Like the massive earthquake in Japan earlier this year, the floods in Thailand are again exposing the vulerabilities of fragmented global supply chains.
Last month, a team of economists from PREM’s International Trade Department [3]encountered some flooding side-effects during a visit to the Indonesian production site for ECCO, a Danish company that manufactures footwear. In order to transfer production to the factory in Indonesia, the workers needed the specific shoe molds used in the Thai factory. But there was a problem: The Thai factory was under three meters of water.
These specialized molds manufactured in the Thai factory would have taken several weeks to manufacture, which would have further delayed production. So ECCO hired scuba divers to enter the Thai factory and recover the molds. They then shipped them via air to other factories around the region, including ECCO Indonesia.
Shoemakers are not the only businesses with drowned components. Automotive producers are also hiring divers to rescue molds from underwater Thai factories, according to the Financial Times [4]. Honda, for one, has said it will cut worldwide production by 50 percent because of a shortage of specialty parts. Reuters [5]reports that computer hard drive prices have gone up 20 to 50 percent because of the flooding in Thailand, the world’s number-two hard drive producer.
The disruption is reminiscent of March, when the devastating earthquake and tsunami in Japan left the auto industry temporarily paralyzed for a lack of specialty parts. In the month after the earthquake, auto production in the U.S. declined by 12 percent, according to one World Bank report [6].
These natural disasters have exposed vulnerabilities in supply chains that rely on the clustering of resources and technical expertise in small geographic areas. There has been much discussion about how global firms will respond to the perception of growing risk in supply chains. Possible adjustments may include making greater use of multiple-sourcing (reversing the trend toward supplier concentration in recent years), insisting on maintaining suppliers from geographically diverse areas, and even simply holding greater inventories across the global supply chain.
But perhaps a more far-reaching impact could be a gradual shift away from the highly dispersed production chains that have been the driving force behind global goods trade in recent decades. Indeed, these recent natural disasters may be triggers of a move to regional chains. But on this front, they are far from the most compelling force for change. Four other trends may in fact be more critical in pushing this transformation:
- Increasing consumption in the developing world. Asia, in particular, is consuming a larger and larger share of its production, and its own supply chains are becoming more tightly integrated. Before long, Asia may shed its image as simply a global export factory and instead develop trade patterns like the European Union’s dense network of intra-industry trade in components and finished goods;
- Narrowing global wage gaps. Serious recession in the developed world means the wage gaps may actually narrow, shifting some activities back onshore. (Forbes reviews the evidence on this trend here [7]);
- Rising transportation costs. Rising oil prices are hitting transport costs and are expected to be long-lasting. This will make it increasingly more expensive to maintain widely dispersed production networks; andRegionalism in trade policy. Growth in regional trade agreements mean that it is easier to trade in intermediate goods within trade blocs. As the World Bank’s Jean-Pierre Chauffour and Jean-Cristophe Maur note in their recent book, Preferential Trade Agreements for Development: A Handbook, these agreements have multiplied in the last two decades, and are expected to continue to dominate in the absence of a Doha agreement.
So, while natural disasters provide a dramatic backdrop for a discussion of supply chain vulnerabilities, perhaps their importance in shifting production networks is overblown. Private sector actors, after all, will make expensive supply-chain adjustments based on long-term calculations, not short-term risk. Indeed, they may look to address changing consumer demand, take advantage of declining real wages at home, cut transport costs, or benefit from recently established regional agreements. If this helps them avoid the wrath of Mother Nature and scuba-diving for parts, all the better.