The desire to “make supply chains robust” has been a major talking point for protectionists (and other industrial policy advocates). This rhetoric has gained momentum since the COVID-19 pandemic is said to have exposed the fragility of globalized supply chains. A few years ago I wrote one post questioning the validity of such claims from the perspective of market failure. Here I will question the theoretical and empirical foundations of this claim.
The argument that protectionism can make supply chains robust is misleading. At first glanceIt makes sense: if supply chains are dispersed, they will be subject to more political, social and economic factors over a larger area. For example, if a company’s supply chains run through Argentina, China, Germany and Canada, political and social unrest in those areas could affect the supply chain. If the chain were entirely domestic, the political and social issues in those countries would not necessarily affect the company.*
However, some consideration shows the fragility of such an argument. It’s common sense, they say, not to put all your eggs in one basket. Rather, diversification is the way to minimize the risk of catastrophic losses. If all your eggs are in one basket and that basket breaks, you lose all your eggs. If your eggs are spread across multiple baskets, the risk of loss if one basket breaks is much lower.
The same goes for supply chains. If companies depend on a single supplier, they are very vulnerable to production shocks (for a technical discussion of this point, see either this paper by Acemoglu et al. or this paper by me). A single shock has a cascading effect throughout the economy and can affect companies far removed from the original shock. The impact of the shock is indeed bigger when there is less diversification, similar to an avalanche, than when there is more diversification.
In theory, protectionism would make supply chains more vulnerable than under free trade. And empirically, we see this effect playing out. A recent article from Japan Research on Asian companies during the COVID-19 pandemic found that companies with greater ties to the global economy had more robust supply chains and outperformed those with weaker ties. When supply shocks started to hit, globalized companies had more partners to choose from and could then offset the shocks. Companies with fewer ties to the global market could not easily compensate for the shocks and thus performed worse.
In theory, we would expect protectionism to make supply chains more vulnerable. Empirically, this is indeed what we see. If politicians really want to protect supply chains, getting out of the way and letting companies build their own networks of partners will do more good than protectionism. By increasing the costs to domestic firms of forming such robust supply networks in the global economy, protectionism weakens the very thing it seeks to strengthen. Protectionism does no good; only damage.
*In the case of a globalized world like ours, this last statement is not, strictly speaking, true. Many items are traded globally, so anything that affects the world price will affect the business, regardless of their connection to international trade. But to undermine the protectionist argument, we will ignore this reality.
Jon Murphy is an assistant professor of economics at Nicholls State University.