Unwinding Globalization: Why Just In Case Is Making A Comeback
Globalization of trade has been a trend for hundreds if not thousands of years. Companies endlessly seek cheaper inputs for their products – cheaper labor, cheaper raw materials, cheaper and more efficient production. After all, why manufacture in the US where it’s expensive when you can manufacture overseas for half the price? Classic trade theory says that if two groups who are specialists both focus on what they’re good at and then trade the final products, then both parties end up with more. I.e. everyone benefits from trade.
But the drawbacks of trade are starting to become more apparent. Covid-19 has laid bare two big weaknesses to global trade that might spur a push towards limited de-globalization and the onshoring of production. First, there’s the knock on effect of a disruption to just in time production, and second, there’s the danger that nationalistic instincts can pose to supply chains for essential goods.
Just In Time or Just in Case
Modern supply chains are highly efficient and incredibly fragile. Products with hundreds of parts are assembled in pieces across the globe, with every component arriving just in time for the final product to be assembled. Factories try to ship out finished product right away, and don’t stock up much on input pieces.
This efficiency in receiving inputs and shipping outputs means the companies can operate with low capital intensity – they don’t need to tie up a lot of money stockpiling goods. Furthermore, the companies don’t carry the risk that the value of their inventory is going to swing against them while they’re holding it.
But Covid-19 laid bare the risks of the just in time supply chains that stretch across the globe. Enforced quarantines, stay at home orders, and the closing of borders caused disruptions to select parts of essential supply chains. A shortage in a single part caused whole assembly processes to grind to a halt.
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The way to prevent this is to shift your supply chain from getting parts just in time to stockpiling enough inventory to be able to continue manufacturing just in case there’s a disruption. This requires more capital, more storage space, and more investment by manufacturers.
A potentially far greater concern and a real driver for de-globalization of select supply chains is the emergence of more nationalistic instincts in vital industries. Two items in particular are worth highlighting; semiconductors and pharmaceuticals.
First, pharmaceuticals. Covid-19 has caused some countries to take a more nationalistic approach to vaccine distribution – strong-arming companies to distribute locally in spite of contracts to supply other countries. The captive approach to medical technology in the face of a global pandemic is a dangerous precedent to set; increasing pressure to bring down medical costs has led to a streamlining and consolidation of medical production – but fewer suppliers means more vulnerable supply chains.
Similarly and perhaps more pressing, we are currently experiencing a global semiconductor chip shortage. Semiconductor chips are essential nowadays for not only computers and electronic equipment, both of which were in short supply during the Covid-19 pandemic, and also for things ranging from automobiles to home appliances to airplanes.
Some semiconductor chips are relatively simple, but the cutting edge of computing is being done on chips that are getting smaller and smaller. These specialized processing chips, some as small as 5 nanometers, are currently only able to be manufactured by two companies in two countries: Taiwan Semiconductor Manufacturing Company in Taiwan, and Samsung, in South Korea. Domestically the United States doesn’t have any manufacturing facilities that can produce these cutting-edge chips – an economic and geopolitical concern. It wouldn’t take a lot of disruption to global supply chains to create an acute semiconductor shortage in the United States.
Fixing this problem is expensive though. The capital outlays to build new factories run into the tens of billions of dollars, and it may be necessary to subsidize the factories in the future to make production competitive. But if we want to be sure we have secure access to crucial chips, we might not have a choice. And it’s not just the United States that’s facing this quandary. Europe, Japan, Russia, and other leading economies across the world are all facing the same issues and coming up with the same answer – de-globalization, subsidization, and local production.
Investing In De-globalization
The shift to localize and onshore supply chains for things like semiconductors will be expensive and will mean there’s more global chip production capacity. We think there are three ways to play that kind of move.
First, you can invest in the companies that sell manufacturing equipment. In the semiconductor space that means companies like Applied Materials AMAT or Lam Research LRCX . They’ve had great runs over the past year as the chip shortage has accelerated, but de-globalization could open up a whole new set of factory expansions to sell into.
Second, you can invest in the companies that are going to be owning the manufacturing plants. That could be companies like Taiwan Semiconductor opening up new plants in the United States, or it could be companies like Intel INTC being given subsidies to try to build out their own manufacturing to compete with the overseas manufacturers.
Third, you can invest in the downstream beneficiaries of subsidized chip supply. For example, automakers like GM or phone makers like Apple stand to benefit from more stable chip supply chains. They could also see chip prices come down if there are more competing suppliers manufacturing the parts.
And a final note – we’ve used the chip supply chain as an example here, but there are a lot of other industries that could experience the same de-globalization pressures.