The US, China and the Supply Chain

Published: 25th June 2021 (2 Min Read)

Contrary to rhetoric from Democrats and Republicans, the U.S. has an economic interest in trade and peace with China. Well known economist, JK Galbraith has written an appraisal of a recent publication from the White House.[i]

In June 2021, the Biden White House published a review[ii] focused on the “supply chain” in four areas: semiconductors, high-capacity batteries, critical minerals, and pharmaceuticals.

China is not the focal point of the paper, but the underlying perspective is the trading and competitive relationship with China and a wide-ranging assessment of vulnerabilities in each sector.

1. The global semiconductor industry is notable for extreme specialisation, constant technological improvement, economies of scale, and global division of labour. US firms dominate in semiconductor design, but American-based production is only 12 percent of the world’s capacity, roughly a third of what it was in the 1990s.

What then is the “China threat” to the semiconductor supply chain? The most important one is stated very plainly. China is the world’s largest semiconductor market. The single biggest risk from China is not some nefarious disruption of components or materials. It is rather, a possible fall in final demand.

Moreover, since much of the industry operates on the two banks of the Taiwan Strait, “even a minor conflict or embargo could have immediate major disruptions to the United States and long-term implications for US supply chain resilience” (p. 57). In a White House document, at this moment of heated China-bashing, this is a welcome recognition.

2. With large-capacity batteries, the principal supply-chain issue is not so much a science-driven matter of design and engineering as it is access to key materials, most notably nickel, graphite, cobalt, and lithium. Reserves are not particularly scarce, although in the case of cobalt they are concentrated in the Democratic Republic of Congo. The review notes that China’s advantage in materials supply results, mainly, from having invested in finding reserves on its own territory.

It turns out, industrial dominance in this area does not rest on the supply side. It lies rather in the development of the industry itself, driven by demand for electrical storage, which is overwhelmingly in the automotive sector. China is the low-cost producer because it is the world’s largest user, consuming 40 percent of global large-capacity battery output. Europe accounts for another 40 percent, and the United States for just 13 percent.

3. In the report on critical materials, prepared by the Pentagon, thirty-eight minerals are listed for which US direct import dependence is above 75 percent. China is a top supplier in eighteen cases. Why? Largely because the growth in China’s own demand for these materials has made it profitable for China to invest in the supply chain, hence to become the high-volume, low-cost producer, to whom the world turns.

The Defense Department is naturally concerned with the possible consequences of conflict, and so with the possibility that access to materials might be lost, especially where there is only one source of supply. The review laments the decline of mining expertise emerging from US university systems.

4. With pharmaceuticals, the problem is not of scarcity but of basic economics. The supply chain moved to India because costs are low as befits the low-price, low-margin, high-volume business of generic drug manufacture. In an open global market economy, drugs will be bought from where they are cheapest to produce.

In this and other instances throughout the Review, the deplorable practices of state planning and national development strategies undertaken by China are, within a few pages, pretty much exactly what the authors recommend for the United States.

Three major conclusions may be drawn.

The first is that the Chinese “advantage” stems from a pragmatic program of economic development, including infrastructure and human resources, in a vast country able to take advantage of a scale of production and internal market impossible anywhere else. This leads to lower costs across a wide range of industrial and engineering capacities. The Chinese edge is a fact of geography and life and not an artifact of ruses or dirty dealing.

The second is that in critical sectors US-China interdependence is essential. Rare earths are a minor example, barring new discoveries in other places. Semiconductors are a major one: without the Chinese market, the American firms that presently dominate the high-end design processes would collapse.

The third is that China is a now-developed country with about twenty percent of the human population; its advantages of stability and scale cannot be replicated even by the US. Anyone who has read Tim Marshall’s “Prisoners of Geography”[iii] would recognise this.

The US position, as an economy with only one-fourth the Chinese population, depends on the Chinese market, and on downstream Chinese firms supplying applications to the world. While precautions against natural disasters and pandemics can be taken, the central unstated message is that the greatest risk to the supply chain is disruption of normal trade relations with China.

In short, the United States has an overwhelming interest in peace. 

Sources:

[i] https://www.ineteconomics.org/perspectives/blog/china-and-the-supply-chain-a-comment-on-the-june-2021-white-house-review

[ii] https://www.whitehouse.gov/wp-content/uploads/2021/06/100-day-supply-chain-review-report.pdf

[iii] https://www.worldofbooks.com/en-gb/books/tim-marshall/prisoners-of-geography/