23 minute read
China: Epicenter of the Supply Chain Crisis
How concentrating dependence on China upended our economy and added risk
BY ROBERT KUTTNER
Early on in the COVID pandemic, indelible
images began to appear of medical personnel wearing trash bags for protection instead of hospital scrubs. It was indicative of unprecedented nationwide shortages of basic medical supplies, particularly PPE (personal protective equipment), such as surgical gloves, masks, face shields, gowns, and hand sanitizer.
Why the abrupt scarcity? Initially, it wasn’t due to increased global demand.
Wuhan, China, where the COVID outbreak began, happens to be a major center of production and export. The Chinese government, a dictatorship that can make draconian decisions instantly, decided not to fool around. On January 23, 2020, when there were still few U.S. cases, the Chinese state shut Wuhan down, including all transport in or out. Some 11 million people in and around the city were under quarantine.
Just west of Wuhan, in Hubei province, is Xiantao, the site of China’s largest manufacturer of nonwoven fabrics used in the production of PPE. An alarming percentage of PPE was made in China, even if the nominal vendor was a U.S.-based multinational corporation, such as 3M. The quarantine blocked not just products made in the Wuhan area, but also exports originating elsewhere that had to pass through Wuhan to get to the ports. Twelve other cities in Hubei province, with a total population of 60 million, were subjected to similar restrictions.
Other Chinese responses to the pandemic emergency disrupted production more broadly, extending the supply chain crisis from medical supplies to the larger economy. Travel restrictions prevented workers who had gone home for the Lunar New Year from returning to work. China’s “floating population” of rural migrant workers is estimated at 288 million, or about one-third of its labor force. Ports were also suddenly short of workers, causing exports to pile up on docks.
In addition, the Chinese government, realizing that it would soon face a mask shortage at home, sent out a call via the Communist Party’s United Front Work Department to have Chinese people living outside the country buy all available PPE and send it to China. By mid-February, as other nations were just beginning to appreciate the impending shortage, overseas Chinese had already sent some 2.5 billion PPE items to China, including two billion masks.
Shortages only worsened as the pandemic took hold. By March 3, 2020, the World Health Organization issued a warning of “severe and mounting disruption to the global supply of personal protective equipment (PPE).” This revealed itself in both monthslong delivery delays and inflation: Prices for surgical masks increased sixfold, N95 respirators tripled, and gowns doubled. Bidding wars and market manipulation proliferated.
China’s extreme quarantine measures have continued into the omicron era. In the Yangtze River Delta, a vital manufacturing center south of Shanghai, outbreaks of COVID in December led to government restrictions on movements in the cities of Hangzhou, Shaoxing, and Ningbo until March 2022, causing factories to cut production. Ningbo is also one of China’s largest container ports. China’s zero-COVID policy is so strict that the Ningbo port, the third-busiest in the world, shut down for two weeks last summer because of one worker’s infection.
So, from the very beginning of the pandemic, China has played a bottleneck role unique in the world, both as a producer and as a consumer. The reason why involves decades of decisions made at the highest levels of public and corporate policy, with devastating
consequences for American workers, consumers, businesses, communities, and our national security.
China is now the world’s second-largest
economy, and the world leader in manufacturing, with 28.7 percent of all manufacturing output, compared to 16.8 percent for the U.S. China’s trade surplus with the U.S. in manufactured goods has grown from $83 billion in 2001 to $310 billion in 2020. This relentless increase in export penetration cost U.S. workers an estimated 3.4 million jobs between 2001 and 2017, and put downward wage pressure on the jobs that remained. The cascading effect on entire communities was devastating. China’s mercantilist strategy was facilitated by its 2001 entry into the World Trade Organization, exponentially increasing the world’s reliance on Chinese manufacturing.
The precarious system of just-intime production coupled with extensive offshoring predates the rise of China as global economic superpower. The strategy of keeping minimal inventory and outsourcing production to far-flung global supply chains became fashionable in the late 1970s. This occurred in the same decade that key elements of the global system for shipping goods from producer to final destination were deregulated—trucking, rail, ports, and later ocean shipping—leaving the world with a less coherent logistics system and more of a series of privatized segments. It was a supply chain with poorly connected links. Just-in-time production was cheered in business schools and on Wall Street as a source of greater efficiency. But this myopic analysis left out the catastrophic risk of supply chain disruption, a risk that was magnified as so much global supply became increasingly reliant on China.
Take, for example, so-called rare earth minerals. According to the Department of Energy, China refines 60 percent of the world’s lithium, 80 percent of the world’s cobalt, and mines 68 percent of the world’s graphite, three core inputs to high-capacity batteries. China’s battery industry has also benefited from at least $100 billion in direct government subsidy.
This advantage in high-capacity batteries and their raw materials in turn creates a competitive advantage that China will exploit as the world moves to electric vehicles. China already outproduces the U.S. in vehicle production generally. The U.S. built about 15 million cars overall in 2021, compared to China’s 24 million.
And China is moving rapidly to displace other makers of electric vehicles. Thanks to cheap labor and state subsidy, China can sell an electric car for about $15,000 less than the cheapest comparable U.S. car. And, amazingly, made-in-China electric cars still qualify for the $7,500 tax credit in the U.S.
China has also subsidized its huge domestic market to promote sales of electric cars, trucks, and buses. In 2018, China’s electric bus fleet comprised 421,000 out of 425,000 buses overall. The entire U.S. electric bus fleet totaled just 300 vehicles.
Rare earths are used not only in production of batteries but in other advanced products, including metal alloys, jet engines, camera lenses, turbine blades, optical fiber, advanced magnets, and a great deal more. China is estimated to control 55 percent of global rare earths mining capacity in 2020, and 85 percent of rare earths refining.
Through its Belt and Road Initiative, China trades investment in development of ports, railroads, roads, and other infrastructure for preferential access to raw materials. China is using this strategy to capture control of even more of the global supply of rare earths. In the case of cobalt, where China has reserves but is not selfsufficient, Chinese companies have actively pursued equity positions or outright ownership in cobalt assets in the Democratic Republic of the Congo, Papua New Guinea, and Zambia.
One can tell the same story across the value chains of one sector after another. We see increased Chinese capacity, increased U.S. reliance on China, and importantly, declining U.S. competence. For example, the fact that the U.S. has ceded so much production of consumer electronics to China has resulted in the erosion of the entire domestic microelectronics ecosystem. As a Department of Defense report put it, citing the case of printed circuit boards, which interconnect circuits in electronics systems: “Today, 90 percent of worldwide printed circuit board production is in Asia, over half of which occurring in China; and the U.S. printed circuit board sub-sector is aging, constricting, and failing to maintain the state of the art.”
A separate Defense Department review of the supply chain for minerals and materials critical for the national defense found that of all the nations of the world, only China has mastery of every step in the supply and production of all key minerals, from mining and extraction to purification, metallurgy, refining, and finishing.
What domestic industry remains in the U.S. is heavily dependent on inputs made in China. So these businesses become part of the China lobby, pressing the administration to lift tariffs and opposing national-security restrictions on Chinese exports. The Biden administration has made some encouraging moves to recapture manufacturing capacity. But due to the reliance of so many producers on China, the counterpressures to maintain the status quo are fierce.
Take solar. As Joan Fitzgerald reported in the Prospect, the U.S. currently has almost no production capacity for solar cells, while China produces 80 percent of the world’s output. In 2020, China also accounted for 99 percent of global wafer production, 75 percent of global module production, and 64 percent of solar-quality polysilicon capacity—all substantial increases over its market share in 2010. So if the U.S. were to pursue a reshoring strategy, it would need to regain production capacity, not just in finished solar cells but in the inputs that go into their manufacture.
All this creates immense pressure to stick to the status quo, since the dominant lowcost producer is China. Whenever the U.S. government proposes strategies for favoring or rebuilding domestic solar production, they are fiercely resisted by the Solar Energy Industries Association, ostensibly a domestic group but actually one riddled with Chinese producers and suppliers. Given Chinese state subsidies combined with cheap Chinese labor, purely domestic solar panels are more expensive to end users, at least for a prolonged interim period until the U.S. regains capacity at scale. If China can create enough such dependency and interlocks, blurring who is domestic and who is Chinese, reviving domestic leadership becomes all but impossible.
In the case of pharmaceuticals, many of the scientific advances that make possible modern lifesaving drugs are the result of U.S. spending via the National Institutes of Health. But the profits go to giant drug companies that commercialize these scientific breakthroughs. And the industry is in turn reliant on offshore production to provide the materials needed to produce drugs, known as active pharmaceutical ingredients (APIs). According to the Department of Health and Human
Across one sector after another, we see increased Chinese capacity and declining U.S. competence.
Services, only about half of the 120 vital pharmaceutical products registered with the FDA have any domestic production capacity. China is only one foreign supplier among several, but coming on fast.
This heavy reliance on foreign sources is not only alarming per se. It creates a kind of path dependence that precludes alternative policy regimes. Suppose the U.S. government wanted to use the Defense Production Act to develop lifesaving drugs directly and put them in the public domain for widespread cheap production. It would run into not only fierce political opposition from the pharmaceutical industry, but the practical problem that the U.S. does not produce sufficient ingredients.
An important research report published last October, “Factory Towns,” pointed out that factory jobs “tend to be higher paying and often offer health care, union membership, and other benefits like pension plans, deferred savings vehicles, etc. that help build wealth and financial security. Manufacturing job growth in the three decades following the end of WWII helped build a growing, thriving American middle class.” Thanks to multiplier effects, these good paychecks cycle through the entire community, creating broad prosperity. When that cycle goes into reverse, the entire local economy craters. And, as the report documents, these economic effects have dire political consequences. The loss of support for Democrats between 2012 and 2020 was heavily concentrated in working-class counties in ten Midwestern states that had lost large numbers of factory jobs.
The reliance on China is a disaster from the perspective of U.S. economic security and leadership in production. But as a source for products and product inputs, the corporate appeal of China is obvious. Wages are low, workers have few rights, and there is minimal health, safety, or environmental
Extreme weather events, like flooding at the Yangtze River in summer 2020, have curtailed Chinese production as much as the pandemic.
regulation, as well as plenty of new investment-banking business for Wall Street. Even better, the state and the Chinese Communist Party could quickly ramp up production as needed to meet U.S. just-intime demands.
Yet by definition, such a system has little if any reserve capacity. Any disruption gets magnified and rattles around the world, creating volatility and instability that can show up in shortages and increased prices. This system was a crisis waiting to happen—awaiting just the right event, or series of events. The pandemic certainly triggered the supply mess we are now dealing with. But interestingly, the strains on the Chinese system were not caused by COVID alone.
Throughout the pandemic, China has had to curtail production because of extreme weather events and energy shortages, which in turn have resulted in factories going dark. In the summer of 2020, the Yangtze River flooded into Wuhan and surrounding areas, shutting down PPE production. In May 2021, extreme heat in Guangdong province, a major manufacturing hub with a GDP equal to South Korea’s, led to increased air conditioner use, leading in turn to power outages and government restrictions on factories.
China’s electricity regulation is rudimentary. Increased power costs may not be passed along to consumers. So rather than relying on higher prices to promote conservation, the government restricts factory hours. The spring heat was followed by summer droughts, which reduced available hydropower, exacerbating the energy shortage. Factories, facing higher input costs, also raised prices.
By the fall of 2021, mandated cuts in energy use were still increasing, with more than half of China’s provinces limiting electric power. No other major trading nation had any such policy reducing factory production. And no other country is as important to the global manufacturing supply chain.
It’s worth noting that China’s lax environmental standards, a major attraction for multinationals due to the lower cost of production, played a role in worsening the climate, leading to the very extreme weather events that knocked out production. None of these costs are ever factored into the choice of where to locate a factory; instead, we all pay the price.
These production-limiting events would not have had such domestic knock-on effects were America not so reliant on China. The central role of China in the supply chain crisis sheds light on both the flaws and risks in the overall system and the special perils of heavy dependence on one source of supply. This is even more risky when that source is a dictatorship that has escalating geopolitical conflicts with the United States, and that has demonstrated its willingness to use economic weapons.
These weapons have not been explicitly deployed against the U.S. yet, but China’s intermittent economic squeezes on Australia are the canary in the coal mine. Over the past 15 years, Beijing has regularly cut off Australia’s access to vital raw materials whenever it didn’t like a policy of the Australian government. That literal playbook, which was given to Western intelligence by a Chinese defector, Chen Yonglin, in 2005, reads like a dress rehearsal for a get-tough policy with the U.S. We are already close to a tipping point of perpetual dependency that China will continue to exploit.
In short, if you wanted to pick a single nation as a dominant offshore source of
supply, a dubious proposition in any case, China is the worst possible candidate. The supply chain crisis puts that reality into sharp relief.
Even where China isn’t dominant, it is
attempting to wrest control. For example, a good deal of the current supply crunch results from a shortage of semiconductors, which are used ubiquitously in products from cars to cellphones to appliances. U.S.-based semiconductor companies, including such crown jewels as Intel, now do most of their actual production in East Asia, to take advantage of state subsidies for new production facilities, known as “fabs,” and cheap labor. The semiconductor industry is complex. It includes many different types of chips, as well as inputs and machines for semiconductor manufacturing. The U.S. is losing capacity at every link in the chain. U.S. global share of semiconductor production is now just 12 percent, down from 37 percent in 1990.
In the immediate crisis, some of the disruption and shortages were once again the result of extreme weather events or random outages that were worsened by the just-intime production strategy. A fire occurred in March 2021 at a Japanese semiconductor plant that, astonishingly, produces 30 percent of all the microcontrollers used in cars. In Taiwan, the world’s top producer of many categories of chips, the worst drought in half a century cut semiconductor production, which requires vast quantities of water. Obviously, such weather events, which will only intensify, would be less damaging if there were more diversified sources of semiconductor supply close to home.
For now, other Asian producers, notably South Korea and Taiwan, outrank China. But China, with 16 percent of worldwide production capacity, is expected to hit 28 percent by 2030. In 2019, of six new major semiconductor production facilities in the world, four were in China and none in the U.S. In 2018, China accounted for more than half of worldwide construction spending on fabs. In 2019, total announced Chinese investments in fabs exceeded $215 billion. This dwarfs the scale of money even the largest private-sector firms, such as Intel or Samsung, can invest. No other nation is spending anything like this.
China is also increasingly dominant in the materials that go into the fabrication of semiconductors. A key input is polysilicon, where China now accounts for more than twothirds of world production capacity. The U.S. has 9 percent. China is also the main source for two other materials crucial to semiconductor production, gallium and indium.
Due to China’s dominance in consumer electronics assembly, U.S. chip-makers are also reliant on China for sales revenue. Qualcomm gets two-thirds of its revenue from Chinese customers such as electronics companies, and Micron 57 percent. A June 2021 supply chain report to President Biden warned: “Heavy reliance on sales to China provides the Chinese Government with economic leverage and the potential to retaliate against the United States.” Dependence on foreign sourcing of chips is a general problem. But other offshore sources of semiconductors, mainly South Korea, Taiwan, and Japan, are basically American protectorates and not about to engage in economic warfare against the U.S.
The dynamics of the supply chain give China
an immense advantage in what the Chinese state views as a global struggle for economic hegemony. If the U.S. is attempting to recapture technological leadership or a larger share of production in key sectors, whether for economic or national-security reasons, we begin at a huge disadvantage if key inputs come only from China—even more so if China begins threatening to withhold such materials as economic leverage.
For the most part, China’s own economy has no such problems. Most of the core ingredients in its own production chain are from domestic Chinese sources, and priority goes to Chinese end users. Extreme weather events and other disruptions that reduce Chinese capacity diminish their domestic supplies, but at a much more muted level than the rest of the world, due to that prioritization. So in addition to the other imbalances in the U.S.-China economic relationship that favor China, supply chain shortages disadvantage the U.S. and help China.
Because of the heavy reliance of U.S. producers on Chinese sources of supply, and the prevalence of “partnerships” in which U.S.-based corporations produce in China and benefit from Chinese subsidies and cheap labor, there is not much of a corporate constituency for a tough, coherent policy to reshore production and crack down on Chinese government abuses. The Biden administration policy on supply chains and domestic production is a vast improvement on that of any postwar Democratic
president. But U.S. public and corporate policy is a house divided against itself.
On the positive side, the White House’s June 2021 report on reclaiming supply chains and domestic production is the most impressive, detailed, and forthright call for economic planning since World War II. It gives a comprehensive picture of the state of U.S. manufacturing and reliance on offshore supply chains in four key sectors, warns explicitly about overreliance on China, and calls for a frankly economic nationalist strategy of reclaiming domestic production. It suggests a drastic and welcome shift in U.S. government awareness, ideology, and policy.
But other Cabinet departments sometimes undermine this effort. Last August, a group of the last remaining U.S. solar manufacturers petitioned the Commerce Department to investigate China’s deceptive practice of transshipping solar products made in China to the U.S. via such countries as Malaysia, Thailand, and Vietnam, to circumvent tariffs on Chinese solar exports that were ordered after extensive antidumping investigations. But the Commerce Department was subjected to an extensive lobbying campaign by both Chinese solar companies and their U.S. customers, as well as a letter by 12 Senate Democrats echoing the talking points of the Chinese solar industry. In the end, the Commerce Department took no action.
The administration has been subject to intense lobbying by industry and its allies to reduce or suspend tariffs on Chinese exports that were first imposed by President Trump. These tariffs serve as a rough offset to the extensive Chinese government subsidies of export sectors. In addition to creating more of a level playing field for unsubsidized U.S. producers, they create general bargaining leverage for a broader challenge to China’s worldwide mercantilist tactics.
President Biden has retained the tariffs, for now. But not only do domestic corporations
Medical Emergency
Supply chain disruptions reduce availability of critical medical devices.
By Esther Eriksson von Allmen
As the pandemic forced workplaces and
schools to switch to telecommuting, demand for computers, smart home devices, and other electronics has soared, contributing to a global shortage of semiconductor chips. Made from silicon and as small as an inch in diameter, these tiny chips function as the “brain” for important tech devices and consumer products, including smartphones, cars, computers, and dishwashers.
Only a fraction of the global supply of semiconductor chips goes toward the medical technology industry, but that figure still represents a huge number of products. And disruptions in the supply chain for medtech have greater implications than making people wait for their new iPhone; they have the potential to seriously compromise patient care in the United States.
A September 2021 study by Deloitte, which surveyed some of the largest U.S. medical technology companies, found that two-thirds of companies have semiconductors in over half of their products. Over 75 percent of companies reported delays, and over 60 percent reported reduced order quantities in their chip supply chains.
“We are hearing that equipment delivery, which historically has never been an issue, is now a concern,” Michael Schiller, senior director of supply chain at the Association for Health Care Resource & Materials Management, told the Prospect in an email. According to Schiller, product lead times have increased significantly, in some cases up to six to nine months, for defibrillators, CT scanners, and patient monitoring and telemetry equipment. Oxygen delivery systems such as CPAP and BiPap units are also becoming less available, which could potentially impact the patient discharge processes.
Semiconductor chips are just one of many products dealing with delays and disruptions in the overall medical supply chain. Currently, between 8,000 and 12,000 industrial containers filled with millions of critical medical supplies, such as gowns, syringes, and surgical gloves, are delayed by an average of 37 days at ports across the country. Hospitals have also reported supply issues with catheters, crutches, gloves, syringes, needles, tubing, suction canisters for medical waste, and urine cups. In late November, a shortage of urine collection kits forced a Minnesota hospital system to find other alternatives, including ordering individual parts to make their own makeshift kits. However, because some of the
urine cups do not fit in the normal hospital tube system, hospital workers must take the urine samples to the lab themselves, diverting time and attention away from patients.
Currently, the two largest manufacturers, Taiwan Semiconductor Manufacturing Company and Samsung, hold 72 percent of the market share. Overreliance on these overseas manufacturers can make supply chains more vulnerable to market fluctuations, which, in the case of the medical supply chain, can pose serious threats to patient care.
New legislation introduced last summer aims to tackle this problem and prevent future supply chain disruptions. The Creating Helpful Incentives to Produce Semiconductors for America (CHIPS) Act allocates $52 billion in federal investments to subsidize American semiconductor manufacturing plants, and the Facilitating American-Built Semiconductors (FABS) Act offers an investment tax credit on domestic semiconductor design and manufacturing. Neither bill has made it through Con-
Two-thirds of medical technology companies have semiconductors in over half their products.
gress yet, prompting 59 corporate execs to sign a letter urging Congress to pass the legislation.
“Medical devices is only a sliver of the overall chips market,” wrote AdvaMed, an American medical device trade association, in a separate public comment to the Chamber of Commerce in early November, “but it is undeniably a critical sector that supports our national security.” n
China produces 80 percent of the world’s solar cell output. want tariff-free inputs; some of his own appointees have called for a rollback. The most egregious of these is his Treasury secretary, Janet Yellen. On several occasions, Yellen has opined that tariffs function as a tax on consumers. Yellen is evidently oblivious to the White House effort to reshore production, and the use of tariffs as vital leverage in that enterprise. Someone, ideally Biden himself, needs to remind Yellen who she works for. This effort is tough enough without being undercut by the president’s own Cabinet.
In addition, others on Biden’s economics and communications staff have been pushing the idea that rolling back some of the tariffs could cut the rate of inflation by reducing prices to consumers. As I have pointed out, not only is that bad China policy; it is bad arithmetic. The tariffs total less than $80 billion a year, in a $21 trillion economy. Some of the costs are absorbed by U.S. companies. If all of the China tariffs were ended, that would be one-third of 1 percent of GDP. The actual proposed cuts are less than one-tenth of 1 percent of GDP. So reducing tariffs on China’s exports would have no discernible effect on inflation, and Biden would be ridiculed if he said so. Some U.S.-based companies, such as Amazon and Tesla, have begun to emulate China by seeking to develop their own proprietary supply chain networks. But few companies have the reach of a Tesla or an Amazon. Tesla has made deals with the French colony of New Caledonia, off the coast of Australia, to assure itself plenty of nickel, a vital ingredient in high-capacity batteries. But Tesla has divided loyalties. This nominally American company does deals with China, produces in China, and even opened a showroom in Xinjiang province, site of the cultural genocide against the Uyghurs. Chinese companies, by contrast, have loyalty only to China. And Chinese producers are advantaged by a master strategy on supply chains orchestrated by their government, something that doesn’t yet exist in the U.S. In sum, the whole system of just-in-time offshoring, with China at its center, has been an economic and political failure. It has ruined communities, discredited Democrats as champions of working people, and left the
entire economy far more fragile to shocks. It did not even deliver its promise of greater efficiency. Rather than producing more price competition and consumer choice, the system facilitated greater concentration and market power.
Disengaging from China will be an arduous process. They play the game much more strategically than Washington does. Beijing has a domestic U.S. lobby doing its bidding, with no counterpart complicating its policies or goals at home. But if the supply chain crisis has called attention to the folly of the U.S.China status quo and America acts accordingly, that will be a silver lining. n
