Government Incentives Needed To Reshore Critical Supply Chains, From Pharmaceuticals to Minerals

One of the two main witnesses in Monday’s final U.S. China Economic and Security Review Commission hearing for 2023 said the U.S. government needs to come up with a list of critical industries and give them all the incentives they need to reshore.

In the hearing, titled China’s Current Economy: Implications for Investors and Supply Chains, Commissioner Robin Cleveland asked if the Commission should recommend Congress come up with a list of critical industries and supply chains.

“Yes, Congress should do that,” said Christopher Gopal, a Global Supply Chain Consultant and Author of the book Breakthrough Supply Chains [Testimony]. Gopal’s testimony and his Q&A responses were the nearest to what CPA would deem to be the heart of the matter for reshoring.

To be considered a critical industry, “it has to be something that will hurt the country in a crisis if we can’t get supplies, not something that will hurt a few big investors or a few companies only,” Gopal said, dialing in remotely to the hearing on Monday. “A critical supply chain may not be something you want to focus on if you can recover from disruption quickly with your allies. A critical supply chain is one that will take a lot of time, money, and effort to build while the economy is being hurt, or struggling to get supplies. It is not an inexhaustible list. It is a fairly short list,” he said, trying to keep things simple.

Cleveland asked about building up stockpiles for critical items, comparing that to the strategic petroleum reserve. The problem with that, said Gopal, is that it does not reshore and fix manufacturing capacity problems in the United States. The strategic oil reserve could be full of Venezuelan crude oil, for example.

“I hope that we don’t just stockpile things we are worried about supply constraints,” he told her. “You have to have the capabilities to manufacture them and get them ready to go out to the market when needed.”

Funding the Manufacturing Boom

The business press has been loaded this summer with stories of the American factory boom. In 2018, some of that was due to cuts in the corporate tax rate. Today, it is mainly due to three pieces of legislation – the CHIPS and Sciences Act, the Inflation Reduction Act, and to a lesser extent, the Bipartisan Infrastructure and Jobs Act.

Gopal recommended more incentive programs like those above for other critical areas of the U.S. economy, or niche areas of the supply chain such as critical medicines and technologies for new, post-fossil fuels energy production.

The U.S. government has now broken with and moved away from the Neo-Liberalism of the past and has taken a number of steps and actions to address this broad issue. This is not enough and much more needs to be done. The government has made a great start with programs such as the CHIPS and Science Act, and restrictions on the export of certain technologies to China, but years of neglect in policy and investment in our critical supply chains and national security have made us vulnerable. We must expand these (laws) to a broader range of critical components, products, supply chain infrastructure and large scale supply chain initiatives…to include the spectrum of supply chains and technologies (for example, food, renewable energy products, aircraft and automobiles), that are critical to our economy. Many of the risks lie upstream in the supply chain. Disruption of our critical supply chains would very likely cause a cascading effect of industry disruptions, some of which would be very hard to contain and recover from quickly. Disruptions in industries such as semiconductors and pharmaceuticals could, in a worst case scenario, bring the country to a standstill. – from Christopher Gopal’s written testimony to the U.S. China Economic and Security Review Commission, Aug. 21, 2023.

U.S. supply chains were revealed to be super fragile and open to disruption during the 2020-2022 pandemic. The country was short on everything from basic cleaning supplies like Lysol (most of those chemicals come from China), basic computer chips used in automotive manufacturing, and face masks used by everyone in the heyday of the SARS2 outbreak.

Beyond the supply chain woes caused by the pandemic lockdowns, on the pharmaceuticals front, the FDA is constantly warning about drug shortages for generic medications regardless of the pandemic. Mostly all of those generic drugs come from Asia, led by India.

“We have exported entire supply chains and jobs under false assumptions and the promised benefits of globalization,” Gopal wrote in his testimony. “Probably the most dangerous result of this approach to supply chain design, coupled with increased industry concentration, has been the increase of points of failure and dangerous chokepoints for our critical supply chains – where disruption could trigger potentially catastrophic effects — and, most importantly, giving China extraordinary power over our security, economy and the average American’s standard of living,” he wrote.

China controls the current supply and manufacture of electric car batteries and the critical elements needed (cobalt, lithium, and nickel) to make them. Supply chains for active pharmaceutical ingredients (APIs) and key starting materials for the manufacture of pharmaceuticals are China-facing. Polysilicon for solar, solar cells, and modules, are almost all made in China or by Chinese multinationals in Southeast Asia. At least three Chinese multinationals are now setting up shop in the U.S. to take advantage of the Inflation Reduction Act tax breaks to manufacture locally. Rare earth elements used in defense systems, communications, and electronics are heavily tilted toward China. In 1993, 38% of the supply of rare earths was produced in China and 33% were produced in the US. The U.S. then began to outsource its mining, production and processing due to environmental regulations and so by 2011, China took 97% of the processing for rare earths, Gopal told the Commission.

Princeton professor and U.S. China Commissioner Aaron Friedburg talked about EVs in America and how China was becoming a huge player in that supply chain. Most notably is in the battery  segment, where battery maker CATL recently partnered with Ford. The only American company that produces batteries is Tesla. All the others are Asian and China is gaining, with tons of money and subsidies to throw at this market back home.

“Can we catch up to China on this without imposing some sort of restrictions on imports from them,” he asked.

Ilaria Mazzocco, a Senior Fellow at the Center for Strategic and International Studies (CSIS) China Business and Economics program [Testimony] said we already have restrictions on China cars, through 25% tariffs. “I’m not suggesting increasing tariffs, but reducing them would not be ideal,” she said.

Mazzocco also warned that China has been spending so much on EVs to sell them locally and to the world that there is overcapacity there now. This is a perennial problem in China. She expects to see more exports of China EVs. And with prices coming down due to oversupply, a 25% tariff might not be restrictive enough.

Concerningly, the CSIS China Business and Economics program appears to provide support in Washington, D.C. for the Chinese government’s policy positions. Despite repeated concerns by the U.S. intelligence community, the program recently praised an article calling for greater partnership between the U.S. and China in the science and technology industries.

Industrial Policy Doesn’t Mean You’re Going China-Lite

Many in Washington hate industrial policy. They prefer individual companies making decisions, and this has worked for generations. But add China to the mix and clearly something has to be tweaked. The U.S. may be able to out-innovate China, but once those products hit mass market, the innovators inevitably make the widget abroad. China has, perhaps until recently due to tariffs and geopolitical risks, been the place to go.

Gopal told the Commission the U.S. needs a national strategy to combat China.

“A lot of our strategy is what comes out of individual industries,” he said. “So we talk about auto tariffs, or restricting technology…yet we have major companies building factories in China, and working with China to circumvent any restrictions that exist. We need a national trade policy that addresses many different things from a national security and economic security point of view, not just an individual business point of view.”

Commissioner Kim Glas said what keeps her up at night is China moving quickly to invest overseas and gain market access in other countries to sell Made in China goods that are being tariffed or face other political risks. “What are those implications longer term for us,” she wondered. “Do we even have enough trade tools in our tool kit to even counter this?” she asked.

“From a supply chain perspective, we are not looking at the same things that economists look at,” Gopal said. “China’s economy is slowing, but the capacity is still there and what have they traditionally done with that capacity when they have no market at home…they are either going to dump that in our market directly, or to other companies and countries around the world. The way we can handle that right now is only through anti-dumping laws,” he said, though this process can take years and will cost companies millions in legal fees just to present their case to the Commerce Department.

As China Deflates…

Mazzocco agreed about China’s overcapacity and dumping goods here, in Europe, or Latin America if they can’t find a place for it at home or in their own backyard. “You will have to keep your eyes on that one,” she warned.

Gopal piled on. Because China’s factories churn out products the locals aren’t buying, it ultimately leads to lower costs because demand is weak. That affects the world market, as we have seen time and time again with steel from China.

“Deflation in China makes our manufacturing uncompetitive,” Gopal said. “We have this short-termism on Wall Street, and in corporate board rooms, and that is going to lead to more offshoring with China deflation. This is an issue we need to look at from a multifunction perspective and not just from an economics perspective,” he said.

Commissioner Carte Goodwin wondered why China, which receives all sorts of benefits back home to produce goods, can be allowed to build a factory in the U.S. to make the same goods and receive tax breaks from the U.S. under the Inflation Reduction Act (IRA).  “Under what condition should China companies even be allowed to benefit from these incentives?” he asked.

“I don’t necessarily have a recommendation as to what the exact conditions should be to qualify and I think it depends on the companies,” Mazzocco said. “It is worth raising the issue. We don’t have a framework to deal with companies in this situation. For now, if the company qualifies to be in the U.S., then there is nothing I can say to make them not be there. But if policy makers think that’s risky, then they have to amend the (IRA) legislation. We are going to keep seeing these questions come up,” she said, adding that it would be helpful for American companies that want to partner with China to get a definitive answer on this so they are not surprised later on that their China partner is banned. Such is life dealing with China today. Washington seems to be okay with that uncertainty and will put the onus on businesses to take on that risk.

Commissioner Jacob Helberg asked Gopal what he would do to secure supply chains if he had a magic wand.

“If I could wave a magic wand,I would increase our funding of U.S. manufacturing to build up the capacity we have lost,” Gopal told him. He mentioned some infrastructure issues that the U.S. is way behind on, and he talked about energy and said the U.S. has to be practical with energy policy and use energy that is competitive as opposed to saying you have to use this energy and not that energy.

Commissioner Michael Wessel said there is too much “willful blindness” when it comes to China.

“It continues to cloud the visibility of many of the challenges we face,” Wessel said. “Biden’s recent Executive Order on export restrictions to China tech companies is still limited,” he said.

CPA agrees with Wessel. See our press release on this here where CEO Michael Stumo calls the EO “merely symbolic” and comes with “no deadlines” for action.

Wessel asked Gopal what new tools in terms of transparency and data were needed to get a handle on where critical goods are sourced. “Businesses are opposed to this,” Wessel reminded him.

“That’s the question of the decade: how do you get businesses to help?” Gopal responded. “I think the only way is you mandate it.  You make sure what they are sharing is highly confidential, You don’t go overboard with every type of data. You need to specify what it is you need if you want to make decisions on what is critical (and needs incentives) and what is not.”

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