Supply Chain Resilience and Comparative Advantage: Rethinking Global Trade After COVID-19

The Covid pandemic of 2020-21 will be analyzed for decades by policymakers and historians to glean important lessons.  One area of close analysis is free trade, which turned out to be vulnerable to the pandemic.  In the years before the pandemic, outsourcing was common and done almost entirely on the basis of financial cost.  Output had increased and consumers had enjoyed lower prices due to the law of comparative advantage.

But the pandemic threw markets into chaos by disrupting supply chains.  Thanks to comparative advantage and free trade, relatively few complex goods were made entirely within any one country.  Imported parts are often a significant component of domestically-made appliances, equipment, and automobiles.  During the pandemic, many people discovered that domestic goods were more difficult to produce due to lack of availability of imported parts.  Gone were the days of most consumers being able to believe that “made in America” or “made in Britain” meant the whole thing.

Supply Chain Resilience

In the aftermath of supply shocks caused by the pandemic, firms and policymakers began to look at the concept of supply chain resilience, or the ability of the supply chain to adapt to negative impacts.  During the pandemic, many firms’ supply chains went through only a handful of countries, making them vulnerable to localized labor stoppages.  Consumers, firms, and policymakers quickly demanded that supply chains be diversified to not draw all resources or parts from just a few countries.

The desire for redundancy, or having multiple backup options, violated the law of comparative advantage.  If your business decides to contract with two foreign firms for resources or parts, only one of those two foreign firms can be the cheaper of the two.  Instead of getting all your resources or parts from the lowest-cost supplier, you are now purchasing some from a more expensive supplier.  This is less efficient economically, but may be worth it in the long run if the lower-cost supplier faces a work stoppage but the higher-cost supplier continues to ship as promised.

After the Covid pandemic, Western firms are willing to explore violating the law of comparative advantage in sourcing suppliers based on multiple factors.

Shutdown Policies

Supply chain producers may be cheaper in China, but China’s government may be aggressive in imposing shutdowns.  This could change the balance of comparative advantage if Western firms factor in the likelihood of future government-imposed shutdowns with cost predictions.  Over the long run, large corporations could predict epidemics or pandemics occurring every X years in major cities where their lowest-cost suppliers are located, resulting in Y level shutdowns.  Factoring in X and Y, these corporations may find it financially beneficial to engage in supply chain resilience by diversifying their suppliers to those in nations that are not prone to shutdowns.

Political Stability

Since Covid, the geopolitical landscape has changed as well.  In the free trade era of the 1990s and early 2000s, China was looking to increase its economic and political ties to the West.  Since the start of the Russo-Ukrainian War in 2022, however, China has increased its ties to Russia, which is currently under Western economic sanctions.  Simultaneously, China’s increasing military strength makes an invasion of Taiwan, which it considers a breakaway province, more likely before the end of the decade.

A major conflict in the Asia-Pacific region could sever many supply chain ties between Chinese and Western firms, creating another harmful supply shock.  Therefore, major corporations may also choose to factor in political stability as a cost of supply chain selection.  A lower-cost supplier in China or surrounding countries may be negatively impacted by war or a severing of political ties, making it cost-effective to pursue more expensive, but far more politically stable, suppliers.

Health Care and Epidemiology

Even if an epidemic or pandemic does not shut down a supplier with government mandates, a nation’s health care and epidemiology characteristics can affect supplier costs.  A nation with little health care or epidemiological research and infrastructure may quickly become overrun by illness, affecting a supplier almost as much as a government-mandated shutdown.  Over the long run, the lack of health care may be worse for the supplier’s output than the imposed shutdown, as the workers may suffer from long-term health effects.  

Therefore, Western companies may have to weigh the one-time shut down costs in more developed countries, such as China, against more widespread and longer-term effects of the disease itself in less developed countries.  This may reduce options in seeking supply chain resilience and force companies to seek suppliers in wealthier countries with better health care but higher costs of production.  These workers will be healthier in the long run but cost higher wages.

Consumer Fears of Foreign Illnesses

Reshoring has become popular as companies seek to avoid tariffs and benefit from public support for domestically-made goods.  The Covid pandemic led to some Western distrust of China, with rumors flying about the Covid virus being created in a Chinese laboratory.  Therefore, many companies may find some financial incentive, akin to a subsidy, in being able to publicly report that their supply chain is domestic rather than imported.  In the United States, for example, there was enough of an increase in consumer demand for products advertised as “made in America” that a law was passed to prevent companies from falsely using the label.

Supply Chain Resilience Cost-Benefit Analysis

Taken together, there are many implicit costs of continuing to use the lowest-cost supplier: they are more vulnerable to disruptions and are less popular with domestic consumers.  Over the long run, many companies may find it cost-effective to diversify their supply chain by sourcing some resources and parts from wealthier, but more stable, countries.  Two issues with this are elasticity of supply and economies of scale, both of which affect the per-unit cost of output.

Elasticity of Supply and Excess Capacity

At present, the cost of a unit of resource or a part from a domestic supplier is Q.  But how long will it remain Q?  As more companies buy from a domestic supplier, price will rise due to increased demand.  Will the company be able to continue making the resource or part with its existing facility and equipment?  If domestic suppliers have little excess capacity, or the ability to produce more output with its current capital goods, it will have to purchase more capital.  This will raise its costs, which will be transferred onto the buyer.  Thus, reshoring one’s supply chain could be more expensive than anticipated.

Economies of Scale

However, hanging on with a domestic supplier as it expands or re-tools could be financially beneficial in the long run as the expanded supplier enjoys economies of scale from improved ability to mass produce.  In the wake of Covid, many small suppliers may be popping up in the West but have yet to experience significant economies of scale.  Especially with government assistance, these suppliers may grow and be able to reduce their per-unit costs, benefiting firms that buy their resources or parts.  

Again, the situation is complicated.  Many firms may try to time the market correctly to maximize profit (or minimize cost) and wait to purchase from a domestic supplier only after it enjoys economies of scale.  This may be sub-optimal, as the supplier will give more favorable deals, secured by long-term contracts, to its original customers and give less favorable deals to customers that only arrived after its growing pains were over.  Customers that wait too long may also find costs higher due to increased demand from competing customers.