WELCOME TO A NEW WORLD OF RISK-AWARE GLOBALISATION

By Gillian Tett
What do securitised mortgages and manufacturing supply chains have in common? Not a lot, it may seem. After all, the art of repackaging debt is part of the arcane field of complex finance, while the business of shipping widgets round the world is a tangible, get-your-hands-dirty activity.
But in one respect complex finance and modern manufacturing have much in common: namely their embrace of globalisation. Western manufacturing has become ever more dependent on cross-border systems of production intended to make business more efficient, by placing each stage of production in the region where it can be most profitably performed. Likewise, western finance has embraced a vision of globally integrated capital markets in the name of more efficient banking.
The recent financial turmoil has shattered many of the previous assumptions in the 21st-century banking world. It has become painfully clear that moving credit risk round the world in complex chains did not make the system safer and more efficient – as bankers once claimed.
So, as bankers reel in shock, this poses an intriguing new question: will recent experience now force a rethink of assumptions in non- financial spheres too? After all, in recent years so-called “Davos man” has taken it for granted that globalisation, free market capitalism and innovation were all thoroughly good things. But as faith wilts, might business leaders rethink their dependency on, say, cross-border manufacturing supply chains, too?
There are hints of a change afoot. This week, for example, Gerard Kleisterlee, chief executive of Philips, the electronics group, told the Financial Times he expected large companies to move away from far-flung globalised supply chains. He blamed the shift on “green” issues, explaining, “a future where energy is more expensive and less plentifully available will lead to more regional supply chains”.
But green issues may not be the only factor at work. In recent years, western manufacturers have scrambled to streamline their operations in ways that were often similar (e.g. all turning to China for cheap manufacturing). But this concentration has created new vulnerabilities and forms of contagion risk. Or, as a fascinating report* prepared for the World Economic Forum last year notes: “The economic optimisation of supply chains, with the geographic concentration of risk as a frequent corollary, has enhanced the systemic vulnerability to a supply chain failure.”
Until quite recently most business executives did not appear too concerned about such aggregations of risk. When Marsh & McLennan surveyed global companies with operations in Asia two years ago, for example, they found only a fifth had business continuity plans to guard against natural disasters or terrorist attacks. But the searing experience of the credit crisis has shown business leaders and policymakers that it can be dangerous to ignore seemingly remote risks, particularly when those risks are embedded in complex chains that are poorly understood. Contagion no longer seems merely an abstract idea.
Nor does concentration risk. (Look, for example, at how Porsche, the carmaker, was recently forced to suspend its production for a period after the manufacturer of the thread used for its seat belts went bust.) And what manufacturers are now realising is that dealing with a crisis is doubly hard when companies are scattered round the globe.
That does not mean the concept of globally integrated supply chains is going to die, any more than the idea of trading financial risk round the world will disappear. Businesses are under ever more pressure to cut costs. But any chain is only as strong as its weakest link. So stand by to hear plenty more debate on the “supply chain” issue. And if manufacturers can learn lessons from the banking crisis on the potential pitfalls of globalisation and innovation, that would be a thoroughly good thing.

* Global Risks Report 2008, by World Economic Forum, Citigroup, Marsh & McLennan, Swiss Re, Wharton and Zurich Financial Services http://www.weforum.org/pdf/globalrisk/report2008.pdf

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