Question: Do We Really Want Our Supply Chains Back?

Editor's note: This article originally ran in LM's sister publication, Supply Chain Management Review. 

We’re seeing mounting pressure from political pundits, policymakers and the American public to decouple our supply chains from China, particularly in the medical and rare earth elements industries.

During last year’s trade war, Trump ordered the Pentagon to seek alternative sources for rare earth elements used in defense systems, claiming that China was no longer a reliable partner.
 
There’s even legislation in the works. Sen. Tom Cotton, R-Ark., is sponsoring a bill that would require government agencies like Medicaid and VA hospitals to cease purchasing drugs that contain Chinese-made ingredients by 2025.

But can some simple-minded legislation or a well-timed, presidential pep talk bring back manufacturing? Can we really go back to the heyday when America was the world’s factory? Some say yes; others say no.

While I’m not so sure myself, I do know one thing — American consumers, businesses and policymakers will have to contend with some unattended consequences from bringing back supply chains.

Get ready for higher costs

Consumables

For one, American consumers will have to accept higher prices for “Made in USA.” In my 20 years of assisting Western companies to buy, outsource and manufacture in China, not once have I encountered a project — auto parts, syringes, electric toasters, jet engine parts — where it was cheaper to produce in the U.S.
 
In general, prices for consumables will go up 20-30 percent.  A China-made lawn mower that retails for $500 at Home Depot, for instance, would go for over $600 if made in the U.S.  The same goes for toys, sporting goods, furniture and auto parts.
 
Randy Altschuler is CEO and founder of Xometry, a manufacturing-on-demand service provider headquartered in Maryland that has relationships with over 3,000 manufacturers in the U.S., Germany and China. “Products are still much cheaper in China,” says Altschuler. “In fact, costs could be less than half for some parts and products, and anything that requires intensive labor.”

Gary Chan, former general manager of Lentz Shanghai, a manufacturer of servo motors used to control such equipment as conveyer belts and camera lenses told me, “Shanghai is probably the most expensive city in China, but labor rates are still cheap compared to the U.S.  We’re paying entry-level factory workers about US$900 per month.  Skilled labor, like mechanical or maintenance engineers, are making from US$3,000 to US$4,000.”

Rare Earths

Trump’s decree to bring back the rare earth metals supply chain would also hike prices for thousands of products containing rare earths. These include electric vehicles, wind turbines, cell phones and plasma televisions.  A magnetic resonance imaging (MRI) machine, for example, contains over 1,500 pounds of rare earth material.
 
The U.S. was totally self-sufficient for its rare earth supply in the 1980s. Then, companies started seeking cheaper solutions. They set up joint ventures with Chinese mining companies, then transferred all the technologies and shut down their North American operations.  Fast forward to today and we’re 100% dependent upon China and other countries for rare earths.

Jack Lifton, founder of the rare earth consultancy firm Technology Metals Research, believes the U.S. will never regain its dominance in the industry. “China has invested billions in rare earth processes and technologies. They’ve educated thousands of mineral engineers and filed hundreds of patents,” says Lifton. “And now suddenly we want to bring it back to the U.S.? No way!”

Lifton noted that even if we could bring rare earths back, we’d be considerably more expensive than the Chinese. “We’ve lost the competitive advantage.”

Healthcare

As with rare earths, the U.S. relies heavily on China for the key components, referred to as active pharmaceutical ingredients (APIs), used in everyday medications like high-blood pressure and diabetes.  As a result, the U.S. has also lost the competitive edge in the production of APIs.
 
Dr. Enrico Polastro, vice president of the healthcare management consulting firm Arthur D. Little, is an expert in antibiotics manufacturing.  “Costs would basically more than double if we produced in the U.S.,” says Polastro. “American companies can’t compete with China’s labor, maintenance and overhead rates.”

On top of that, the powerful pharmaceutical lobbying group, PHRMA, opposes any initiatives to bring API manufacturing back to the U.S. They claim that their supply chains should be diversified and global to prevent disruptions from any one incident.
 
That’s legalese for “We don’t want to pay billions to invest in factories when we can pay pennies on the dollar for China-made stuff.”

I don’t necessarily blame them for the pushback. Even with quality that is sometimes suspect, Big Pharma, and its shareholders, has profited greatly from China’s supply chains. As one executive told me, “Why change? China has been an awesome partner. They supply great materials at rock-bottom prices. Hey, if it ain’t broke, don’t fix it.”

 
Environmental concerns

In 2004 Bristol-Myers Squibb closed the last factory in the U.S. that manufactured antibiotics. Soon after, I began taking U.S. drug formulators and pharmaceutical companies to Hubei Province’s capital city, Shijiazhuang, about 200 miles southwest of Beijing. It was the pharmaceutical manufacturing capital of the world, producing the APIs needed for antibiotics like amoxicillin and penicillin.

These dozens of visits over a span of 10 years left me one everlasting impression of pharmaceutical manufacturing: It’s literally a dirty business. At the factories, I witnessed tons of waste material — solids, liquid and sludge — being loaded into dump trucks to eventually be hauled away to landfills in faraway mountains. There was always a certain stench in the air that smelled like rotten eggs.

Dr. Polastro told me, “As a rule of thumb, about 25 pounds of waste is generated per pound of active pharmaceutical ingredient output.” Most of the byproduct is biohazardous and must be specially treated. “There are biomass [solids], and wastewater that need to be treated,” says Polastro. “Both the solids and wastewater must be chemically treated and sent to landfills, incinerated or recycled.”
 
Annual consumption of penicillin in the U.S. is about 5,000 metric tons. In order to meet that demand every year, 125,000 metric tons of toxic waste would need to be disposed of. But that’s just penicillin. Multiply that amount by the 100 or so most common APIs used in the industry and we’re going to need a lot more wastewater treatment plants and landfills. So we solve one problem, but create a new one.
 
Don’t’ get me wrong. I’m all in favor of bringing back drug manufacturing, but I sure don’t want an antibiotics factory in my town. Do you?  Besides the health and environmental issues, think of all the red-tape — the EPA, OSHA, state and local regulations — that could severely delay, inhibit and derail such an endeavor. 

Government subsidies

Higher prices for domestically-produced rare earths mean that for-profit, nongovernment-related businesses will likely continue purchasing rare earths from China. This leaves only the Department of Defense and its contractors as potential customers.

Lifton estimates the defense industry uses about $100 million worth of rare earths annually.  And that’s not nearly enough to cover the hundreds of millions of dollars to build processing factories, let alone turn a profit.  Thus, they’ll be operating at a loss—forever.

Who wants to pay higher prices for medications?  Not me and probably not other price-conscious consumers.  To reduce costs, the federal government will invariably have to subsidize Big Pharma’s manufacturing investments, as well as the higher over-the-counter drug prices.  That’s about the only way I see PHRMA agreeing to reduce its addiction-like dependence on China and support a domestic manufacturing agenda.
 
We’re talking about revitalizing old, environmentally-unfriendly industries that will never be profitable or able to compete on a global scale.  They will forever be subsidized by American taxpayers. Billions, if not trillions, will be spent.  Yet, in these specific cases, for the sake of national security, it may be worth biting the bullet.

Think long and hard

Amidst the coronavirus pandemic, we’re short on patience and long on knee-jerk reactions. We’re lacking medical supplies. We’re fearful that China will hold us hostage to our diabetes and high-blood pressure medications and our rare earth metals. “We need our supply chains back NOW!” screams everybody.

Hold on. Take a quick walk around the block — of course with your mask on – and consider all the angles. Let’s ask more questions before we hop on the bandwagon and choose the most simple-minded solution: Decoupling from China.
Can our already decrepit healthcare system handle higher drug prices? Do you want a biohazardous wastewater plant in your backyard? Do we subsidize billions of taxpayers’ dollars to mine rare earths while leaving miles of savaged wasteland behind? Let’s think long and hard. I don’t know about you, but I’ve got plenty of time: I’m quarantined!

Stanley Chao is the author of “Selling to China,” (2018) and managing director for All In Consulting, assisting western companies in their China business strategies.  He can be reached at [email protected]. Follow Chao on Twitter, @stanleychao6