Through off-shoring, the relentless pursuit for profit has created an unacceptable amount of systemic risk in our societies.
The phenomenon knows as Globalization accelerated and picked up pace during the 1990’s. Large corporations were finally able to deploy their capital anywhere in the world. Accelerated by international commercial treaties, de-regulation, low oil prices and support from political elites, multi-national companies started branching out of their home turfs and venturing towards towards developing nations.
Across boardrooms and senior executive teams, the idea of cost reduction took hold with fervor. Firms started off-shoring some of their most crucial activities, in particular manufacturing. With the reliability of industrial automation, you could produce the same goods, at (almost) the same quality anywhere in the world. Manufacturing labor started moving outwards to countries whose cost structure was much more attractive.
Developing nations were armed with cheap labor and hungry for foreign investment. Developed countries were armed with capital, intellectual property, and an insatiable customer base. Off-shoring meant huge cost savings for industrial conglomerates. A massive shift took place, whereby companies invested capital in developing nations to build manufacturing facilities, brought their production know-how to far-away places, hired cheap labor, and scaled out production at a fraction of a cost compared to their home countries.
This massive shift in production required a fundamental re-architecting of the supply chain, which now required a global footprint. Raw materials needed to be procured and sent over to distant places. Transportation and logistics increased their complexity by orders of magnitude. Insurance had to play a more prominent role in protecting all those billions of dollars of materials and goods as they moved from one side of the world to the next one. Complex distribution chains had to be built for this purpose.
The formula proved to be successful. By putting the cost structure under pressure, profits increased. By producing at lower cost, goods were accessible to even more customers, thus increasing sales.
Lower production costs + more sales = higher stock prices and bonuses for the exec teams. Impossible to refuse
Why produce textiles in Switzerland, when you could do it much cheaper in Honduras? Why manufacture in Germany, if you could do it cheaper in Thailand? Why pay the high salaries of “expensive” USA blue-collar workers, when Chinese workers could do the same job for much less?
The idea was executed wonderfully and was a win-win situation. Large multi-nationals could earn more money. The customers could have access to more and cheaper goods. Developing nations increased the employment of their workforce. Developed economies transferred some of their know-how and expertise to countries which did have it.
It all came crashing down with the Coronavirus.
The capacity of rich nations to produce tangible goods by themselves was severely diminished throughout the last three decades. In some industries, rich countries can’t even self-sufficiently produce some very essential goods. Rich, developed nations have become overly reliant on a global supply network which, when put under stress, can become dislocated and create social pressure in affected nations.
In their endless pursuit for profit, rich countries and their corporations have annihilated their ability to produce basic goods themselves:
I am not writing this to denounce globalisation or the off-shoring of labor in general. Quite the contrary, sometimes this is needed. In certain industries, countries cannot supply the demand for specific skillsets with in-country staff. Under such conditions, having access to a larger talent pool is crucial. But when the decision to off-shore is made purely on its benefit to financial bottom lines, then problems start. If the only driver for decision-making is money-making, you can be sure that excess and risk-taking will happen at industrial scale.
I’d like to call this phenomenon the leveraging of the supply chain. In finance, leverage is the process whereby you take capital from someone else and invest it for your own profit. Like borrowing money from the bank and investing it in the stock market. When things are good, your returns on investments will be larger than the cost to service your debt, so you make a profit. So you borrow more money to achieve higher returns. But when things go bad and you start to lose money on the market, you have both a capital loss and you need to pay your debt (plus interest). Leverage is a magnifier for both profits and losses.
This is the same phenomenon applied to manufacturing. When things go well, off-shoring increases your profits handsomely. But when the global supply chain is dislocated, the magnitude of these systemic shocks are more profound. As the Coronavirus crisis unfolds in the West, rich countries suddenly found themselves in a very poor situation:
Unable to produce hand sanitizer by itself, Switzerland found some of its imports being confiscated by Italian customs authorities
Unable to provide the most essential Personal Protection Equipment (PPE) to their health care staff, US personnel are forced to improvise and use anything to protect themselves
- The food supply chain has been put at risk in many parts of the world.
Usually, financial crises are caused through some type of over leverage. In the same way, I believe that we have been leveraging the supply chains too much and we should use its coronavirus-induced dislocation as a wakeup call to de-leverage it. For example, in the same way that anti-trust regulators intervene and block the sale/merger between companies when such a deal might compromise the benefits for consumers, governments and policymakers should also exercise veto power when a company’s off-shoring might put the national supply of some critical good or service at risk. Or governments might want to incentivize a company to keep some degree of local production, at least the bare minimum needed within a specific region.
This has to be done through a framework of cooperation. The purpose here is not to push for nationalisation or populism. What I strive to achieve here is to mitigate the risks that modern society is exposed to if most of the manufacturing capability of the world is concentrated in a few spots around the globe.
Update April 19th, 2020: Want to share this excellent piece written by Marc Andreessen