The desire to “solidify supply chains” has become a major talking point for protectionists (and other industrial policy advocates). This rhetoric has accelerated since the COVID-19 pandemic purportedly demonstrated the fragility of globalized supply chains. A few years ago, I Posts questioning the validity of such claims from the perspective of market failure. Here, we question the theoretical and empirical basis of that claim.
The argument that Protectionism The question is whether the supply chain can be strengthened. At first glanceand it makes sense. As your supply chain spreads out, it’s subject to more political, social, and economic factors across a wider geography. For example, if your company’s supply chain passes through Argentina, China, Germany, and Canada, political and social unrest in those regions could affect your supply chain. If your supply chain were entirely domestic, political and social issues in those countries wouldn’t necessarily affect your company.*
But a closer look reveals the fragility of such an argument. It is said that common sense tells us not to put all our eggs in one basket. Rather, diversification is the way to minimize the risk of catastrophic loss. If you put all your eggs in one basket, and that basket breaks, you lose all your eggs. If you spread your eggs across several baskets, the risk of loss if one basket breaks is much lower.
The same is true for supply chains: if a company relies on a single supplier, it is highly vulnerable to production shocks (for a technical discussion of this point, see This paper According to Acemoglu et al. This paper A single shock can have cascading effects across the economy, affecting firms far from the original shock. In fact, the impact of a shock can be big When there is low diversification, avalanche-like phenomena occur more than when there is high diversification.
In theory, protectionism would make supply chains more vulnerable than free trade would make them, and empirically we see this effect play out. Recent Japanese Papers A study of Asian companies during the COVID-19 pandemic found that those with stronger ties to the global economy had stronger supply chains and performed better than those with weaker ties. When the supply shock began to occur, globalized companies had more partners to choose from and were subsequently able to offset the shock. Companies with weaker ties to global markets had a harder time offsetting the shock and performed worse.
In theory, protectionism would be expected to make supply chains more fragile. Empirically, this is exactly what has happened. If politicians really want to protect supply chains, getting out of the way and allowing companies to build their own partner networks would do a better job than protectionism. By increasing the costs for domestic companies to build such robust supply networks in the global economy, protectionism weakens the very thing it was trying to strengthen. Protectionism does no good; it only does harm.
*In a globalized world like ours, this last statement is not strictly true. Many items are traded around the world, so anything that affects world prices affects companies, regardless of their connections to international trade. Yet they ignore this reality to bolster their arguments for protectionism.
John Murphy is an assistant professor of economics at Nicholls State University.
