As the fallout from COVID-19 wreaks havoc on supply chains, a major economic and geopolitical tug of war has broken out.
The reason: a global shortage in the supply of semiconductors — the microchips at the heart of countless products in a modern economy. While companies potentially prepare to fight their suppliers and the United States threatens to bring production back home, Ford Motor said the shortage has slashed its profit forecast by more than $2 billion. Worse still, major producers like Intel and Taiwan Semiconductor Manufacturing are warning that the shortage may last more than a year.
How did we get here? Decades of underinvestment.
Semiconductors are a roughly half-trillion-dollar industry, with opaque, byzantine supply chains. A widespread shortage makes it exceedingly difficult to buy a PlayStation 5 or the latest Nvidia graphics card. But it could also disrupt production of everything from 18-wheelers to medical equipment. Though there may be only one or two semiconductors in a given product, without them goods sit unfinished on the factory floor. Even worse, one chip often can't be easily substituted for another.
At the moment, the exact impact of the shortage on consumers is difficult to assess. That's because reliable data is difficult to come by. Given the ubiquity of these chips, it's shocking that even major companies may not know how vulnerable they are to disruptions in even a single factory.
It's encouraging, then, that in recent weeks the Biden administration has held at least one high-level meeting with executives from companies like Ford Motor and Google to discuss the resilience of supply chains — a critical piece of economic infrastructure often ignored by politicians. While executives from Intel, Nvidia, Qualcomm, Verizon and others have formed a coalition calling for federal funding to address the problem, there is no guarantee that businesses will invest in resilience of their own accord. So the Biden administration must be prepared to actively monitor existing supply chains, while making direct targeted investments to ensure they are strong. The risks to global economic stability are simply too great.
To solve the problem, Washington first needs to understand the frightening precarity of the modern global supply chain. From the last decades of the 20th century on, U.S. firms embraced "just in time" production tactics, created "lean" supply chains, and outsourced production to foreign factories. In concrete terms, this means they cut inventories of critical inputs to the bone — think microcontrollers and printed circuit boards — for a cheaper system of shipments between foreign factories that must arrive just in time. In this system, even slightly delayed deliveries of critical inputs from Taiwan-based Foxconn Technology Group or Taiwan Semiconductor can mean shortages that grind global production to a halt.
Consumer products and industrial machinery, for example, often rely on low-tech chips like those currently slowing the production of car companies across the country. Low profit margins mean many manufacturers are reluctant to invest in facilities that make these chips. This, in turn, means that sudden spikes in demand put great strain on the entire chain. Whole industries might be impacted by the disruption of a single factory.
The supply chain for cutting-edge chips like those made by Taiwan Semiconductor is no better. Producing the newest five- or seven-nanometer chip requires billions of dollars in investment in specialized factories and a highly skilled labor force. As a result, there are relatively few facilities that make them. If one of these factories goes offline, as the Samsung operation in Austin, Texas, did for weeks after the Texas grid failure, there might be no other factory able to step in.
With the help of global shipping and information technology, companies can break the production of even the simplest chips into dozens of steps, and assign each step to the cheapest provider. Instead of owning the entire production process for individual chips, every company and factory competes globally over every step of production. Many factories and design companies have either been driven out of business or rolled into mammoth firms like Intel.
This dynamic — fewer and fewer companies engaged in fierce international competition — has made it prohibitively expensive to invest in robust supply chains. If two firms produce the same chip, the more "efficient" firm — the one focused on maximizing the return on every dollar invested, rather than on making sure production won't be interrupted — will drive the other out of business.
But what good is such a hyper-efficient, super-lean factory if, say, a natural disaster knocks it out of commission and there's no backup supply of the chip it makes? Not much, Toyota discovered in 2011, after the Tohoku earthquake damaged a key Renesas-owned chip factory. However, the lessons from that experience taught Toyota to protect its supply chain, which has largely kept it safe from the current shortage.
Today's shortage may well resolve itself as consumer spending shifts from pandemic-era electronics to dining and recreation in a fully reopened economy. But the disruption could also metastasize, affecting the production of medical equipment and consumer appliances. In either case, we need a plan for dealing with all contingencies. If private business won't do it, the government can and should.
If lawmakers need convincing, they should not forget that supply chain management is a national security issue. The Department of Defense has struggled to establish secure suppliers for these chips. Complete reliance on foreign producers for certain chips also gives away geopolitical leverage. As it stands, the American solar panel industry is heavily reliant on China's Xinjiang region for critical polysilicon.
To ensure that the necessary investments in capacity to shore up our brittle supply chains are made, lawmakers should utilize supply chain monitoring techniques, price and purchasing guarantees and targeted investments. The time to prevent the next shortage is now.
With the Biden administration's push for a major infrastructure overhaul, now is time to make resilient and sustainable supply chains part of the conversation around critical economic infrastructure. Semiconductors are the place to start.
Alex T. Williams is an economist and research analyst at Employ America, a think tank focused on creating tighter labor markets. He wrote this article for the New York Times.