The dangerous war on supply chains

Protectionism in a crisis only concentrates risk domestically and diminishes economies of scale

Martin Wolf

James Ferguson illustration of Martion Wolf’s column ‘The dangerous war on supply chains‘


“One of the things that this crisis has taught us, sir, is that we are dangerously overdependent on a global supply chain for our medicines, like penicillin; our medical supplies, like masks; and our medical equipment, like ventilators.”

Thus, did Peter Navarro, an influential adviser of US president Donald Trump, draw lessons from the Covid-19 crisis for American trade policy. This view is seductive to protectionists. But it is wrong.

The lesson from the crisis is to be better prepared. Self-sufficiency in “essential products” would not be a good way to achieve this. On the contrary, it would be a costly error.

Attacks on cross-border supply chains should not be viewed in isolation.

The latest forecasts from the World Trade Organization suggest that the collapse in trade now could be far bigger than in response to the 2008 financial crisis. It would be very damaging if policymakers responded to the steep decline in their countries’ exports by curbing imports.

Yet that is what forced “reshoring” of supply chains means. It would be yet another assault on liberal trade. (See charts.)

Covid-19 brought forth a wave of export restrictions instead. The products covered by these prohibitions and restrictions vary. But most of them focused on medical supplies (face masks and shields, for example) and pharmaceuticals and medical equipment (ventilators, for example).

These restrictions are legal. But that does not make them wise. In a collection of essays on Covid-19 and Trade Policy, Richard Baldwin of the Graduate Institute in Geneva and Simon Evenett of St Gallen ask: “Should governments react to the health, economic, and trade crises by turning inward?”

The answer is: No. “Turning inward won’t help today’s fight against Covid-19 . . . Trade is not the problem; it is part of the solution.”

Chart showing Covid-19 is causing a huge decline in global trade, world merchandise trade volume (2015=100)


Remember that the problem was not with trade, but rather with a lack of supply. Export restrictions merely reallocate the shortages, by shifting them on to countries with the least capacity. A natural response to this experience is for every country to try to be self-sufficient in every product that might turn out to be relevant.

That is what Mr Navarro suggests the US should do. Yet businesses would then lose economies of scale, as global markets fragmented. Their capacity to invest in innovation would be reduced.

Only the largest and most advanced economies could plausibly seek self-sufficiency in such a wide range of technologies.

For all others, this would be a dead end.


Chart showing the growth of trade has already fallen sharply relative to world output, annual % change, average over previous three years

More relevant, self-sufficiency is not at all a guarantee of greater security. In his chapter in the book edited by Profs Baldwin and Evenett, Sébastien Miroudot of the OECD distinguishes helpfully between “resilience” and “robustness”. The former refers to the ability to return to normal operations after a disruption; the latter to the ability to maintain operations during a crisis.

In a pandemic, the latter is probably the more relevant. It is necessary to have access to essential supplies in a pandemic, though it is also necessary to be able to restore production quickly if some of it is disrupted.

Chart showing trade distortions are increasing, share of world trade facing a given trade distortion in force in the year in question (%)


The obvious way to achieve robustness is to diversify suppliers across multiple locations.

Producing in one’s own country is not a guarantee of robustness. Any given location might be affected by a pandemic, hurricane, earthquake, flood, strikes, civil unrest or even war. To put every egg in one basket, even the domestic one, is risky.

Robustness in supply can thus be achieved through a mixture of a multiplicity of suppliers with holding stocks of essential products. The possibility of importing increases the potential number of suppliers and possibly the access to surplus stocks, too.

Protection, however, concentrates risk domestically, reduces the diversity of potential suppliers and diminishes the pressure of competition and economies of scale.

Chart showing the US has become much more reliant on imports from China, US manufacturing reliance (%)


So far, global supply chains in health products have turned out to be robust. Mr Miroudot notes the ability of South Korea to supply Covid-19 test kits globally. He argues that its ability to expand supply quickly “requires international networks, skilled supply chain managers, reactivity, and agility.

This type of experience simply does not come from local production and activities shielded from competition.”

So what would a sensible policy look like?

There would be national and global efforts to identify essential products in the event of various emergencies. There would then be monitoring of relevant supply chains and inventories, both domestic and global.

Chart showing countries specialise by exporting and importing medical supplies, top importers and exporters of medical products, 2019 ($bn)


To achieve this, one would need respected and well-funded national and global bodies working alongside private industry. This should be viewed as a fundamental security concern. The pandemic has, after all, posed a vastly greater threat to security than the military threats governments have been spending trillions of dollars to contain.

In the course of such an effort, countries might seek to identify potential vulnerability to supplies from particular partners. Mutual vulnerability can be a source of stability. But countries might regard some sources as too risky. Yet a shift of supply back home need not be the response. Other possibilities exist.

Trade is a vital part of the global response to a pandemic, including the creation and distribution of the vaccine we need. Trade must also remain a large part of the global economy more broadly.

The ability to trade freely augments the diversity, and even reliability, of supply.

It also creates a big opportunity.Covid-19 may indeed reverse the integration of production of past decades.

We will regret it greatly if it does.

Gold shoots above $1,800 for first time since 2011

Nine-year high for the haven asset on fears over economic hit from coronavirus

Neil Hume, Natural Resources Editor

 Gold bricks
Gold has risen about 19% this year, cementing its position as one of the best performing major asset classes of 2020 © Bloomberg


Gold prices rose to more than $1,800 an ounce on Wednesday for the first time in nine years as data showed investors had stashed a record $40bn of cash into funds backed by the precious metal during the first half of the year.

The commodity, widely favoured by investors as a store of value in times of stress, breached $1,810 during afternoon trading in London, with a gain of more than 1 per cent on the day.

Gold has risen about 19 per cent so far this year, cementing its position as one of the best performing major asset classes of 2020 as investors have looked for safe places to park their cash at a time of heightened uncertainty for the global economy due to the Covid-19 crisis.

James Steel, chief precious metals analyst at HSBC, one of the world’s biggest bullion banks, said prices “were already rallying well before the emergence of Covid-19”, which has further added to their momentum. Net inflows into gold-backed exchange traded funds hit $5.6bn (or 104 tonnes) in June, taking global holdings to a new all-time high of 3,621 tonnes, worth more than $200bn, according to data published by the World Gold Council this week.

Line chart showing gold breaches $1,800 for the first time since 2011


Overall net inflows in the first half of the year came in at almost $40bn (or 734 tonnes), surpassing the highest level of annual inflows, both in tonnage terms (646 tonnes in 2009) and US-dollar value ($23bn in 2016), according to the WGC.

This has helped offset a collapse in jewellery demand, which HSBC reckons could be down by a fifth this year, and an increase in recycling. “Investment demand is doing a lot of heavy lifting at the moment and needs to continue for gold to prosper,” said John Reade, chief market strategist at the WGC.

Like other asset classes, gold was hit hard in March as investors rushed to liquefy their investments when the scale of the Covid crisis became clear. Since then, governments and central banks across the world have unleashed huge fiscal and monetary support packages, driving down yields on other safe assets, with some US Treasuries in effect paying investors a negative return.

That has undermined one reason not to buy gold: that it provides no income. More recently, the metal has benefited from nervous investors hedging their exposure to riskier assets after a rise in new Covid infections in the US.

“Fears of further increases in infections and related lockdown fears have been driving demand and thus prices,” said Carsten Menke of Swiss bank Julius Baer.

“This suggests that short-term price risks remain skewed to the upside as long as the virus does not come under control.”

Net inflows into gold-backed exchange traded funds soar


Gold’s strong run has turbocharged the performance of big producers, which can enjoy rising prices without an accompanying increase in costs.

The NYSE Arca Gold Miners index is up 28 per cent so far this year.“We expect a strong interim reporting period,” said Numis analyst Justin Chan, who is forecasting a 79 per cent year-on-year jump in earnings from the gold producers he follows.

The key question investors are now asking themselves is whether gold will surpass its 2011 record high of slightly more than $1,900.

“The health, financial and economic uncertainties generated by the Covid-19 pandemic and its aftermath are likely to continue to support gold’s rally well into 2021, but at a reduced level, we believe,” said HSBC’s Mr Steel.

He thinks prices could reach $1,845 by the end of this year before falling back to $1,705 in 2021.

Explaining China’s Economic Resilience

It is naive to believe that forced technological decoupling, trade sanctions, or forced changes to global supply chains will put an end to China’s future economic expansion. If critics are too short-sighted to see this, it will be their loss.

Zhang Jun

zhang44_AFP via Getty Images_chinatechnologydeliveryecommerce


SHANGHAI – Widespread lockdowns and border closures aimed at combating the COVID-19 pandemic have interrupted global supply chains and largely paralyzed the global economy.

Yet, the real weakness of today’s global economy is not the vulnerability of its globalized production networks, but rather souring attitudes toward globalization – and toward China in particular.

Fear of China’s growing economic clout drives many countries’ foreign-trade and investment decisions these days, and not only in the United States. Concerns about the dependence of global manufacturing on China have prompted calls to reshore production and cut the country out of global supply chains. And the US is even threatening to stifle the Chinese economy through technological decoupling.

But China’s critics are mistaken in assuming that the country’s continued economic growth depends almost entirely on the maintenance of the global free-trade system and access to Western technology.

Although China is undoubtedly an important global manufacturer, the real drivers of its economic performance over the last decade or so have been rapid growth in its huge purchasing power and fixed-asset investments – including in the country’s thriving technology sector.

The world has not yet fully appreciated the significance of the country’s inward shift of economic gravity away from “external circulation.” This is partly because many economists have instead been busy criticizing China’s investment expansion and highlighting the potential debt risks arising from it.

As a result, politicians in America and many other countries still think that the most effective way to contain China is to target its position in global trade and supply chains.

To be sure, China has so far been the largest beneficiary of economic globalization over the past decades, mainly because of its integration into the global free-trade system before and after joining the World Trade Organization in 2001. Indeed, by the late 1980s, Chinese policymakers were advocating that the country use global supply chains and international markets to help it industrialize and accumulate capital.

China thus took advantage of its abundant cheap labor and adopted a “both ends out” approach, importing parts and components in order to assemble finished products for export.

But Chinese policymakers have long since understood that this growth model could not turn China into a fully developed, high-income economy. In particular, the severe impact of the 2008 global financial crisis on Western economies forced China to accelerate its “change of focus” by developing a more closely integrated huge domestic market and promoting growth driven by “internal circulation.”

Such efforts have gained further momentum in recent years as a result of escalating trade frictions with America, and a recognition that China’s continued economic expansion requires overcoming structural imbalances.

China has taken several steps to correct these imbalances and boost domestic demand. For starters, it allowed the renminbi to appreciate against the US dollar for at least a decade after 2005, and began to open up its protected market to foreign firms in line with its WTO entry commitments.

The government not only liberalized imports, especially of intermediate and capital goods, but also started allowing foreign penetration in financial markets and other non-tradable sectors. And by establishing an increasing number of free-trade zones, China has honored its commitments regarding foreign-portfolio investment and facilitation of cross-border capital flows.

Second, China has increased physical infrastructure and logistics investments at a rate of over 20% annually over the last 15 years, resulting in new and improved domestic highways, railways, airports, and harbor facilities. During the last decade, for example, the country has built a high-speed railway network of more than 35,000 kilometers (21,748 miles).

Third, since the beginning of this century, the Chinese authorities have consistently supported the construction of large-scale information and communication infrastructure networks, and encouraged private enterprises to innovate in cutting-edge sectors such as mobile payments, e-commerce, the Internet of Things, and smart manufacturing.

This has helped to foster the emergence of many locally based international technology firms, including Alibaba, Tencent, and JD.com. And at the beginning of 2020, the government decided to launch a new round of large-scale investment in 5G base stations.

Finally, the Chinese government has actively promoted national strategic plans aimed at integrating domestic economic mega-regions and generating domestic demand. This includes the construction of the Xiong’an New Area, where non-core functions of the capital will be moved from Beijing, and which will accelerate the development of the Beijing-Tianjin-Hebei triangle.

In addition, the government has been developing the Guangdong-Hong Kong-Macau Greater Bay Area and is encouraging closer cooperation among 16 cities in the Yangtze River Belt. The Yangtze River Delta has been leading the economic integration process among mostly industrialized provinces, headed by Shanghai.

Likewise, two of southwest China’s most important urban centers – Chengdu, the capital of Sichuan province, and Chongqing, the main city on the upstream section of the Yangtze River – have been given incentives to create a “double-city circle” through closer economic cooperation.

Furthermore, the freight railway to Europe from China’s west and southwest, and the “new land-sea channel” to the south, will not only boost the mainland Chinese economy but also help to stabilize global supply chains.

Indeed, despite the ongoing shift in its economic gravity, China will certainly not have an incentive to disengage from global technology supply chains or retreat into isolation. On the contrary, it will remain an active participant in and contributor to global trade and investment.

And in opening up more access to its domestic market to foreign investors, China will further support globalization by helping to correct global trade imbalances. Efforts to stimulate domestic demand will create further expansion and opportunities for domestic and foreign investors, thus boosting future global economic growth.

It is therefore naive to believe that forced technological decoupling, trade sanctions, or forced changes to global supply chains will put an end to China’s future economic expansion. If critics are too short-sighted to see this, it will be their loss.


Zhang Jun is Dean of the School of Economics at Fudan University and Director of the China Center for Economic Studies, a Shanghai-based think tank.

How Pension Funds Die, CalPERS Edition

by John Rubino


Say you’re running a big pension fund that – according to the politicians who are handing out ultra-generous benefits to public sector employee voters – has to generate 7% annual returns in order to meet the resulting obligations. But the bonds you used to rely on now yield between 0% and 2%, depending on how far out on the yield (that is, risk) curve you’re willing to go.

Stocks, meanwhile, have been rising, but can also go way down. You remember the near-death experiences of 2008 and this past March, and you never, ever want to experience another such nightmare.

So what do you do? Well, if you’re extremely brave and your family already has plenty of money, you stand up, tell your bosses that their goals are impossible to achieve, and hold your head high as security escorts you to the door.

If you’re less brave and/or rich, you might roll the dice and bet the farm on high risk/high potential return strategies, and just hope that it all works out. Worst case, you’ll collect another couple years of big paychecks before security comes for you.

That’s what the biggest pension fund just decided to try.

CalPERS gambles on risky investment move

The California Public Employees Retirement System, the nation’s largest pension trust, benefited greatly from the runup in stocks and other investments during the last few years, topping $400 billion early this year. 
CalPERS needed it because it was still reeling from a $100 billion decline in its investment portfolio during the previous decade’s Great Recession and was tapping state and local governments for ever-increasing, mandatory “contributions” to keep pensions flowing and reduce its immense “unfunded liability.” But it faced a backlash from local officials who said vital services were being cut to make their CalPERS payments. 
Just when CalPERS appeared to be climbing out of its hole, the COVID-19 pandemic erupted early this year, sending the economy into a tailspin. Virtually overnight, the fund saw its value take a $69 billion hit as the stock market — CalPERS’ biggest investment sector — tanked. Stocks have since recovered, but CalPERS is still down about $13 billion from its high early this year. 
Further investment erosions would, almost automatically, trigger even greater CalPERS demands for contributions from government employers, but the recession is also eating into their tax revenues, creating substantial budget deficits. 
It underscores CalPERS’ vulnerability to capital market gyrations.Investments more immune to fluctuations would be safer but they offer very low returns and CalPERS could not safely meet its lofty earnings goal — an average of 7% a year.

It’s a vicious circle of conflicting demands and priorities, driven by an official policy of providing generous, inflation-adjusted pensions for government workers, bolstered by the political clout of public employee unions. 
CalPERS desperately needs an escape route and has chosen the perilous path of debt. It plans to borrow billions of dollars — as much as $80 billion — to fatten its investment portfolio in fingers-crossed hopes that earnings gains will outstrip borrowing costs. It mirrors the recent and risky practice of local governments borrowing heavily to pay their pension bills via “pension obligation bonds.” 
“More assets refers to a plan to use leverage, or borrowing, to increase the base of the assets generating returns in the portfolio,” the system’s chief investment officer, Ben Meng, wrote in the Wall Street Journalrecently. “Leverage allows CalPERS to take advantage of low interest rates by borrowing and using those funds to acquire assets with potentially higher returns.” 
What could possibly go wrong? 
The new scheme is an implicit admission that CalPERS can’t meet its 7% mark without increasing its exposure to the vagaries of the market. “There are only a few asset classes with a long-term expected return clearing the 7% hurdle,” Meng wrote. 
Perhaps, then, the real problem is the 7% goal, much higher than those of private industry pension plans.

The author of the above article is appropriately skeptical. But it’s a safe bet that both public sector unions and local government officials are applauding CalPERS’ move because it buys them more time on the gravy train.

The near-universal hope is now that either an existential financial crisis forces the current national government to fold a pension bailout into a broader “everything bailout” or a newly-installed Democrat administration starts its reign by rewarding the public sector unions that helped elect it with a sector-specific bailout.

Both of these hopes are completely plausible, so it’s hard to fault CalPERS’ logic. But from a bigger-picture perspective, this kind of moral hazard appears to sit firmly at the intersection of greed and cowardice and is exactly the kind of thing that kills both pension funds and entire societies.

India picks a side in the new cold war

It is folly for China to drive its rival into America’s arms

Gideon Rachman

James Ferguson illustration of Gideon Rachman column ‘India picks a side in the new cold war’
© James Ferguson



Prime Minister Narendra Modi, has tried to avoid choosing sides in the fast-developing antagonism between Washington and Beijing. But a parting of the ways between India and China now seems inevitable following last week’s border clashes between the two nations’ armies, which left at least 20 Indian soldiers dead and an unknown number of Chinese casualties.

Mr Modi has met President Xi Jinping of China several times since becoming India’s leader in 2014 and has made five visits there. As recently as last October, the Indian and Chinese leaders held a friendly summit, after which Mr Modi hailed “a new era of co-operation between our two countries”.

The mood in New Delhi is now very different. Whatever happened high up in the Himalayas, Indians feel assaulted and humiliated by China. On Friday, Mr Modi held emergency meetings with leaders of the Indian opposition — a remarkable development in itself, given the extreme partisanship of Indian politics today.

There is now near-consensus in the Indian policymaking elite that China is a hostile power and that India’s only feasible response is to move closer to the US and to Asian democracies, such as Japan and Australia. Despite Mr Modi’s efforts to build a close relationship with Mr Xi, Indian anxiety about the rise of China has been growing for years.

Indians have watched nervously as China has built up a special relationship with Pakistan — a country India has fought multiple wars with. The expansion of Chinese influence in neighbouring states such as Sri Lanka, Myanmar, Bangladesh and Nepal has also gone down badly in New Delhi.

India signalled its displeasure by refusing to send a top-level delegation to China’s Belt and Road forums in 2017 and 2019. But while the China hawks in New Delhi have been gaining in influence, there remains a dovish school that has long argued it is not in India’s interests to get sucked into an American effort to “contain” China.

In part, this reflects the legacy of history. During the original cold war, India pursued a policy of non-alignment and was, in reality, often closer to Moscow than Washington. As a country of nearly 1.4bn people, India is understandably determined to forge its own path and maintain strategic autonomy.

There are also sound economic arguments for trying to maintain a good relationship with China, which is India’s second largest trading partner.

Any thought of trying to maintain equidistance between the US and China, is now likely to be abandoned by India. There are even hints that India may consider a formal alliance with the US.

One Indian intellectual, close to the Modi government, observed pointedly last week that one reason China might feel free to kill Indian soldiers — but not Japanese or Taiwanese troops — is that Japan and Taiwan are sheltering under a US security umbrella.

Donald Trump’s hostility to the American alliance system makes it highly unlikely that the US president would consider extending a security guarantee to India, at least, not without considerable financial inducement. But an administration led by Joe Biden, his Democratic rival in November’s presidential elections, might well jump at the idea of a formal alliance.

In recent years the US has become more overt in its efforts to woo India, as a balancing force to a rising China. In 2018, the US military renamed its Pacific command, the Indo-Pacific command and India’s increasingly close military ties with the US has been reflected in arms purchases, port visits and joint military exercises.

An intensification of that co-operation, in co-ordination with Japan and Australia, looks inevitable.

Indians are wary of further direct confrontations with China in the Himalayas. But they may try to challenge Beijing on other fronts by working with allies in the Indian Ocean and the South China Sea.

India is also likely to make more concerted moves to lessen its economic dependence on China.

The chances of Chinese telecoms company Huawei being awarded contracts to build a 5G network in India now seem vanishingly small. Should China care?

Beijing’s confrontational posture suggests the Chinese have discounted the dangers of any Indian retaliation. China knows that its economy is nearly five times the size of India’s and that its military has more firepower.

The Chinese may even have judged that now is a good time to put India in its place when the country is stricken by the coronavirus and the US is distracted. In the aftermath of last week’s border clashes, the Global Times, a nationalist newspaper in Beijing, wrote, in an editorial, that India should learn from this incident and cannot rely on Washington for support and succour.

In the short-term, that might well be right. Over the long-run, China should be worried.

The four largest economies in the world, ranked by purchasing power, are China, the US, Japan and India.

All four nations are intensely concerned by the balance of power in the Indo-Pacific region.

It is folly for China to drive India into America’s arms.