Supply Chains

But President Andres Manuel Lopez Obrador is wasting the opportunity.

The Union of South American Nations (UNASUR) — an organization that once aspired to become South America’s answer to the European Union — quietly faded away last month. Deep divisions over Venezuela’s turmoil and internal leadership battles precipitated its demise. Yet its real vulnerability stemmed from something deeper: the economic isolation of its members. Unlike the European Union, Latin America’s multilateral bodies haven’t ignited commercial ties between their participants. This economic detachment not only doomed UNASUR, but has held the region back, and may keep it on the margins in the decades to come. UNASUR wasn’t the first attempt to integrate Latin America. In the 1960s the six-country Latin American Free Trade Association fell victim to protectionism. In the 1980s, a dozen nations tried again with the Latin American Integration Association, largely to no avail. In the 1990s Mercosur took center stage as a vehicle to knit South America together: Its common currency never materialized, and trade between the partners peaked shortly afterward, then again declined. Despite more than a dozen different multilateral organizations, Latin American nations remain commercial strangers. Sure, Argentina and Brazil exchange some auto parts, Colombia and Ecuador do a decent trade in paper and plastics, and Chilenos watch Mexican soap operas. But overall, less than 20 cents of every export dollar goes to one of its neighbors. Compare that with well over half of international sales in Europe or Asia. More broadly, Latin America’s regional agreements have done little to boost their members’ share of world manufacturing exports and their participation in global markets. Importantly, Latin American nations tend not to make things together. Today the vast majority of goods circling the earth are intermediary goods — parts and components being sent elsewhere to be sewn, welded, stamped, and otherwise assembled into clothes, cars, computers and thousands of other products. This shift in trade reflects the rise of global supply chains, as everyday products are increasingly made across numerous factories and even countries. These supply chains have bolstered the fortunes of many emerging markets — mostly when they worked with their neighbors. Asia’s big four newly industrialized economies — South Korea, Taiwan, Hong Kong and Singapore — jump-started their decades of near double-digit growth with Japanese outsourcing and investment. They later benefited from China’s rise. Many Eastern European nations saw their industrial base and larger economies blossom when their Western European brethren poured in after the fall of the Berlin Wall. And Mexico’s successes in cars, planes, medical equipment, and other manufacturing has been due mostly to the commercial ties born of NAFTA. Latin American nations are instead largely focused on mining the iron ore, lithium, copper and other raw materials that go into the making of steel, batteries, and electronics; or growing the soybeans, fruit, and coffee processed and consumed oceans away. Excluded from the most dynamic parts of international manufacturing chains, Latin American companies and workers are less likely to gain access to new technologies, to develop new skills and to move up the value-added ladder to higher-margin products and better-paying jobs. This isolation leaves the region less able to compete vis-a-vis other parts of the world in the making of things — not least because of the rise of other more successful regional hubs — and less able to attract global consumers to its homegrown brands. It helps confine so many nations to the middle-income trap. Without the commercial ties to keep the politics on track, diplomatic conflicts often lead either to neutered talk shops unable to resolve pressing issues — the Organization of American States’ response to Venezuela comes to mind — or to full-on institutional suspensions, a la UNASUR. Given the distances involved, South America is unlikely to be drawn into Asia’s, Europe’s or North America’s manufacturing orbits. Its nations instead should turn to their neighbors to nurture industry and boost economic growth. The legal mechanisms are there: More than two dozen regional agreements cover some 80 percent of trade. These could be expanded to include the thornier sectors that remain, and could and should be consolidated into a few broad agreements — for instance, expanding the Pacific Alliance to streamline the current thicket of rules and regulations. Governments could also make it easier for international companies to invest through tax and investment treaties with neighbors. They could tackle the outsized transaction costs shippers face from woeful infrastructure between countries. And they could reduce excessive red tape and strengthen the rule of law, enticing to any foreign investor or multinational. If Latin American entrepreneurs and businesses looked next door more often, they would finally provide a stronger economic foundation for the wider integration politicians have long discussed but never realized. View article originally published on Bloomberg. 

Global trade and the supply chains that support it are undergoing a period of profound change. Supply chains face threats including a resurgence of protectionism, climate change, decaying infrastructure, and human rights abuses. The Development Channel’s series on global supply chains will highlight analysis on emerging trends and challenges. This post is from Zoe Rubin, former intern with the Council on Foreign Relations’ Civil Society, Markets, and Democracy Program.  In recent years, U.S. and British lawmakers have pressed corporations to voluntarily address rampant labor abuses in global production networks. In particular, new and proposed laws require firms to publicly report what actions they’re taking to eradicate slavery and human trafficking in their supply chains. These laws depend on consumer pressure, with the assumption that the fear of being “named and shamed” will compel companies to do their human rights due diligence. California passed the California Transparency in Supply Chains Act (TISCA) in 2010, which requires companies headquartered or doing business in the state to disclose their efforts to eradicate slavery and human trafficking from their supply chains. A similar UK law, the Modern Slavery Act, came into force in 2015. And the U.S. Congress is currently considering the Business Supply Chain Transparency on Trafficking and Slavery Act, which would mandate that public companies disclose measures taken to address forced labor conditions to the Securities and Exchange Commission. None of these sanction companies that do nothing to identify or address forced labor in their supply chain. Greater corporate transparency alone will not bring about much-needed reforms in how firms do business. To spark change, governments should hold companies legally accountable when they fail to investigate rights violations in their supply chains or address these abuses when they find them. Studies show consumers don’t care.  A 2014 poll found that British consumers were largely apathetic to labor abuses in companies’ product supply chains. They cited other corporate practices as more pressing, namely tax dodging, exorbitant executive pay, and corruption. And management research suggests that while consumers value corporate transparency, they don’t use the new information about a company’s supply chain to demand changes in the way it makes things. After a scandal revealing hazardous denim treatment practices, Nudie Jeans, a Swedish clothing brand, began disclosing its supplier lists and factory audit reports. The company found that consumers were subsequently more willing to purchase its products, despite the fact that reports revealed some workers treat the jeans with dangerous chemicals that cause potentially life-threatening respiratory disease. Likewise, Patagonia, the American outdoor clothing company, is completely open that human trafficking persists, despite its longstanding social responsibility efforts, and its customers keep buying. Major companies, meanwhile, regularly flout supply chain transparency laws. Five years after the passage of the California act, less than a third of corporations affected by the law actually published all the information they’re supposed to report. Dole, a fruit and vegetable company, did not even post a TISCA-mandated slavery and human trafficking disclosure statement, and Caterpillar, Hyundai Motor America, and Krispy Kreme Doughnuts all reported that they make no effort to evaluate and address human trafficking and slavery risks. (Compliance with other domestic supply chain-related regulations has also varied widely. A study of the U.S. Dodd-Frank Act rule on conflict minerals published last year found that only 7 percent of companies reported strong efforts to determine whether they bought minerals that benefited armed groups.) If supply chain transparency laws alone will not advance labor rights, then how can governments clean up global supply chains? Requiring firms to proactively address, not just disclose, slavery and human trafficking risks would be an important start. Other countries have done this. Since 2003, Brazil’s labor ministry has published a so-called dirty list of firms found to employ forced laborers. Blacklisted companies cannot receive loans from state-backed banks, face restrictions on the sale of their products, and experience private sector boycotts, as some firms publicly refuse to buy from them. The government will remove companies from the list after two years only if they have paid all required fines and reformed their labor practices. Companies can lose their assets, namely land, under a 2014 constitutional amendment if they are found to use slave labor. These financial—not just reputational—costs create strong market incentives for employers to better monitor their working conditions. When held legally accountable for their suppliers’ labor violations, corporations more readily identify, prevent, and mitigate human rights abuses. In 2008, Brazil prohibited children under eighteen from farming tobacco, and subsequently enacted strict penalties for domestic and international tobacco corporations, including foreign companies, whose suppliers use child labor. Human Rights Watch found that as a result, most tobacco companies now require farmers to sign contracts that contain an explicit ban on child labor and mandate financial penalties for noncompliance. Company representatives conduct routine site visits to suppliers to reinforce their zero tolerance policies on child labor. Various European countries, including Finland, Germany, Italy, Spain, and the Netherlands, also punish companies in their construction sectors whose subcontractors fail to meet certain labor standards. The court of public opinion is no substitute for a court of law. The United States, United Kingdom, and other governments should require businesses to find and address instances of labor abuse throughout their supply chains—a call that many advocacy groups have taken up—and punish those who fail to do so.

Global trade and the supply chains that support it are undergoing a period of profound change. Supply chains face threats including a resurgence of protectionism, climate change, decaying infrastructure, and human rights abuses. The Development Channel’s series on global supply chains will highlight experts’ analysis on emerging trends and challenges. This post is from Sang Kim, Associate Professor at Yale School of Management.  The rise of outsourcing has transformed many companies into managers of global supply chains. While this change has brought many benefits—lowering labor costs, increasing productivity, and gaining access to international markets—it has also created new kinds of costs. In particular, firms are now vulnerable to supply chain disruptions. Factory shutdowns in Japan following the 2011 Tohoku earthquake cascaded across automotive and electronics supply chains. The 2013 collapse of Rana Plaza in Bangladesh, which killed over a thousand workers, damaged the reputation of many well-known clothing brands. And recent revelations that Indian textile company Welspun mislabeled products as Egyptian cotton already cost them one of their biggest buyers, Target. There are two kinds of supply chain risks. Some are predictable; they include the uncertainties that businesses face on a day-to-day basis, such as delays in product deliveries, fluctuations in consumer demands, and product shortages. Because managers encounter these problems repeatedly, they have become adept at dealing with them. For example, managers collect and analyze data on past product shortages to forecast future ones, and build up their inventory to head off potential losses. The real challenge is managing unpredictable risks, including natural disasters, catastrophic equipment failures, and terrorist attacks. These risks are harder to plan for since they occur less frequently but with often much higher costs. For instance, in 2007, a power outage at a Samsung plant unexpectedly shut down production for a day. As a result, Samsung lost an estimated $40 million. Many companies struggle to manage such risks. One strategy to address unpredictable risks is duplication. This means maintaining multiple copies of products and suppliers. For example, managers will build standby production lines, buy each type of part from multiple suppliers, or hold backup inventory for all their parts and products (in contrast to the selective and targeted inventory involved in predictable risks). Though duplication does protect against disruptions, it’s expensive if it is not carefully planned. A cost-effective way for a duplication strategy to work is investing in making supply chains more flexible. This might involve designing products to use common, standardized parts so that a substitute can be readily found if the original part becomes unavailable after a disruption, or engineering production lines so they are capable of manufacturing multiple products, allowing for quick switches if a supplier shuts down. Some companies may enter into contracts with suppliers that allow for last-minute orders in the event of a disruption without necessarily buying regularly. While it may still be necessary to keep some additional inventory, a focus on flexibility lessens the need for costly and often unused duplication at every stage of the supply chain. Although these contingency planning strategies cost money, managers must address unpredictable risks, as the costs of not doing so can be even higher. The 2000 Phillips Electronic shutdown illustrates the threat of this type of supply chain disruption. A fire started by lightning forced Phillips Electronics to close a cellphone chip factory in Albuquerque, New Mexico, leading to shortages of critical parts for two of Phillips’ customers, Nokia and Ericsson. Nokia, in an illustration of flexibility, had maintained relationships with its other suppliers, who freed up their production capacity to provide replacement parts on short notice. In the end, Nokia emerged from the incident relatively unscathed. Ericsson, on the other hand, did not have built-in flexibility and suffered big losses, which contributed to its eventual exit from the cellphone manufacturing business. As this example illustrates, a well-thought out contingency plan that increases flexibility can make or break a company. And with supply chains becoming increasingly complex and geographically dispersed, the capability to quickly respond to sudden disruptions is more important than ever.

Commerce has fundamentally changed over the past thirty years. Intermediate goods—or parts of products traded through global supply chains—now account for 70 percent of all trade. The Civil Society, Markets, and Democracy program hosted a workshop in May to explore the evolution of global supply chains, the risks they face, and how U.S. policies help or hinder the country’s competitiveness. The workshop included current and former government officials, supply chain experts, corporate representatives, and finance specialists. Over the coming months, we will share posts from many of these experts here on the Development Channel, asking them to weigh in on emerging trends, strategies for mitigating supply chain risks, and transparency and sustainability, among other topics. To introduce the series, here are some of the main takeaways from the global supply chains workshop. Read the full rapporteur report here: The Future of Global Supply Chains. Current State of Supply Chains In just a single generation, supply chains have grown to dominate global trade, as products are increasingly made across countries rather than within them. Workshop participants noted that many of the most striking changes come from China’s rise as a major manufacturing hub within these chains, now producing approximately one-quarter of global output. But many factors that enabled China’s growth—such as its labor cost advantage—have eroded, making regions such as Southeast Asia and eastern Europe more appealing by comparison, and threatening China’s place at the center of global supply chains. Worldwide, governments and companies alike are working to make supply chains more transparent. In what participants called a “sea change” in attitudes toward production, China has seen a growing number of voluntary corporate guidelines for supply chain transparency. And in the United States, legal changes—such as a recent amendment of Section 307 of the U.S. Tariff Act of 1930—can help address labor concerns. This spring U.S. customs officials seized a Chinese shipment of soda ash under the new guidelines to keep out products made by forced labor, and participants expect to see many more Section 307 cases, forcing changes in current practices. Supply Chain Risks and Compliance Trends Participants stressed several risks to global supply chains that threaten their resilience and viability, including natural disasters, cyberattacks, climate change (as rising sea levels alter shipping routes), and public health crises such as Zika. In the United States, decrepit infrastructure—ports, railroads, bridges, and airports—hinders competitiveness and the ability to integrate into these globalized means of production. As one participant noted, their company sees much of the United States as “a second-world country.” Protecting workers’ rights remains a major challenge, as chains lengthen and companies use a growing number of small subcontractors to provide components or services, in many cases losing their visibility into working conditions along the supply chain. But workshop participants observed a change in the way that companies and governments are overseeing compliance with labor and environmental standards. They discussed a shift from a traditional compliance model, where companies’ incentives often don’t align with their providers down the chain, to more of a partnership model, where buyers and suppliers embrace a relational (rather than transactional) contract, giving lower-tier suppliers the incentive and security to invest and improve. U.S. Policies to Boost Competitiveness Some participants stressed a fundamental change: trade is no longer the engine of economic growth. This is due to both cyclical changes, such as weaker demand and the commodities bust, and structural changes, including a resurgence of protectionist policies. Many participants focused on new trade agreements such as the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP) as tools to help reverse this trend, and to improve supply chain practices around the world. For instance, the mere desire to qualify for the TPP is helping spur reforms in Asia, despite Chinese officials’ and corporations’ initial skepticism. Still, the TPP and TTIP may not be enough—participants noted the TPP’s limits, including its inattention to the quickly-expanding services sector. And in the face of rising protectionist attitudes, the deals may never materialize. Others pointed to the outdated and fragmented regulatory approach to trade given supply chains’ current realities. With oversight spread across nearly fifty agencies, proliferating standards and regulations can constrain how companies source, manufacture, and move goods around the world. National security concerns can also complicate policy formulation. Participants noted a fundamental tension between creating nimble supply chains that quickly satisfy customer demand, and building more resilient production linkages that can weather unforeseen disruptions.

The UK’s Modern Slavery Act now requires companies to report efforts to prevent human trafficking and slavery in the making of every part and every process of production, from headquarters down to individual suppliers along production chains. In the United States, the Dodd Frank Act’s disclosure rules for conflict minerals hold mining and technology companies to similar standards. But surveys and reports show companies still fail to monitor their suppliers, let alone prevent abuses. To comply with these laws, multinationals must investigate the origin of each chip, stitch, or mineral in its products, and workers’ treatment at each stage. Many do not for two reasons: Supply chains have become more geographically dispersed. Today products are mostly made across countries rather than within them. A Ford Fusion sold in a U.S. dealer’s lot counts parts from 234 suppliers in 32 countries. An iPhone brings together minerals from Mongolia and pieces manufactured in Korea and Taiwan before assembly in China. To follow their intricate production chains, companies must inspect labor practices on each factory floor, farm, or mine in every country, from raw materials to manufactured parts to fabrication. Subcontracting of subcontracting. Agreements between brands and suppliers can be just the start. After a factory signs a contract, they often subcontract to smaller firms that subcontract to even smaller ones. The demands of fast fashion in particular mean that suppliers routinely farm out large contracts to dozens of not just smaller factories, but also networks of sewers, finishers, and embroiderers working in their own homes. These workshops don’t have government permits and often lack basic sanitation, ventilation, and lighting. They demand long hours and deny paid maternity leave. One study of Bangladesh’s apparel industry found that out of 7,000 producers, about half are informal subcontractors. These realities make it difficult for corporations to monitor working conditions. Even well-known multinationals struggle. After long hours and low pay drove desperate Chinese iPhone makers to suicide, Apple started publishing yearly reports on labor rights in its factories. Four years later, these reports show worker conditions are still unsafe, and hours often exceed two to three times the legal limit. Nestlé grapples with child labor in Ivory Coast cocoa suppliers, even after adopting measures to address the problem. Some of Nestlé’s suppliers in Thailand use slaves to catch fishmeal that ends up in the brand’s pet food, and it buys coffee beans from plantations in Brazil that may rely on slave labor. Still, there are success stories. Intel now maps its entire electronics supply chain, tracing metals it buys in China and Russia to African smelters. Working with other electronics brands, Intel helps smelters in the Democratic Republic of Congo identify conflict-free sources, enabling them to support often poor tantalum miners without funding the nation’s violent militias. And for corporations looking to improve their practices, help exists. Outside auditors can map supply chains, identifying risks and violations. Many non-governmental organizations (NGOs) partner with companies to spread awareness and educate local governments on what counts as abuse and how workers can report cases so that the company can respond. Others design and deploy technologies, including text messaging and social media analysis, to help companies pinpoint labor violations. The UK and U.S. laws set important guidelines for today’s global factories, though the response so far shows these laws are just the first step. To be successful, legal norms need to proliferate, moving beyond industrialized nations to emerging economies where workers rights are often most tenuous. And they need to be internalized by companies, becoming a part of everyday practices and operations.

Yesterday on my blog, I wrote about the importance and difficulties of including more women-owned businesses in global supply chains, the topic of a meeting I hosted this week as part of CFR’s ExxonMobil Women and Development Roundtable Series. As I note:   While better incorporating women into global supply chains can be a major lever for change, it’s difficult to do. Women business owners in many markets face strong cultural and structural barriers.   You can read about some innovative solutions to these obstacles in the full post here.