Supply security is threatened by technical, business, natural and policy shocks, as well as geopolitical tensions. Is there a rationale for policy intervention? If yes, what are efficient and effective measures that achieve de-risking? This article first explains why private incentives do not generally lead to an optimal diversification of supply sources, and then discusses measures that strengthen protection against and resilience in the face of shocks. Governments should refrain from policies that further disincentivise diversification such as the ex post skimming of excess profits when adverse shocks force the halt of production and should work on framework conditions that facilitate diversification. Importantly, most measures are best taken at the EU level.
In recent years, various shocks, including pandemic related production interruptions abroad, disruptions of maritime transport routes caused by pirates or extreme weather as well as politically imposed sanctions and countersanctions, have led to bottlenecks in supply chains. These have had a lasting impact on industrial production and triggered, at least partly, higher prices. Increasing geopolitical tensions and higher climate risks make such disruptions more likely.
The EU has a higher degree of openness than the US or China. It is, therefore, more exposed to external disruptions of supply chains. Because of its lack of a common foreign policy and a military, it is also more vulnerable to opportunistic behaviour of foreign powers that seek to employ asymmetric economic interdependence as a geoeconomic weapon. This danger became clear in 2021 and 2022, when Russia first raised uncertainty about gas supplies to Europe and eventually massively cut its exports.
A major reason for the supply risks and for high procurement prices for important raw materials and intermediate products was and still is the partly low diversification of the supplier portfolio of European companies or the supply channels through which they obtain their imports. Against this background, many countries have begun to fundamentally rethink their foreign economic policies, which have often led to a much more active industrial policy. Both the United States and the EU are stepping up efforts to secure their strategic autonomy and to reduce blackmail opportunities due to one-sided dependencies. The focus is on China and Russia, but the list of potentially problematic suppliers has grown longer in recent years.
This paper presents the difficulties arising in the identification of strategic dependencies. It derives welfare economic justifications for government interventions in supply chains. It elaborates general regulatory principles for supply chain regulation. Finally, it discusses measures that should lead to an improvement in the diversification of the supplier portfolio.
Identifying strategic dependencies
How can strategic dependencies be identified? Objective answers are hard to come by because the available data are incomplete and circumstances are constantly changing. Therefore, there is a risk that government interventions are poorly calibrated. The following passages highlight some fundamental premises for evidence-based economic policy in the supply chain context.
The need for a European perspective
Welfare-theoretic foundations
General policy principles
Measures to promote diversification
A European supply security office
Conclusions
Our economic model depends on secure and largely unhindered access to world markets. In recent years, this system has come under threat as various trading partners have sought to exploit Europe’s dependence on certain supplies from abroad and on certain export markets to obtain foreign policy concessions. At the same time, the COVID-19 pandemic has highlighted how vulnerable domestic supply chains and security of supply can be.
Given incomplete and asymmetric information, it is im possible to draw up lists of critical goods, technologies, or sectors according to objective standards for the purpose of financial support by the general government or deriving foreign trade policy measures.
To avoid the emergence of dependencies, an appropriate regulatory framework is needed that can internalise the existing security externality. We have proposed several measures that make it easier for companies to diversify their supply networks, such as free trade agreements, and the promotion and facilitation of foreign investment to develop alternative sources of supply.
A European perspective is central to both the assessment and the development of economic policy responses. Not only does competence for most foreign economic policy fields lie at the EU level, the integrity of the internal market and its dynamism are the best insurance against attempts from abroad to instrumentalise any dependencies. To ensure that national policies and initiatives are optimally dovetailed with the European level, a European supply security office should be established to harmonise the collection of data on supply chains, develop uniform stress tests and monitor the impact of national policies on the internal market.
