Comment on “Geographic Diversification of the Supply Chains of Japanese Firms”

Abstract

The worldwide COVID-19 outbreak has impacted on the domestic and international supply chains of Japanese firms. In particular, internationalized production has been blamed for working as a propagation mechanism in the worldwide spread of negative shocks. Todo and Inoue (2021) extensively review existing studies that have examined the shock propagation through supply chains and what characteristics of supply chains enhance or mitigate the propagation, in the cases of previous crises and the current COVID-19 crisis. Based on their literature review and the data observations on the current characteristics of Japan's supply chains, Todo and Inoue highlight the need for more geographical diversification in suppliers and clients of Japanese firms to build robust and resilient supply chains and improve the firms' performance. In the face of the COVID-19 crisis, there has arisen a renewed argument that shorter and simpler supply chains and reshoring production back to the domestic economy would be less vulnerable to shocks. Against this kind of turning-inward policy argument, Todo and Inoue emphasize the potential benefits from supplier substitutability and international knowledge diffusion through geographically diversified supply chains, which is quite meaningful. Nevertheless, I suspect that geographical diversification of trading partners is not the only way to build a resilient supply chain. A firm's optimal strategy for resilience might not coincide with that for robustness. The concept of system resilience was originated in the ecology literature and was applied to the risk management literature. In the light of supply chain management, resilience can be the ability to resume normal operations after an acceptable period of disruption, while robustness is the ability to maintain operations amid a crisis (Miroudot, 2020). Supplier substitutability appears to be a key to achieving robustness. Maintaining geographically diversified suppliers or alternative locations of production would enable firms to withstand a location-specific supply shock, which leads to the greater robustness. To improve resilience, on the other hand, a firm might rather prefer to develop a long-term relationship with a single supplier, or a handful of suppliers such as keiretsu, as discussed in Miroudot (2020), for example. Maintaining a less diversified but close relationship would enable a firm to receive investment or support from the partner for minimizing the time and cost of disrupted operations and facilitating recovery from the disruption, which leads to the greater resilience. Indeed, Todo and Inoue (2021) touch on the possibility that the keiretsu-type relationships would help improve resilience in the case of knowledge-intensive goods. It would be insightful if Todo and Inoue could elaborate on the implications of geographical diversification for the robustness and resilience of supply chains with more careful consideration of the two related but distinct concepts. In addition, I am skeptical of Todo and Inoue's policy suggestion that the Japanese government should intervene to promote the geographical diversification of suppliers. The diversification of suppliers is not necessarily an optimal strategy from the firm's perspective, depending on whether the firm prioritizes the robustness or resilience of supply chain as well as on the firm's product or industry characteristics. Even if the current level of diversification is less than the optimal level as argued by Todo and Inoue, a government inevitably faces implementational challenges on the intervention and possibly distorts a firm's decision on production locations and sourcing patterns, which could force the choice of an inefficient location. Rather, a government should devote itself to ensuring an environment where firms can build and develop domestic and international supply chains as they need, as a basis for economic growth, which brings greater efficiency, expands the production frontier, and facilitates technology and knowledge diffusion and spillovers. Last but not least, Todo and Inoue's literature review and accompanying discussion focus on the effects on supply chains of supply shocks such as natural disasters. When thinking of the robustness and resilience against the current COVID-19 spread, however, we should be aware that COVID-19 generated both supply and demand shocks. As a result of social-distancing policies, industries relying on the movement of people, such as hotels, restaurants, and passenger transport services, have been impacted greatly through the fall in domestic final demand. It would be worth discussing the robustness and resilience of supply chains not only against supply shocks but also against demand shocks. Does the shock propagation mechanism of supply chains matter to a similar degree and work in a similar way in the case of demand shocks as in supply shocks? The firm's strategy for robustness or resilience of concern also would depend on the source of shocks. Todo and Inoue could discuss on this further.