the EUEU, respectively. Toward ASEAN states, China divides them to prevent unified positions on the South China Sea territorial disputes and in the competition for Persian Gulf oil. Most recently China threatened Australia with boycotts due to Canberra’s call for an independent inquiry into the origins of the coronavirus pandemic. Toward the EUEU, Russia’s customs agreements from Kazakhstan to Belarus enhance Russian identity. However, China’s integration of trade routes through Kazakhstan circumvents Russia anyway.

Former Russian Foreign Minister Yevgeny Primakov launched a multilateralist policy to displace US influence and counter China’s rise. The more US policy emphasizes exceptionalism and superpower status, the more attraction this narrative may have in areas where EU economic development is not benefiting ethnic Russians. Moscow’s stokes a divisive narrative that is combined with territorial invasion or division, threatened and executed cutoffs of oil flow, and assassinations of anti-Russia activists and agents.

Decision Points

The US is in a privileged position to decide what level of autarky it needs and compete globally to grow the economy. Most economies do not have that luxury. Of the 200 or so countries in the world, abut 40 are developed while the rest are emerging. Which economy needs to grow — US or global? That may be a false dichotomy, yet more people see the world economy splitting into Western led and China led spheres, as in a “splinter net.” These are the stakes of decision making today.

From a business perspective, government contracts are desirable due to their reliability compared to the private sector where diversifying suppliers erodes purchasing power. However, the complexity of knowing even what government-quality supply chains look like frustrates self-sufficiency. Prior to the COVID-19 outbreak, outsourcing by US companies via Third Party Logistics (3PL) to Mexico and Southeast Asia was a trending alternative to suppliers in China. Declining shipments from China and increases from Southeast Asia and Europe provide further indications. As China’s income levels rise, its skilled labor and performance standards will have to add more value to sustain competitive supply chains. The complexity of various countries and their sub-divisions “re-opening” complicates the ability to forecast and plan a reliable supply network. Open and uncensored Information sharing via such websites as multimerchant.com can help by promoting innovative solutions.

The Trump administration‘s response to China’s trade war with the US, born of persistent frustration with unfair competition and systematic disinformation and intellectual property theft, has increased the cost of doing business with China. Apple, Google, Intel, Microsoft, Samsung, Ericsson, Nokia, Intel, Nike, and Adidas apparently intend to diversify their supply chains, but what about small businesses which account for 40% of US GDP? The ability to follow through requires cash. Any move therefore is likely to be gradual as governments deficit-spend their way through the pandemic shutdown and any subsequent re-attacks.

In the US, pandemic re-opening is not likely to be a rush toward self-sufficiency even with low interest rates and incentives to onshore more infrastructure. With over 50,000 small businesses supporting the DoD in many innovative projects, shutdowns scatter specialized labor. Chinese vendors such as Huawei, ZTE are standing by to buy. The pressures of an extended shutdown incentivize strategic small businesses to seek cash flow. The National Defense Industrial Association and Professional Services Administration requested Congress to delay prohibiting small businesses from working with Huawei and ZTE. In response, government programs are poised to spend trillions more, accumulating more debt that is financed by China’s purchase of US government securities to the tune of $1 trillion. In this information environment, which US businesses are confident enough to risk selling factories in China at a loss? Will the US government step in to subsidize that?

Autarky at any level requires energy. All supply chains need an energy source. Dependence on foreign energy is decreasing, but the price of shale oil is still higher than Middle East oil. If we want to use US oil for domestic consumption rather than pay less for foreign oil, transportation costs will increase. That effects nearly all products. An alternative to that is exporting US oil, which means allowing market forces to determine the distribution over time, again.

As Northeast Asia’s dependence increases and parts of Europe become moored to Russian oil and natural gas, US oil can compete in these markets. Is autarky on demand is an option? That is, can we turn off exports and redistribute energy for local consumption when needed, other than the national energy stockpile? If so, who will assure our allies the free flow of energy? A growing global population with water shortages and food distribution challenges requires an efficient global economy, one that is not de-globalized. And then there’s climate change which requires a global approach as weather extremes and sea levels rise.

For all of these reasons, a retreat to relative isolationism is a path to strategic irrelevance. The latter is a relative position. China‘s early exit out of the pandemic without heavy deficit spending and with plenty of capital means that Beijing can be a source of investment. The big question is whether China‘s authoritarian capitalism can be trusted. Transparency of information-sharing, particularly during Xi’s highly centralized governance, is deliberately hidden.

For states that do not trust official China’s intent, shortening supply chains makes sense where efficiency can be found, but diversification is best. This trend began before the current pandemic as many corporations sought robust resilience. Most small business can’t afford to do this, and most small businesses will go where the appropriately skilled labor costs are low. Local or regional manufacturing needs to be a bottom up set of incentivized decisions, not a top-down unfunded mandate. Expensive US exports will not compete with cheaper labor elsewhere, given the low cost of maritime transport.

One of the areas where US capacity needs to adapt during this pandemic is warehouse capacity. Warehouses are not sufficient for the increased supply due to decreased transportation, yet imports still arrive from China. Goods arrive without demand so 3PLs are being contracted. Compare this situation to China’s transcontinental industrial plan with regional logistics centers — ports and airports. Prologis and CBRE, for instance, provide warehouse space and consulting to manage real estate leases as e-commerce retail sales push up demand for local distribution.

For China’s neighbors who desire alternatives to shortening supply chains with China, a globalized US economy engaged in international institutions is critical. Even shortening supply chains means developing closer relations and relationships. Therefore the US needs to exert leadership in collaborating against global threats such as this pandemic, in international institutions to expand supply chains production, in inventory technology, research and development, transportation and infrastructure, and most of all in setting norms for information sharing.

Leadership is a competition. China is looking for alternatives to US suppliers and vice versa. There are 18 emerging economies that have experienced growth rates that achieve upper middle income status over a 20- 50 year period. That is where a global recovery of manufacturing and trade can begin. The 53 other emerging markets were under-performing before the pandemic. Proactive investment leadership looks at the timing of growth cycles for opportunities when risk-reward ratios look good. Such as when currencies are inexpensive and good companies are trading at low prices.

To act upon these global opportunities, globalization must be protected. The obstacle to doing this is the globalization of protectionism. Every country has protected sectors, but China’s protectionism is authoritarian and globalized. We see its heavy hand most prominently in emerging markets.

China’s approach to the emerging markets is to buy debt, then purchase desired assets. Distress-buying serves China’s state-subsidized domestic overcapacity, which seeks markets. Growing and then protecting China’s market share on a global scale is what the Beijing politicized economy is designed to do. With 60 million Chinese employed by state-owned, collective-owned and private enterprises, the Beijing needs high rate economic growth to stave off political unrest. China’s approach contrasts to that of the IMF and WB: restructuring debt payments in return for domestic policy reforms. China’s approach becomes an acceptable alternative for emerging economies when democratic economies politicize and frustrate their reforms. This is what happened in the 2008 global financial crisis.

Western banks’ capital ratios for banks were weak, resulting in loans not backed up by enough reserves. Even though the IMF, US Federal Reserve Bank, other Western central banks and Japan provided emergency financing and loans, China was better positioned for the crisis. A divided US Congress failed to approve increases in IMF funding quotas in a deal that would have elevated the voting shares of Brazil, Russia, India and China. This led to the BRIC’s establishment of the NDB and AIIB. Compared to the easy credit and low interest rates that drove risky loans in the US, China’s higher reserve ratios and interest rates enabled its banks to lend more when it was needed. China’s actions stimulated growth through infrastructure projects while the US, Europe, Japan and others were in recession.

Now the world is a mix of protected globalization and globalized protectionism. Decisions made by the governments of the largest two economies can determine the balance. The strength of the US dollar as the international currency of choice guides financial flows through US markets. To the extent that US tariffs against unfair traders such as China protect fair trade, they protect rule-based globalization. In contrast, China’s opaque information sharing, dark supply chains, predatory lending practices and economic threats globalize protectionism. A coordinated disinformation campaign claims openness while China’s tariffs, subsidies and currency manipulation promote unfair trade. Prior to the pandemic, the Trump administrations’ hardline in bilateral trade negotiations found a compromise after decades of unfair trading practices. Now what?

Recommendations

Supply chains are becoming more integrated in complex ways even as some aspects of supply chains become decoupled from undesirable partners. Sudden decoupling from China is unlikely; however, we should be looking for alternative supply chains closer to home.

The following list of four recommendations for US policy and business makers distills our discussion so far, and presses it a bit further:

  1. Lead hemispheric integration of specialized supply chains for competitive advantages, employment, and growth with common health and safety standards. The Americas have potential with respect to industrial capacity, a growing middle class, and capable governance to create the kind of transcontinental scale and efficiencies that Eurasia presents China. The challenges in Latin America challenges are acute, as noted by Dr R. Evan Ellis: underfunded public health care; high debt levels; low liquidity; major defaults-Argentina is next; and mass protests before COVD-19. Canada is the largest consumer of US goods, more than China, Japan and the UK combined. The second largest consumer is Mexico, with 40% of US imports from Mexico made in the USA. Mexico is also the top foreign supplier of US medical equipment. With China likely to lend more, provide personal protective equipment, and shutdown political opposition to its increased presence, US leadership in the Americas is critical. The North American Free Trade Agreement, for instance, transformed Mexico from one of the most protectionist economies to a free trade economy while Canada and US trade tripled.
  2. Strengthen engagement with Europe, India, and East Asia. Trusted commitment to NATO and stronger EU ties are needed to compete with China’s BRI inroads and counter Russia’s divisiveness. While Russia’s influence operations across the EU are persistent, Moscow has a new front in the Philippines pursuing a joint military technical agreement. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), expanded after protectionism in the US killed the parent TPP agreement, is expected to include Australia, Brunei, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. If the US continues to fail to participate in this partnership, we are not even in the arena of epic Eurasian integration. US military support of ASEAN assertiveness against China’s territorial claims also miss a competitive economic commitment. US alliances with Japan, South Korea and Australia are solid on military matters, even as basing negotiations and US-China trade tensions limit their diplomatic effects. Closer military cooperation with India is more constrained by policy differences such as innocent passage and a vaguely hopeful Sino-Indian understanding on mutual spheres of influence. China benefits from US disengagement by constructing manufacturing and infrastructure projects, though BRI is currently suspended due to the pandemic. Unless the US expands its engagement, China may extend its lead as the largest trade partner with US allies Australia, New Zealand, Japan, Philippines, Thailand.
  3. Incentivize selective protectionism for national security-related defense, infrastructure, food and health. In what instances is it worthwhile to pay more for protecting supply chains, based on associated risks? The risks include competitor and adversary combined effects, from compellence to coercion. Which types of medical supplies and ingredients, for instance? Government-induced incentives can shape supply chains as in foreign military sales and strategic capabilities. Consider Project Socrates, which began as a Reagan administration initiative to develop technological competitive advantage. By 1990, the effort had been canceled by the Bush-41 administration because it looked like industrial policy. In fact Project Socrates was an information-age long-term strategy for technology-based planning. As pointed out separately by Stefan Banuch and Bonnie Gerard, the change instituted a policy of finance-based planning. Naturally, selecting which aspect of intertwined economies are ”essential” assembly or manufacturing can become an exercise in proliferation. Components that go into ventilators for instance can easily result in many producers being regarded as essential producers. This should be the result of government-incentivized private sector decisions.
  4. Collaboratively shape the rules of international institutions, which are influence space. Compared to national governments with sovereign rights—centralized or shared, multilateral institutions derive their influence from membership. Each member may have one vote in the United Nations General Assembly, for instance, but each has unequal power in most other aspects. The UN needs leadership among its members to solve global supply chain problems. This requires engagement. Supply chains tend to be nationalistic and subject to protectionism, so each country pursues a mix of protectionism and interdependence. Influence in international institutions will follow economic growth, advanced technology, and military power. With that as a premise, China and Russia will attempt to set the standards set for international finance and trade just as they are trying to set new territorial terms for confrontation and cooperation. Absent strong US engagement and enforcement, rules will likely be determined by an authoritarian power hostile to democratic interests and values. For instance, the fact that China does not allow third party audits of its stocks yet US investors have lost billions to Chinese fraud, results from US laws that loosened compliance requirements for emerging market investors. Shaping the rules of institutions should include creating new institutions with like-minded states who are dissatisfied with existing organizations.

Taken together, the four decisions above can create political commitment and economic inducements for the following combined effect:

  • Continental integration of American supply chains
  • Negotiated globalization with transparent protectionism

American supply chain integration can compete with, moderate and appropriately participate in China’s economic expansion. US engagement in multilateral institutions can lead transparent negotiations that admit reasonable protections for member states. Because supply chains tend to be nationalistic or nationalized, the US needs to lead an open rules-based trading system backed by hard negotiations for free and fair trade. Negotiating is also a spectrum of competition from cooperation to confrontation.

Because cooperation and confrontation are competitive, states and firms will pursue the best options for them. That means we need to stay globalized to compete, while protecting what we need. Small businesses in particular depend upon supply chains originating in China, even though disinformation is massive. Transparency is profoundly important to trusted banking. Yet China’s state agencies secret credit to favored firms, provide lending to unofficial BRI projects and non-bank subsidiaries, and are deliberately non-transparent. The US probably cannot afford to walk away from China, or China will fill markets and lead institutions toward illiberal rules.

Even if China progresses away from its single-Party autocratic governance, a more pluralistic China is not likely to be a less nationalistic China. Until China has independent courts, a free press, and an apolitically professional military, we are likely to be competing against Beijing’s complex warfare. Our “when deterrence fails” approach to warfare is narrow and subsumed by China’s DIMES-wide warfare. Beijing’s attacks include orchestrating disinformation campaigns, undercutting outside investors via banks, constructing or seizing then militarizing disputed territory, shutting down human rights by brutal means, and creating supply chains that restrict foreign competition. Taken holistically, there is an authoritarian synergy of nationalistic narrative-corrupt finance-territorial expansion-domestic control-protected supply chains. Technology is spawning new arenas.

New Arenas

Supply chain competition will be heavily influenced by 5th generation (5G) wireless technology, artificial intelligence (AI), and quantum computing.

5G technology will create a global infrastructure for information at faster speeds and lower latency. A protectionist approach to 5G technology, such as placing Huawei and affiliates on the Department of Commerce’s Entity List, needs to include participation in international standards-setting institutions. Without that kind of protectionist-globalist balance, US leadership in 5G will be reduced by China’s participation in such groups as the Institute of Electrical and Electronics Engineers, the International Standards Organisation (ISO) and the International Telecommunication Union (ITU). Just as Apple dominated the international market for earlier generation devices, China’s state-sponsored tech could set hardware and software standards that achieve comparative advantage. For instance, Huawei already uses commercial bandwidth that the US government restricts US firms from using (see Department of Defense v Federal Communications Commission argument over Ligado and military Global Positioning System). Military power follows economic power.

Quantum computing is expected to consume, create and process data at exponentially higher speeds. Beginning with more accurate clocks and better encryption/de-encryption, quantum improvements will make legacy transactions irrelevant. Quantum-based technology differs from bit (binary digit: 0 or 1)-based technology due to super-positional states that can be simultaneously 0 and 1. Once computer chips contain many qubits (quantum bits) and few errors, a 5G competitor can process, store and disseminate more information. Applied to supply chains, the ability to map, update and adjust the complex structures and interactions of supply chains can generate a range of answers to persistent problems. New capabilities for data analytics and forecasting will set new standards for optimal solutions. Artificial intelligence will out-pace human learning in more areas. Machines may prove to be more collaboratively competitive than humans, presenting us their solutions to global threats such as climate change, earth impacts, and pandemics. Computing power strengthens economic and military power.

Super AI is here. Machines are more effectively intelligent than humans in areas such as experience-based gaming (chess, go), operations research and data science solutions (optimization problems), and maximizing utility functions as a rational actor (decision-theoretic agent). AI can threaten human control, even in: (a) symbiotic machine-human systems wherein machines learn what human preference structures are, and obey them; and (b) narrow AI, such as driving a car. There are plenty of biological examples of predators and parasites that are more narrowly intelligent in terms of particular skills (hunting and infesting, eg.) than their generally more intelligent prey and hosts. Predators and parasites that play by their own rules include PLA Unit 61398 and GRU Unit 74455. Their prey and hosts include Google, Adobe, Github, the World Anti-Doping Agency, the Organization for the Prohibition of Chemical Weapons, and Westinghouse Electric Company. Such attacks are denied by official China and official Russia. General knowledge requires survival skills.

Competing in these arenas and others requires upgraded supply chains and new skills. Transportation Insight recommends five best practices: (1) visualized data analysis; (2) information sharing with application tools or third party consultants; (3) knowing what data relates to external market competitiveness; (4) managing customer expectations of location and delivery time; (5) independent unbiased analysis.

All of the above can be done by a large-scale, China-style industrial policy. The key vulnerabilities in China and Russia are the banking industry and rule of law. State-owned banks are notorious for issuing bad loans due to pressure by local Party and government bureaucrats, and contract enforcement is weak. The lack of political competition at the Party level (China) and at the state level (Russia) inhibits some types of reform and promotes corruption.

In democracies, eternal debates over privacy and law enforcement (FBI v Apple) occur under public scrutiny. Basic citizen rights and government responsibilities are based on rule of law, eternally interpreted. That does not happen in China and to a lesser extent Russia. To compete and win legitimate standards and values, democracies need to maintain economic and technological supremacy in the information environment.

The future of the international political economy, eroded by protectionism since its inception, will be heavily influenced by supply competition in a context of new technologies and integration. Globalism will always be protectionist to a degree. Protectionism will always be globalist in the sense of sourcing and selling goods and services outside one’s national borders.

With the exception of clearly specified supply chains nourished by the US government, US businesses have to venture into the global network of production, storage and distribution of goods and services. The challenge is more than creating secure enclaves of encrypted data or shielded hardware. Securing a network of suppliers all the way to customers requires risk-aware trust in suppliers, or a protectionism that reduces competitiveness. Like the classical trade-off between responsiveness and efficiency, protectionism and competitiveness are difficult to have simultaneously without massive national investments.   

The extent of integration that any state, company or individual desires will vary. Yet all actors want to be prepared for pandemic-scale threats to survival, health, prosperity and values. Globalization and protectionism will continue to coexist. Supply chain competition can help governments and businesses identify the specifics of each that they seek. Solving supply chain problems requires rules-based protected globalization. This is also the type of constructive competition we need to eliminate planetary threats.

Author: Thomas A.Drohan, Ph.D., Brig Gen USAF ret.

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