ESG investors: be careful with supply chains

Supply chains have been top of the agenda in 2020, as the coronavirus has rudely awakened companies, governments and investors — who had grown used to smooth and seamless flows of global trade — to their vulnerability.

As it turns out, if all your supply of a raw material or component comes from one country, you can suddenly have none of it, for a host of reasons.

Covid-19 has forced factories to close, disrupted transport and in some cases driven governments to hold back vital goods for domestic consumption, rather than allowing them to be exported.

But this is merely a new kind of supply risk. President Trump and the US Congress’s habits of firing sanctions and tariffs at friend and foe alike — and of turning cool international relationships into hotly angry ones — are also helping to make the world dangerous for international trade.

Bank of America has been conducting a series of studies into how companies are reacting to this, and finds a growing movement to shift manufacturing out of China — to cheaper Asian countries, other emerging markets that may be more sympathetic to the West, or right back to Europe and north America.

So far, there is little hard evidence — the trend is based on what BofA’s analysts hear from the companies they cover, so it includes companies merely thinking about such moves or conducting pilot experiments, as well as more meaningful shifts.

But investors appear to believe the story. In BofA’s Global Fund Manager Survey in July, two thirds of them picked supply chain ‘re-shoring’ or localisation as the biggest structural shift coming in the economy. Protectionism came second.

This is worrying, considering how grave a threat climate change is. The need for green energy and sustainable infrastructure was only the fourth most predicted structural shift.

A curious aspect of the shift away from China and back to the developed world, if it truly is a trend, is that, according to BofA, part of the impetus is the growth of environmental, social and governance investing.

Consciousness of ESG certainly seems to be growing rapidly, both among investors and in the corporate world.

And this may indeed, as BofA argues, be creating a new culture in which companies pay more attention — at least on the surface — to the needs of stakeholders other than shareholders, such as employees, local communities and the governments in their major countries of operation.

Whether this has truly gone so far as to mean companies have become less devoted to maximising shareholder return is another matter.

Investors, and hence company management, taking a broader view of their responsibilities and duties to society — the ‘purpose’ narrative espoused by BlackRock’s Larry Fink — is one thing.

Interpreting corporate responsibility to mean supply chains should be re-shored is another.

Bringing jobs back home plays well politically and in the media — especially in the US, where President Donald Trump has whipped up protectionism and nationalism.

That does not make it ethical. People in China need work, just like Americans, British people or Italians. In fact, it should be self-evident that investors with a social conscience ought to start from a position of indifference to where workers are based, or where companies operate.

It would be regrettable if ESG investors started to diverge from that in a lazy or glib way.

As part of its analysis of supply chain shifts, Bank of America ranked countries by 20 ESG metrics and found that possible beneficiaries of relocation away from China, such as Mexico, Brazil, Poland, India and Vietnam, scored quite well for ESG — and that therefore it might please ESG investors if companies moved production there. These also happened to be states in a reasonable degree of political alignment with the West.

But for investors to think about companies’ manufacturing arrangements in those mechanical terms would be to abdicate responsibility, not to assume it.

There may be — and often are — specific reasons to have concerns about involvement in certain countries or regions.

Some NGOs believe there is probably some element of slavery in almost every supply chain, for example — and that there are actually more slaves in the world now than in the 18th century.

One could debate the specifics, but it is incontrovertible that companies of all kinds, which are household names in the West, are exposed to the risk that some of their suppliers are infringing human rights — or committing environmental atrocities, such as burning forest in the Amazon.

This includes banks, which finance most of these activities, directly or indirectly.

Responsible investors are increasingly alert to these risks, and some of them — such as Aviva, Nordea and APG, which support the Corporate Human Rights Benchmark — are trying to tackle the issue systematically.

Putting pressure on companies to raise standards in their supply chains can yield results, whether in China, India, Brazil or elsewhere. The essential points are for companies to not just put in place toothless policies, but carry out thorough on-the-ground checks and due diligence on suppliers, to give workers and communities safe ways to express any grievances, and then to admit and remedy any breaches.

Engagement of this kind is likely to yield much more direct improvements in the livelihoods of oppressed workers than abandoning them and moving production to another emerging market, or back to the West.

Indeed, BofA’s research highlights that an important reason why some companies are considering moving out of China is the opposite of socially responsible — Chinese wages are rising and environmental and regulatory standards are now higher than in some other emerging markets.

Of course, there may be specific cases in which it is best for investors and companies to vacate a country altogether until it mends its ways — the movements at different times to divest from South Africa and Myanmar are examples.

Human rights is not the only intersection between ESG and supply chain location. Uncontrolled global transport of goods, using the present dirty methods, is highly damaging to the environment — even ignoring extreme examples like shellfish being flown thousands of miles to be processed before being flown back.

Producing more goods near where they are to be consumed could reduce carbon emissions from transport.

But this is only likely to make a dent in climate change as part of a comprehensive policy to price in transport carbon emissions, develop cleaner forms of transport and give poor countries where goods and food are produced alternative sources of income.

Investors haphazardly praising companies for re-shoring this or that element of production is naïve and verges on greenwashing.

Supply chains are highly complex, sensitive systems. It is welcome that investors are now becoming aware of them, having long all but ignored them. But this must be done intelligently, and with an engaged sense of responsibility, rather than a box-ticking approach based on scores and generalisations.

Any investor not convinced by these arguments might consider the drought that has afflicted Europe in summer 2020, for the third year running.

Like the coronavirus pandemic, this is just a mild test of what will come in future years when climate change really gets going. What happens if a substantial share of the European wheat crop fails?

This kind of disaster is not imaginary — it has really happened in many developing countries in the past. One day it will happen closer to home. Then, Europe will need to source food from all over the world — at a time when others may not want to share it.

What will count then is having supply chains that are resilient, flexible, diverse — and that can be negotiated and altered in a calm, sane and co-operative dialogue.

The present tilt towards nationalism, self-sufficiency, ‘me first’ and dividing the world into camps is the opposite of what is needed to build the people-first supply chains that will be so vital in the future.