Should Policy Makers Push for Supply Chain Resilience?

Your Christmas gifts this year may be stuck somewhere on the ocean. The latest NBER research gives some tips for policymakers to prevent this kind of supply chain disruption from happening again.

Over the past two years, you may have had a hard time finding daily necessities in a supermarket, or your car salesman might have informed you of a several months long wait to get a new car. The global supply chain, which consists of just in time production of individual component parts, has been hit hard by lockdowns and labor shortages led by the pandemic. This has forced suppliers to rethink how to efficiently aggregate the components into the products we see on shelves. This “new normal,” unfortunately, may dictate that this will be neither the first nor last supply chain disruption. Anything might cause another disruption in the future, from huge earthquakes to power outages.

The precise clockwork of our global supply chains enabled the modern consumer economy, but we need to build resilience to prevent shortages and delays. International organizations and policy makers have discussed how to increase resilience in the global supply chain. For example, the World Trade Organization (WTO) focused this year’s public forum on “Trade Beyond COVID-19: Building Resilience”. Furthermore, U.S. President Joe Biden advocated for a “diverse and secure supply chain” (Executive Order on America’s Supply Chain, 2021) for the economic benefit of Americans. This naturally raises the question of who should take responsibility for assuring this resiliency; should policymakers be involved, or should we just rely on the invisible hand of the market?

In a recently published NBER working paper (Gene M. Grossman, Elhanan Helpman, Hugo Lhuillier, 2021), researchers propose that private companies usually have some incentives to avoid supply chain disruption, and the governments should only be involved when the incentives aren’t strong enough to support the total social benefits. The main reason that incentives for firms may not be sufficient is due to the consumer surplus for goods outweighing producer surplus. However, researchers suggest that companies may excessively seek resilience whenever they can take advantage of a rivals’ input supply issues. Therefore, the private protection of a supply chain to gain advantage over rivals reduces the need for government intervention.

The research builds a framework focusing on situations where sourcing domestically costs significantly more but poses less risk than sourcing externally. A final producer faces the risk of supply shortages and has four strategies to mitigate this risk: domestic (onshoring), international (offshoring), both (diversification), or neither. Each strategy will influence the market in a different way. Conversely, policymakers who want to increase social welfare can encourage or discourage diversification, reshoring, or offshoring with subsidies or taxes. “Reshoring” refers to the firm action of moving the production line back to the home country, whereas “offshoring” refers to the firm action of moving the supply relationship out of the home country.

Grossman, Helpman, and Lhuillier start a policy discussion related to supply chain resilience with a simple framework. From this paper, we learn that policymakers should consider firm incentives and consumer preferences when they want to intervene and strengthen supply chain resilience. There are two key concepts that we can take away from this research. First, policy makers can achieve efficient sourcing only if they apply more than one policy instrument. The policy instruments include diversification tax or subsidy, reshoring tax or subsidy and offshoring tax or subsidy. Second, a policy related to diversification or a policy that can change relationship incentives in a country leads to first-best outcome. If policy makers cannot implement these kinds of policy, they should consider a subsidy or a tax, which can result in second-best outcome.

The high cost of labor market has posed obstacle for manufacturing industry looking to reshore in the United States, nevertheless, U.S. President Joe Biden has made some effort to encourage reshoring and discourage offshoring. The famous policy, “Biden Offshoring Tax Penalty”, gives a 10% offshoring surtax as punishment for companies that offshore production to the foreign countries and rewards companies for reshoring with a 10% tax credit. Whether these actions can actually improve the status of U.S. supply chain remained to be seen, but we hope those policies can increase the resilience of supply chain and prevent U.S from another supply chain disruption.

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Gene M. Grossman, Elhanan Helpman, Hugo Lhuillier (2021). “Supply Chain Resilience: Should Policy Promote Diversification or Reshoring?” Working Paper 29330, NBER. https://www.nber.org/papers/w29330

Executive Order on America’s Supply Chains. https://www.whitehouse.gov/briefing-room/presidential-actions/2021/02/24/executive-order-on-americas-supply-chains/