How the War in Ukraine Is Further Disrupting Global Supply Chains

Russia’s invasion of Ukraine is adding to global supply chain problems. It affects industries ranging from semiconductors to cars to food. It will almost certainly accelerate the shift from global to regional sourcing that was already underway due to the China-US trade war, pandemic and climate-related events. However, given China’s dominance in many sectors, the transition will be gradual and will require government support.

The invasion of Ukraine by Russia and the sanctions imposed for it and new pandemic-related shutdowns in China are the latest events rocking global supply chains. Combined with the China-US trade war and other pandemic and climate-related disruptions, this will surely accelerate the movement of Western companies to reduce their dependence on China for components and finished goods, and on Russia for transportation and raw materials, leading towards greater localized or regional sourcing strategies. If China decides to support Russia in the Ukraine conflict, it would only fuel this movement.

In the 1990s, companies pursued strategies such as outsourcing, offshoring and lean manufacturing to reduce costs, maintain their market position or gain competitive advantages. China emerged as a major manufacturing center to serve global markets, including many Asian economies opening up.

Things started to change after the 2008 financial crisis. With a sharp rise in the price of oil in 2008 and a host of natural disasters, from the SARS epidemic in 2003 to the 2011 Japan tsunami and Thailand floods, industry leaders realized that the strategies adopted in the 1990s were changing could increase their vulnerability to operational problems and impair their ability to respond effectively to natural disasters. This prompted many companies to increase local production in order to be less exposed to global risks and to be able to respond much more quickly to local demand.

However, given the advantages of relying on China and other Asian countries for manufacturing and the growing Asian markets, the change was not radical. Between 2014 and 2018, China’s manufacturing output grew by 21%, while that of the United States grew by 13%. In 2019, just before the pandemic, China accounted for 28.7% of global manufacturing output, while the United States accounted for 16.8%.

However, over the past four years, the China-US trade war and supply chain disruptions caused by the pandemic and climate-related events have meant that the pace of supply chain localization has increased significantly. In fact, a Survey January 2020 of 3,000 firms motivated by the China-US trade war found that companies in a variety of industries — including semiconductors, autos and medical devices — had moved or were planning to move, at least in part, their supply chains from their current locations. Companies in about half of all global sectors in North America declared their intention to “reshore”.

This is already happening. Consider the recent decision by Schneider Electric to build three new manufacturing plants in North America, one of them in El Paso, Texas, and the plan by automakers and battery manufacturers to do so Construction of 13 new battery factories for electric vehicles in the United States within the next five years. Similar announcements were recently made in the Solar, semiconductor and biotech industries. The Ukraine war and the closer rapprochement between China and Russia will fundamentally change the exchange of energy, raw materials, industrial parts and goods between the western world, China and Russia and promise to accelerate the reshoring trend.

As oil and gas prices soar due to the war, transportation costs will follow suit. Less obvious but just as important are the war-related limitations on the ability to use Russia’s transportation infrastructure to support production in Asia. In fact, many companies build components and finished goods in China and use Russian railways to ship these items to Eastern and Western Europe. Of course, it is possible to ship some of these items by air, but that is significantly more expensive, especially now that airlines have to bypass Russia.

Equally important is that Ukraine delivers about 50% of the world’s neon gas, which is used to manufacture semiconductor chips. Governments and big companies are now scrambling to get alternative supplies, but supply is becoming tighter and prices have risen dramatically. Russia and Ukraine are also major exporters of grains such as corn, barley and wheat, as well as fertilizers. While the full impact of the war on the global food supply is not yet clear, prices are already skyrocketing.

These factors are increasing interest in local supply chain strategies. the recent agreement Électricité de France (EDF) to buy part of GE’s nuclear power business, which GE bought from Alstom in 2015, illustrates this shift from globalization to localization. France increases its dependence on nuclear power plants, which already generate 70% of their electricity. It decided that to do this it needed better control of the entire supply chain for such assets. Another example is semiconductor manufacturing facilities. The governments of the United States and the Netherlands have blocked ASMLthe world’s largest maker of lithography equipment used to make computer chips, from selling its most advanced machines to China.

Finally, the surprisingly large impact of the Ukraine war on European car manufacturing has highlighted the risk associated with the current global supply chain. For example Volkswagen and BMW have closed Assembly lines in Germany due to the lack of wiring harnesses manufactured in Ukraine by the German company Leoni. And tire manufacturer Michelin recently announced It may close some plants in Europe due to logistical problems created by Russia’s invasion of Ukraine. There is no doubt that the European car companies will deal intensively with the risks of international suppliers and buy more locally, even if this requires additional price increases. This could present an opportunity for Europe to strengthen its internal manufacturing sector.

But as one of us (David Simchi-Levi) and others have noted, the localization approach is not a panacea. With China now a dominant, if not sole, source of thousands of components, reducing reliance on it will require significant investment and time in many cases. A typical case is Intel’s recently announced plan Spend $20 billion to build two semiconductor fabs in Ohio. The first plant will not start production until 2025.

In addition, industry will not be able to tackle many of today’s supply chain challenges alone. Governments need to be involved. In the United States, federal and Status Governments are increasing investment in ports, airports and other infrastructure. the US CHIPS Law (which Congress has yet to fund) and the European chip law are examples of government efforts to reduce dependence on Taiwan and South Korea for semiconductors. The Ukraine conflict should also give impetus to the development European Battery Alliancefounded by the European Union in 2017 to make Europe a leader in the advanced battery industry.

Until infrastructure investments are made in local regions, companies should stress test their supply chains and implement strategies to make them more resilient to risk. The only thing that is certain at present is that the challenges facing global supply chains will increase in the foreseeable future.

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