SUPPLY CHAINS AND GEOPOLITICS / GEOPOLITICAL FUTURES

Supply Chains and Geopolitics

U.S. tariffs on China could disrupt supply chains on which American companies depend.

By George Friedman

The U.S. imposition of tariffs on China threatens to disrupt the supply chains of American businesses that may not fully recognize their dependence on Chinese products. Discussions around supply chains have sometimes included reference to geopolitics, primarily in terms of tensions between countries. But the connection is deeper. Supply chains are both inherently geopolitical and critical to how geopolitics understands the world. There are two ways to look at the effects of the U.S.-China confrontation. In one, it appears completely asymmetrical. China’s exports to the U.S. are equivalent to about 4 percent of China’s gross domestic product. U.S. exports to China account for a little more than 0.5 percent of U.S GDP. If trade collapses completely, China’s economy will contract significantly; the American economy will contract very little. But this would be an undifferentiated financial analysis. The other way of looking at the effects of the confrontation reveals that the real economy is much more complicated.

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The international financial system is an abstraction of reality. It evaluates the value of production and transaction and provides a framework for the flow of investment and financing. These are real and important things, but looking at the economy from a financial point of view captures only what has happened while lagging behind what is happening and what will happen.   The Mechanics of the Global Supply Chain The concept of a supply chain is simple. All products begin with a primary element, from oil to manganese to corn. That element is refined so it can be sold to someone who will use it for purposes as diverse as cooking a meal or making a cellphone. Industrial production involves moving the primary element from its place of origin – like a mine or a farm – to locations where it is made into a specific product and moved to another factory or node, where it is further developed using components from other factories, then sent on to a string of other factories where it is further refined, until it can finally be sent to a consumer. The chain has multiple parts with branches and alternative movements that take a particular item to many points that produce seemingly unconnected things. A piece of cloth can become a shirt, or it might become a component of an electric drill, or perhaps used to wrap jewelry. The global supply chain is, by its nature, enormously complex. It is also very difficult to create an abstract model of it because it is completely heterogeneous. Dissimilar things with utterly different histories are in constant motion. Whereas financial transfers are frequently abstract, without a physical dimension, the supply chain is inherently physical. The immediate challenge to this model is the internet. But even that is a very physical thing. The cloud is a vast array of servers, located in a particular place, using physical entities that are manufactured and delivered to the site, and delivering its product through vast networks of physical fiber to other physical servers and then on to the user. The fastest way to take out the internet is not through cyberwar but with missiles targeting server farms. Transmission of any sort is a physical event. It can be interdicted.   The Supply Chain and the Trade War Geopolitics is the study of the nation-state and its external and at times internal dynamics. It sees economics, politics and war as different dimensions of national behavior but still integrated into a single system. It uses geography to understand the constraints and imperatives in which the nation-state and its parts exist. Geopolitics looks at the military as a physical and therefore geographically constrained force. It sees the political system as shaped by geography as a nation comes to be in a certain time and place. And while its view of economics is aware of the abstract prism of finance, it is far more aware of the physical and geographical dimension of the economy – the supply chain. The U.S.-China confrontation is expressed in the first interest as a financial relationship, generated by political forces. But it is intimately connected to China’s fear of a U.S. military blockade of the South China Sea and the United States’ fear of Chinese movement into the Western Pacific. China is afraid that its supply chains of both exports of finished products and imports of raw materials will be disrupted. The tariffs are a financial matter. The South China Sea is a military matter. Both become supply chain-focused economic matters.

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The U.S. move is an undifferentiated strike on the Chinese economy. The Chinese response is that they don’t need to counter such a strike and that an alternative will inevitably emerge. The very process of imposing a higher price on Chinese goods disrupts the supply chain on which U.S. business has become dependent. In other words, the tariffs will be borne by the United States in the form of increased costs to its supply chain and to consumers. Now the question becomes who – the U.S. or China – will bear more of the pain caused by the United States through damage done to businesses dependent on Chinese components of their supply chain. The issue touches on internal pressures in both countries and each country’s strategic fears about the other. The U.S. attempt to impose pre-emptive pain on China is a valid tactic if the byproduct becomes too great for China to bear – something that will become clear by watching the political process in each county. Each country’s ability to tolerate the pain is dependent on whether an alternative supply chain is available or can be rapidly found. The problem is that, in general, the greater the value of a product, the more complex its fabrication and the more specialized the supply chain. The rapid evolution to a new system of sourcing or a new product set being produced without these components is likely difficult to achieve at a cost rivaling the tariffs. The United States has used intrusion into supply chains as a tool in the past. The battle against Japan in World War II began with the U.S. interrupting the flow of oil and steel to Japan. The Reagan administration blocked the sale of wheat to the Soviet Union in the 1980s. The only new thing about the trade war is that American companies have become dependent on supply chain components from certain countries, unaware of the fact that disruption of that supply chain by their own government was possible. Businesses tend to think of themselves as central to the economy, and not as potential collateral damage. They miss the point that the structure of the supply chain is inherently political and that relations between nations are constantly shifting. These companies are enormously sophisticated about their own supply chains but frequently naive about that supply chain’s geopolitical security. I have focused on China here, but as I have written before, the U.S. is moving to be more aggressive in applying economic power and less aggressive in applying military power. Geopolitically this was predictable (and we did predict it). At the same time, the peculiar complexity of the supply chain requires an intimate understanding of particular supply chains along with geopolitical forces. The question for the U.S. and China is: Who can withstand greater pain, generated by the same action? China faces economic contraction. The U.S. faces supply chain disruptions for specific companies and increased costs for individual consumers. The value of geopolitics in examining this question is that it treats politics, economics and war as essentially different parts of the same thing.