The Cost of Achieving Sustainable and Secure Supply Chains

As 2023 begins, the supply-chain issues that have been prevalent over the past two years are beginning to improve. However, new challenges are on the horizon, such as the rise of “green protectionism” and an increased effort by multinational companies to diversify away from China.

The two interrelated trends of sustainability and resilience offer significant long-term benefits, but will likely entail significant costs for companies and consumers in the meantime. Sustainability promises a more livable planet, while resilience offers a more robust global supply chain. Both of these goals are important, but achieving them will require significant investment and effort.

The European Union's pending carbon border adjustment mechanism (CBAM) is a levy on energy-intensive imports from countries with lower carbon taxes than Europe. This threatens exports from the United States to Europe, but China will be among the hardest hit because of the way the tax is structured. The CBAM would tax some "indirect emissions," including carbon emissions from the electricity generated to run factories. This would have a significant impact on China's economy, as the country is currently the world's largest energy user and sits at the center of global supply chains.

A portion of certain energy-intensive Chinese industries—aluminum and polysilicon, for example—run on clean hydropower, but China’s grid overall is still far more reliant on coal than are most major economies, including the U.S. China’s own carbon prices, which currently only apply to the power sector, may be deductible from Europe’s tax plan, but are only around a tenth as onerous—58 yuan, equivalent to $8.42, per metric ton at the end of November according to state media, as opposed to around 80 euros, or $84.84, a metric ton in the European Union.

The U.S. Inflation Reduction Act is a clear attempt to target China's dominance in electric vehicles and batteries. The bill mandates that to receive subsidies, electric vehicles must be assembled in the U.S. and their batteries must contain a certain percentage of material from the U.S. or its free-trade partners. This is a direct challenge to China's control of the battery-material processing industry, and its cheap electric vehicles and batteries. U.S. allies in Europe and Asia, such as South Korea, are furious, but breaking China's grip on this industry seems to be the real, unstated aim of the bill.

The U.S. and Europe are taking steps to address two major threats that have become more prominent in recent years: rising global temperatures and the excessive concentration of key supply chains in a rising geopolitical rival. However, these initiatives come at a cost, even when not taking into account the direct subsidies to taxpayers.

If European policymakers succeed in helping energy-intensive industries like metals smelting survive, it could come at the expense of downstream sectors like the auto industry. Alternatively, some auto-parts suppliers in the EU may move to other countries to access cheaper raw materials. If U.S. EV subsidies aren't changed, European auto manufacturers could find themselves at a disadvantage compared to their counterparts in the U.S. and China.

U.S. auto manufacturers will find themselves subsidizing the creation of expensive battery and mineral supply chains, while forgoing cheaper Chinese batteries that are already available. U.S. consumers may find themselves paying for inferior, relatively pricey domestically produced mass-market EVs if China’s low-cost EV manufacturers conclude the U.S. market is more trouble than it is worth.

The goal of greening the West's industry and breaking Beijing's stranglehold on key global supply chains is a costly one, but it is worth the investment.