Will Japan’s quake change global manufacturing forever?

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The earthquake, tsunami and nuclear crisis that hit Japan have woken up the world’s business community to the precariousness of the global supply chain. Japan is a major manufacturer of all kinds of stuff that goes into other stuff, like car parts and chips, and the disruption of production in Japan in the wake of the natural catastrophe has ricocheted around the globe. General Motors had to idle a small truck factory, and production in the global auto industry could be hampered for months by short supplies of parts. In Europe, the interruptions in Japan are expected to strain supply chains already being tested by rising demand, likely putting upward pressure on prices of inputs. A recent report by Moody’s noted that the Japan quake “will curtail the entire technology supply chain.” Japan, the report points out as an example, controls 90% of the world’s production of something called bismaleimide-triazine resin, which ends up in chips and circuit boards. Manufacturers have already suffered shutdowns, and continued disruption could create problems across the entire electronics industry. Here’s Moody’s:

We believe the current impact is manageable, as semiconductor companies are now living on the existing channel inventory at both the supplier and manufacturer levels, which ranges from 1.5 to two months. However, a prolonged supply suspension will be problematic, affecting the entire chip-making industry…This, in turn, will affect global shipments of electronic products such as handsets, flat-screen televisions, and PCs, negatively impacting branded consumer electronics companies.

Yikes! The disruption to industrial production in Japan has sent firms around the world seeking other sources of supply. So here’s the question: Will the impact of Japan’s quake on manufacturing be temporary, or will it lead to a complete re-think of the way in which products are made today?

Here’s what I mean:

For the past 30 years, the process of manufacturing has become more and more globalized. Products are manufactured from components made here, there and everywhere, and shipped to a factory somewhere else for final assembly. Typical of this process is the worldwide network used to produce an iPhone. The process of manufacturing was split up in this fashion to benefit from the specific comparative advantages of individual countries. Japan may do a really good job at manufacturing bismaleimide-triazine resin, for example, while China’s cheap, efficient workers are just the thing for fast, cost-effective assembly. With communications and transportation becoming faster and more reliable, splitting up manufacturing and capitalizing on local strengths made more and more sense. Manufacturing in essence became “borderless.”

But Japan has taught us all a lesson: Those “borderless” supply chains are actually quite vulnerable to something bad happening within one of the borders. Perhaps your factory uses only a part of a part of a part made in Japan, but a disruption in the supply of that part could halt your entire assembly line. “Borderless” manufacturing, in other words, isn’t that safe after all.

So does that mean supply chains will become shorter as a result of the Japan quake? Will supply systems contract, and become more concentrated? In other words, will the globalization of manufacturing reverse itself? My opinion is that the impact from Japan, while painful, will likely be too short-lived for manufacturers to dramatically overhaul their supply strategies. Plus, concentrating supply and manufacture in a narrower geographic range will only make production more vulnerable to shocks like quakes and nuclear fiascos. If anything the crisis in Japan will result in more diversified, and perhaps even more global supply networks as manufacturing look to expand their sources of important parts and components.

But that doesn’t mean the current system won’t change anyway. Kevin Brown of the Financial Times believes the global supply chain we see today is becoming outdated, but not due to the short-term jolt from the Japan quake. The more important, long-term issue, he argues, is the emergence of emerging markets as consumer economies in their own right:

The focus on dealing with the immediate pain is obscuring a much bigger challenge for multinationals: whether the whole concept of globalised supply chains is being outmoded by the rise of new centres of demand in Asia and Latin America that might be best served by a return to regional sourcing and production…The global supply chain made sense when most of it pointed in the same direction – from Asian producers to western consumers. As Asia and Latin America join the consuming bandwagon it will make more sense for multinationals to site production and assembly close to their customers, which has the side effect of cutting transport costs. That is likely to mean a return to regional production centres, with Chinese factories switching from exporting to producing for Asian consumers and new factories making goods for the US being sited in Latin America.

Interesting stuff. I, however, don’t agree. First of all, there has always been an element of “go local” as manufacturing supply chains have gone global. Companies locate production to better penetrate certain markets and fulfill the needs of specific consumers. That’s why Toyota, Honda and Hyundai make cars in the U.S. for U.S. consumers. Many of the cars, mobile phones and other products sold to Chinese consumers today are already made in China specifically for the Chinese market. Perhaps as emerging-market consumers become wealthier, more production will be geared towards serving them, and that will alter the nature of supply chains.

But that doesn’t spell the death of the global supply chain. In my opinion, the basic rules of comparative advantage will still hold. If it is cheaper or most efficient to produce Part X in Country A, it will remain that way whoever is buying the final product. Perhaps rising costs or other factors in Country A will change its competitiveness in making Part, X but that doesn’t mean the contraction of supply chains are the inevitable result. The world will find a new, more cost-effective place to make Part X, whether that place is close to the end consumer or not.

The situation is the same with the quake in Japan. Perhaps the quake will cause some diversification of supply networks, especially in electronics, but it won’t reverse the globalization of production. Those rules of comparative advantage still apply. If Japan is especially adept at making bismaleimide-triazine resin, my guess is that Japan will keep making and exporting bismaleimide-triazine resin. The short supply disruption caused by the quake doesn’t mean Brazil or South Africa suddenly becomes a better option for the manufacture of bismaleimide-triazine resin. Manufacturers will buy their components from whoever makes the best product at the best price, earthquakes aside.

The bottom line here is that Japan’s quake won’t permanently change global “borderless” manufacturing, because is won’t change the fundamentals of economics.

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