The Geopolitics of Supply Chains

The nature of globalization is evolving. For over two decades, China was the leading solution for offshore production. That is no longer true, in part because rising geopolitical tensions are spurring a fundamental rewiring of supply chains. But is there a next China? We believe the answer is no. Instead of simply pursuing a “China plus one” strategy, companies are navigating a “China plus many” world. Firms seeking to increase the resilience of their supply chains and insulate themselves from geopolitical risk have little choice but to engage with this complexity.

In a new report, Lazard’s Geopolitical Advisory team assesses the rise and relative decline of China as an offshoring destination and evaluates five countries—India, Vietnam, Mexico, Poland, and Thailand—emerging as manufacturing alternatives in this new geopolitical environment.

Traditional supply chain analyses often have not centered around geopolitics. Today, though, while traditional questions such as inputs, labor force, energy supplies, raw material availability, and economic and political stability are all critical, geopolitics is central to patterns of trade and is no longer a secondary or tertiary variable to consider.

We believe geopolitics is integral to corporate decision-making on supply chains. If companies neglect to integrate assessments of geopolitics—such as the impact of increasing tensions and restrictions between the United States and China—they may put their future operations at risk, while those that do will be able to seize opportunities for growth in a changing world.

This report underscores that there is no “one-size-fits-all” solution. Companies must pay closer attention than ever to geopolitics in determining how, and where, to reorient their supply chains.

Our key findings:                                                                                                      

Geopolitics is increasingly transforming supply chains and foreign investment. Companies will need a nuanced understanding of diverging geopolitical trajectories of different countries and regions to remain competitive and manage uncertainty. Tariffs and trade agreements, bilateral and multilateral political relationships, subsidies, and export restrictions are all key indicators of how geopolitics will shape supply chains.

China remains the dominant global manufacturing power. China’s trade surplus continues to grow. Approximately 17 percent of all global intermediate goods imports come from China; India, Vietnam, and Thailand each import more than 25 percent of their intermediate goods from China. Even as trade with China becomes more complicated, China will remain a core manufacturer, and companies will need to be more attuned to Chinese policies and restrictions implemented by the United States and Europe.

There is no “next China.” Instead of “China plus one,” globalization is entering a “China plus many” phase. Companies seeking to diversify and de-risk supply chains outside of China will find an ambiguous, complex operating environment with no obvious single candidate to replace China. Foreign companies are unlikely to move their entire manufacturing facilities to another nation. Instead, they will have to engage with different geographies to find solutions to their own manufacturing needs. 

Labor supply, productivity, and demographics are key for the success of advanced manufacturing exports. An aging population, such as China’s, reduces the available labor supply. Even in the case of nations with large, young workforces like India and Vietnam, firms often highlight dissatisfaction with the skill level of employees. Evaluating how governments plan to increase productivity can help identify high-potential sectors and countries. Both quality and quantity of labor are critical—for example, while Poland has a skilled labor force, it has a worsening labor supply problem, whereas India has the opposite issue with abundant labor and lower productivity levels.

Companies should tailor their strategies to specific regulatory and policy environments. Consistency of regulatory enforcement, dispute resolution processes, and the ease of capital movement differ across geographies. Countries with constitutional protections for investments or with similarly codified laws, like Thailand and Poland, can give companies confidence.

Companies need effective infrastructure for trade, but financing gaps are creating bottlenecks. Financing gaps create opportunities for private sector infrastructure investment, but these investments are also becoming increasingly geopolitical. While some nations have the fiscal space for significant investment, like India and Mexico, many do not. The consequence is a growing role for private companies able to finance export-enabling infrastructure—and a larger role for China in financing projects in places such as Thailand and Vietnam, even as those countries are wary of closer ties. 

Companies must build climate adaptation into their investments. Water scarcity in Mexico and Poland, flooding in Thailand, heat in India, China, and Vietnam, and other climate stresses are already affecting production processes. While some countries are investing effectively to adapt, like Thailand and Poland, others, like India and Mexico, are lagging, creating business uncertainty. Companies ahead of these trends can work with governments to deploy capital effectively and adapt to climate disruptions. Integrating climate change into investment decisions is necessary for the success of manufacturing projects.

Read the full report here.

By Peter Orszag , Siddharth Mohandas , and Apratim Gautam