Supply chain politics: National security meets economic growth
Government policies will become even more national security-focused but remain engines of economic development. Elections bring uncertainty.
Published: February 21, 2024
Highlights
Governments' supply chain policies will continue to shift toward national security priorities, while some economic aspects will become less important.
Nation-state cooperation and competition for access to critical supply chain inputs are set to heighten as geopolitical conflicts continue. Protectionism and sanctions will remain a key part of nations' policy tool kits and may find new applications.
Supply chain policies have boosted economic growth via investment subsidies but carry the seeds of future inflation in materials and labor. Resource-guarding, partly to boost royalties, will widen.
Focusing on local policy implementation is as important as tracking global geopolitics, especially considering the numerous local elections in the next two years that could disrupt policies.
Government supply chain policies are increasingly seeking to meld national security and economic development policies. That will inevitably lead to greater rivalry with rising protectionism, resource guarding and investment incentives. Uncertainty will continue to cloud the outlook as elections across most major economies could herald new governments with new policies heading into 2025.
Security first: Supply chain and national security policies intertwine
In the period following the COVID-19 pandemic, supply chain policies have been put to work to deliver national security priorities in direct and indirect ways.
Direct actions will continue to focus on the technology sector, particularly semiconductors, with their use in military and domestic applications. Governments will also enhance measures to prevent technology-related leakage to adversaries and, as the EU is pursuing, reduce the risk of the "weaponization of economic dependencies or economic coercion," as indicated in its economic security strategy.
Indirect actions include protecting key commodities and manufacturing capabilities as well as building supply chain resilience through a strengthened industrial base and enhanced domestic production. Such actions will likely be more frequent as countries become more inward-looking and engage in retaliatory actions centered around industrial policy subsidies.
Competition over the control of the supply of critical inputs will increase, risking new conflicts and rivalries. Food has become a susceptible topic, with recent weather-related shortages of rice and onions leading governments such as India's to impose export restrictions. This situation will expose supply chains to new sanction regimes and compliance requirements. It will also create opportunities for reshoring to countries with less protectionist trade policies and fewer geopolitical entanglements such as Mexico and Vietnam.
The private sector will play a crucial role, partnering with the state (external affairs) and defense ministries over the next few years. However, corporations may be limited by financial considerations in their willingness to participate, as discussed in "Footing the bill: Paying for resilience."
The US Defense Department has already intervened in critical supply chains, and its involvement has expanded over the past five years. In February 2021, the Biden administration implemented an executive order giving the presidential assistants for National Security Affairs and Economic Policy coordination powers over developing critical supply chains. The Defense Department has also entered agreements to boost domestic production of nickel and lithium under the Defense Production Act Title III.
Protectionism protected: Tariffs and nontariff barriers continue
Protectionism remains rife and will continue to be so in the coming years. This is mainly because trade measures such as tariffs and nontariff barriers are part of industrial policy, which was adopted by the previous US and Indian governments. Although significant, tariff-busting trade deals are fewer now; the number of trade-restricting measures has also decreased globally, while the number of trade-facilitating measures has increased.
During the pandemic, 203 trade-restrictive elements — mostly export restrictions — were implemented as countries sought to secure medicine and personal protective equipment for their citizens.
While most of those policies are no longer in place, trade restrictions may increase again in 2024 and beyond.
Several factors could contribute to this, including tariff usage for industrial policy, state-supported investment programs and trade policies aimed at environmental outcomes. Such protectionist measures can hurt the country's economy, as they increase inflationary pressure, distort supply chain decision-making and act as an effective tax drag.
S&P Global Market Intelligence
Free trade deals to watch
Although major trade deals seem to be on hold for now, there are several situations to monitor.
The EU had a challenging year in 2023 for finalizing free trade agreements, and it might restart the process over the next three years. Its deal with the Mercosur group came to a halt in December 2023. Restarting the agreement with Australia is complicated due to agricultural interests and might have to wait until the EU Parliament elections.
The Comprehensive and Progressive Agreement for Trans-Pacific Partnership trade group is expanding, and many markets, including mainland China, Taiwan and South Korea, are waiting to join. The UK, which is the most remote candidate, might have the best chance of joining because it has no regional, geopolitical or territorial issues.
The UK is also trying to replace inherited deals and create new ones after Brexit. Negotiations with Canada, Mexico, the Gulf Cooperation Council, Israel, Switzerland and South Korea are underway and could yield traditional, tariff-cutting and regulation-busting agreements.
In Asia, the Regional Comprehensive Economic Partnership established in 2022 will gradually reduce trade barriers among members. The bloc is open to expansion, although interest has been modest so far, with smaller regional economies such as Sri Lanka, Hong Kong and Bangladesh looking to join. However, this could change as the deal matures.
Alternative trade negotiation structures are also emerging, such as the US-sponsored Indo-Pacific Economic Framework, which has several chapters under discussion. The India-Middle East-Europe Corridor faces regional conflict challenges but has the impetus of competing with the Belt and Road Initiative. The latter has lost momentum due to higher debt-servicing costs and default rates.
A final challenge is the lack of a quorate judiciary in the World Trade Organization's appellate body, which hinders its ability to serve as an arbitrator in trade disputes. This is because the US has blocked new appointments since the Trump administration. There is little prospect of a resolution at this stage, leading countries to adopt ad hoc measures instead. Without a unified dispute resolution process, further trade protectionism will likely persist.
Carlos Cardenas
Research and Analysis Executive Director
Conflicts to continue, sanctions to remain
Conflict between nations can significantly affect global supply chains, both directly and indirectly. This impact can persist beyond the initial conflict as supply chain managers find alternative solutions to mitigate the effects. The impact of these conflicts can change over time as the conflict spreads and policies evolve in reaction.
For example, the conflict between Russia and Ukraine has significantly affected the energy industry and related sectors. The EU has diversified its gas supplies to reduce its dependence on Russia, while Russian oil exporters have found new markets. The food industry has faced challenges due to diminished supplies and higher prices, but shipping remains unaffected. ;
Israel's conflict with Hamas has affected the natural gas industry, but its impact on global trade has been felt more via reduced shipping through the Red Sea. That, in turn, has led to higher shipping costs and diversions in deliveries, but it has yet to fundamentally remap global trade.
The impact of future conflicts will depend on their targets, escalation pathways and international reactions. Conflicts in regions such as Taiwan, the Korean peninsula or the South China Sea could be particularly disruptive to electronics-based supply chains and global trade flows.
Sanctions are often used to enforce policy decisions but can be challenging to impose and remove. The ongoing sanctions against Russia for its actions in Ukraine have significantly affected its economy and trade relations. Russia has sought new markets in Asia and pivoted toward using the renminbi rather than the US dollar.
The expansion of the sanctions coverage has been forced to adapt to changes in supply chains, particularly in the technology sector. This may require secondary sanctions against third-party countries unwittingly involved in transshipment evasion strategies.
Lastly, the use of sanctions to enforce forced labor regulations has steadily increased. The US, for example, has increased its use of withhold release orders to expand its coverage of forced labor regulations. More information can be found in "Labor: A critical component of supply chains under growing pressure."
S&P Global Market Intelligence
Trade data hints at supply chains healing around sanctions
An analysis of nearly 5,200 products exported from the EU to Russia revealed that 627 products met the following conditions of materiality during the third quarter of 2023 compared with the third quarter of 2021.
EU exports to Russia fell by at least 70%, which indicates that sanctions have had an effect.
EU exports to selected countries, including Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Turkmenistan, Uzbekistan and Tajikistan, increased by more than 40% compared with the rest of the world, showing abnormal growth in shipments.
The increase in value of EU exports to the selected countries was more than 20% of the drop in value to Russia, suggesting a degree of diversion.
Passenger cars and parts, centrifugal pumps, construction machinery parts, parts for utility-grade electrical switching systems, and printing machines were the largest products that met the three criteria.
A further 1,501 products met two of the three criteria. The largest of these included network-connected devices (such as modems and routers), thermostatic valves, parts for domestic-grade electrical switching systems and computer processors.
Carlos Cardenas
Research and Analysis Executive Director
Central to growth: Supply chains' part in economic policies
Supply chains contribute to global economic growth by making production more efficient, leading to stable inflation rates. The international trade sector plays a major role in this. The percentage of world trade as part of global GDP has remained steady since 2005 at 22%.
We continue to see supply chains expanding globally, especially in Southeast Asia and other emerging markets. S&P Global Market Intelligence forecasts indicate that global trade will grow at a compound rate of 3.3% through 2028, while GDP growth will be 2.6%.
Supply chain development as a contributor to economic growth
Small, open economies are likely to benefit from connecting to global supply networks, as seen in the East Asian growth story. However, spending on "subsidy farming" and the need to replace existing capital stock could crowd out investments in supply chain resilience. There is also evidence of a reconfiguration of trade in certain sectors in Asia and ongoing reshoring to Mexico due to US industrial policies. Chinese investors are becoming leading players in financing manufacturing abroad, particularly in sectors where supply chain reconfiguration is taking place.
S&P Global Market Intelligence
Openness is key to successful reshoring
Reshoring is a far from simple process and has been the subject of deep research from across S&P Global, including, "Nearshoring to Mexico: National trends and regional disparities," "For Mexico, Nearshoring's Potential Benefits--And Obstacles--Are Significant" and "Look Forward: India's Moment." Vietnam, Malaysia and Turkey are also expected to benefit from the reshoring trend. Future Look Forward: Supply Chain journals will dig into the topic in more detail.
Common policy-driven lessons include the following:
An openness to global trade in the form of minimal trade barriers and rule-of-law implementation of antidumping mechanisms. That is not to say that import or export barriers are never used, though less is more when trying to encourage inbound investment.
A large domestic market provides a ready source of financing in the form of local customers, reducing the reliance on maintaining international competitiveness over the long term. Mexico's membership of the US-Mexico-Canada Agreement and India's large population are examples of inherent advantages.
A willingness to pivot on policy in response to negative commercial or popular feedback can ensure that mistakes are rapidly corrected. India's decision to postpone limits on imports of laptop computers — part of a push to onshore manufacturing of such devices — is a recent example.
Countries looking to attract reshoring investments will have to balance their neutrality between the emerging rival geopolitical blocs carefully.
Carlos Cardenas
Research and Analysis Executive Director
Resource guarding at heart of nexus between resilience and security
Government policies are becoming increasingly focused on securing domestic production of critical materials, such as minerals for energy transition and high-tech components. This competition is likely to lead to export restrictions, investment barriers and renegotiation of resource access agreements, with states seeking to maximize royalty incomes from resources. The security concerns underpinning these efforts have been seen in mainland China's restrictions on exports of certain materials, and food protectionism may continue due to historical drivers of commodity market disruptions and the impact of climate change.
Supply chain disruptions as a driver of inflation
The Biden administration has linked supply chain policy to inflation reduction, but other countries have not followed suit. Supply chain shortages have dissipated, leading to disinflation in manufacturing input and output prices. However, there are potential upside risks to inflation in the commodity sphere, while disruptions to shipping through the Red Sea have increased shipping costs. Reshoring production can provide near-term advantages for a country's growth and employment. Still, it results in a higher underlying cost structure and introduces distorting measures such as subsidies and tariffs. (See chart, "Producer price inflation has slowed as supply shortages have dissipated")
Tensions between supply chain resilience and employment priorities
Many countries are implementing new industrial policies to benefit from generational shifts in supply chains, such as the electrification of transport. This has led to higher labor costs, which may be a drag on resources needed for supply chain resilience. Labor strikes resulting from failed negotiations over pay, terms and conditions have been an emergent challenge for supply chains in 2023 and will continue to pose a risk in 2024 and beyond. S&P Global Market Intelligence forecasts wage inflation to slow in the US, but Vietnam's advantage over mainland China may widen. The need to invest in staff for growing sectors, as well as economically or politically motivated protests, will continue to disrupt supply chains.
There is also a need to invest in staff for growing sectors, as manifested by challenges in enhancing semiconductor supply chains in the US. Skills-matching will be a significant challenge in delivering governments' policy aims, as discussed in more detail in "Labor: A critical component of supply chains under growing pressure."
Multiple elections will occur in 2024, including in the US, EU, Mexico, India and South Africa, granting unions the opportunity to obtain state support because governments will likely favor resolving wage disputes before electoral campaigns begin.
Economically or politically motivated protests not connected to wage negotiations will also continue, potentially disrupting supply chains, as protest groups target highways, rail infrastructure and project sites.
Global trends, local implementation: Issues to watch by region
Supply chain decision-makers must consider a variety of political issues, which can change over time, particularly as a result of national elections. The next two years bring elections across Mexico, the US, the European Parliament and many other countries.
The impact of US and EU elections is more likely to be felt in 2025, though election campaigns will set their policy tone and responses from key emerging economies. We remain convinced that supply chains will stay global.
Europe may be experiencing a renewed swing to populist politics at the same time as the European Parliament elections. Europe is at the epicenter of the convergence of supply chain and environmental policymaking with the Carbon Border Adjustment Mechanism, a deforestation-free directive, a corporate sustainability directive and an expanded emissions trading scheme. Many of these will be characterized by EU rivals as little more than trade protectionism.
Both the US and Mexico have national elections in 2024, with the potential for a new stack of supply chain policies — as well as the repealing of prior administrations' actions — to take effect in 2025 and beyond.
The future of supply chains in the Middle East and North Africa will, in part, be defined by the Israel-Hamas war, with a potential knock-on effect for supply chains both regionally and globally if the Suez Canal remains under threat. More positively, the India-Middle East-Europe Corridor brings potential benefits to regional trade and economic integration. Governments will continue to be challenged by disrupted energy and food supplies linked to the conflict in Ukraine.
Sub-Saharan Africa continues to struggle with adequate policy action on the availability of energy and logistics services. Energy issues could be resolved through renewable investments including carbon- and nature-for-finance credits and bonds. Governments are starting to tighten control over critical minerals, with measures such as localization and value-added demands. Elections in South Africa and Ghana bring uncertainties. New logistics projects that could address problems are being implemented, but the fiscal aspects will be a challenge.
In Latin America, Brazil and Argentina recently had a change in administration, with potential implications for the future configuration of trade within Mercosur. Newly elected Argentina President Javier Milei voiced his opposition to the trade group. The US-Mexico relationship will be challenged by the run-up to the US election, particularly if the US campaign focuses critically on migration, Mexican labor rights and drug trafficking.
One of the biggest potential risks for global supply chains comes from the South China Sea, Taiwan Strait and Korean peninsula. Like Africa and Latin America, most Asian governments will continue to seek to expand their value chain of critical minerals via regional partnerships and protectionism. There will be intensifying trade ties between mainland China and the Association of Southeast Asian Nations, including growing mainland China foreign direct investments in manufacturing to bypass US direct-supply restrictions.
Finally, India's reshoring-led manufacturing expansion is in flight and unlikely to be disturbed, barring a shocking election outcome or sharp change in policy direction. The challenge is shifting from policies focused on industrial incentives to the delivery of state-supported logistics investments, as discussed in "'Make In India' Manufacturing Push Hinges on Logistics Investments."
Learn more
Canal route pain: Red Sea shipping disruptions' impact on North American supply chains
'Make in India' Manufacturing Push Hinges on Logistics Investments
For Mexico, Nearshoring's Potential Benefits--And Obstacles--Are Significant
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Footing the bill: Paying for resilience
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