Geopolitical impacts on global supply chains

By Dr Merriden Varrall, Director, Geopolitics and Tax, KPMG Australia

Most of the time, supply chains work seamlessly.

That is, until a geopolitical stressor exposes the weaknesses of a system with too much efficiency and not enough resilience.

With the highly unpredictable landscape at present, we are seeing an increase in the speed and depth of these stressors.

Pre-COVID-19, there were four main themes underpinning this geopolitical uncertainty.

This article explores these themes.

  • Shifts in the international system’s structure and institutions
  • Citizen dissatisfaction, unrest and a concomitant rise in populist politics
  • Rapid and dramatic tech transformation
  • Climate change has the potential to seriously disrupt global supply chains

COVID-19 has exacerbated and accelerated these existing flux trends, with real and tangible impacts to business supply chains.

More than ever, the business community needs to mainstream geopolitics into its supply chain analysis and planning to effectively navigate the unpredictable landscape.

Shifts in the international system and its institutions, the politicisation of international relations, and a tendency towards self-reliance

The international system as we know it is not inherent or natural, but is a construct created out of the chaos and horror of the two world wars, and the existential threat of the Cold War, to maintain stability and promote prosperity. The system, with its key institutions like the United Nations, the International Monetary Fund, and the World Bank, is by no means perfect, but it has supported international development and free trade, and it is now under considerable pressure.

The strategic competition between China and the United States, including discussions of ‘decoupling’, has profound implications from the top to the bottom of the international system, including for the norms and rules for international trade.

There are two high-level trends arising from this fracturing geopolitical landscape. The first is that bilateral and multilateral relations are becoming increasingly politicised and unpredictable. The second, and inextricably interconnected, is that domestic market dynamics may shift towards greater self-reliance. As part of the politicisation of international relations, and aggravated by COVID-19, we see a shift from liberalism to protectionist tendencies. Pre-existing trade tensions are intensifying, tariff and non-tariff barriers are being imposed, or at least threatened. There is an increased interest in ensuring the stability and continuity of domestic industries in distress. It is now commonplace for governments to be talking in terms of strategic self-sufficiency, on-shore or near-shoring, and stockpiling.

We are also seeing heightened levels of anxiety around vulnerabilities associated with over-reliance on key trading partners, in particular, concerns around slowdown or shutdown of key suppliers and critical operations, delays in getting inbound and outbound raw materials to production sites and finished goods to market, and challenges around insolvency for upstream partners and key customers. As a result, there is a renewed focus on the adequacy of contingency plans and the long-term sustainability of current strategies.

Increasing domestic discontent is contributing to a rising trend of populism and a political rather than economic policy logic

Widespread disillusionment with globalisation is resulting in a growing mistrust of political and business elites. Populist leaders are taking advantage of discontent with an anti-elite and anti-pluralist agenda, promoting an inwardly-focused nationalism rather than international engagement and cooperation. Democratic institutions, including free media and the independent judiciary, are often eroded as leaders move national policies towards the extreme left or right to demonstrate their appeal to their domestic power base.

This trend will likely drive more inward-focused policies, less impetus for international cooperation and more unpredictable social and economic policies. We are therefore seeing the potential for rapid changes to the conditions for doing business, with decisions about domestic markets likely to exhibit internal political logic more than global economic logic.

This trend is likely to intensify around many parts of the world, although not all, as a result of COVID-19. The uneven way in which the pandemic is affecting different communities among and within countries is further deepening inequality and poverty. Feelings of mistrust, disillusionment, and alienation from a system which is seen to have failed them will fuel populist leaders’ ability to politicise public policy.

Technological transformation is advancing rapidly but not everyone is a winner

Digitisation offers businesses efficiencies and value-creating opportunities, including e-commerce, process automation, data collection and artificial intelligence, which are delivering new ways to engage customers. Technology advances can also strengthen customs controls and reduce compliance risk, enhancing the safety and security of global trade. But there is also great uncertainty over the impacts of technology on job security, national security and commercial governance.

Technology divisions are emerging out of the strategic competition between China and the US. Businesses may find themselves divided between two global technology hemispheres, impinging upon the interoperability of technology systems and information flows across borders.

Continued technology transformation will force businesses to consider:

  • ways to further optimise each module of their supply chains – processes, communications and regulation – through digitisation (digitisation no longer appears optional and there will be pressure on businesses to innovate and adapt);
  • the ability of existing digital infrastructure to cope with severe business disruptions, and ways to continue to uplift capability to meet demand (during COVID-19, remote working and massive service demand tested the limits of many businesses’ and governments’ ICT infrastructure); and
  • how to ensure flexibility in digital infrastructure and investments, should it become increasingly necessary for businesses to adapt to, and bridge, technology divides.

Climate change has the potential to seriously disrupt global supply chains

Already we are experiencing the physical risks associated with extreme weather events like the 2020 bushfires. Resource scarcity, including insufficient potable water supply, already threatens many countries, including Australia. Associated socio‑political risks such as mass migration, displacement, health crises, and unrest – including within and across borders – are likely to follow.

Businesses need to consider how climate change impacts the operation of, and changes to, supply chains:

  • extreme weather events could shut down critical supply routes and increase the costs of transport and insurance (fires in South East Asia annually disrupt flights and commerce in Singapore and Malaysia., just as major storms in the South China Sea could seriously disrupt shipping);
  • changing consumer preferences could drive greater demand for sustainable goods and corporate brands could suffer from failure to address climate responsibilities (the need to embrace more climate‑friendly products and services could see businesses face great pressure to adapt quickly or lose value); and
  • the impact of carbon pricing schemes could drive increasing business costs (this could in turn drive businesses to pivot to greener and more efficient technologies).

So what for business?

This picture of converging geopolitical trends seems alarming – the volatility of the environment means that sudden changes can quickly undermine the value created in businesses’ supply chains. But there are opportunities for the informed and adaptive.

It is critical for businesses to understand these trends and embed geopolitical awareness, not only in planning for COVID‑19 recovery in the medium term, but also for the operating environment of the future.

In an already uncertain trade environment, COVID-19 has been the catalyst for sudden disruption of operations at domestic, regional and global levels and created supply and demand shocks.

Businesses need to think about future-proofing their supply chains post COVID-19, and consider the impacts of:

  • shutdowns of key suppliers and critical intermediary operations, creating delays in delivery of raw materials to production sites and finished goods to market – for example, if conflict in the South China Sea cripples shipping routes;
  • counterparty risk and solvency concerns with upstream suppliers and key customers – events like Brexit cause currency fluctuations, while COVID-19 is financially straining business around the world;
  • ensuring a focus on the adequacy of contingency plans and long-term sustainability of current policies and strategies; and
  • regionalisation and localisation of value chains, resulting from a prioritisation of domestic and local markets.

In addition to considering how business needs to pivot to navigate these geopolitical challenges effectively, we also have a powerful role to play in mitigating and preventing them. This can include but is not limited to integrating environmental, social, and governance (ESG) principles in future strategic planning.

This is not only an ethical consideration, but a reputational one, in a world where trust is increasingly important, and at the same time, increasingly difficult to win and maintain.

This article was originally published on KPMG Tax Now, KPMG Australia’s subscription news service for tax and finance professionals.

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