Industrial sovereignty or resilience? (Note)

Usefulness of the article: This article aims to understand the challenges facing France’s industrial sovereignty highlighted by the Covid-19 crisis.

Summary:

• The Covid-19 crisis has highlighted France’s dependence on Chinese imports, particularly for strategic products such as masks, PCR test reagents, and ventilators.
• The supply problems encountered by certain sectors that are highly dependent on China can be explained primarily by the highly concentrated organization of global value chains.
• While a country’s ability to produce certain strategic goods contributes to its resilience, other strategies must be considered, including seeking greater diversification of suppliers and sources, building strategic stocks, and attracting foreign investors to France.

The Covid-19 crisis has highlighted France’s dependence on imports of essential goods such as masks, reagents for PCR tests, and respirators. Due to the introduction of health measures and the sudden increase in demand for certain goods, the health crisis has also led to supply problems for companies that are heavily dependent on foreign inputs.

This dependence has highlighted the excessive international fragmentation of production processes, with France, like all major developed countries, being deeply integrated into global value chains. As a result, certain sectors that are highly dependent on Chinese imports, such as the electronics industry, saw their production virtually grind to a halt at the beginning of March 2020. However, the intensity of the shock depends largely on companies’ ability to find alternative suppliers to Chinese producers and to draw on their stocks. Indeed, the risks stem primarily from the highly concentrated organization of supply chains.

The health crisis has therefore brought the issue of industrial sovereignty back to the forefront of the debate, with the idea that the (re)localization of strategic activities would make it possible to respond more effectively to a future global epidemic or major conflict. While a country’s ability to produce certain strategic goods undoubtedly contributes to its resilience, other strategies must also be considered, including seeking greater diversification of suppliers and sources and building up strategic stocks.

1) Intensification of trade between China and France

In recent decades, globalization has led to the fragmentation of global value chains (GVCs) and their geographical dispersion, i.e., the division of production processes across several countries. A country’s level of integration into GVCs can be measured by the share of foreign value added in its gross exports. From this perspective, France is highly integrated into GVCs: in 2015, the share of foreign value added in French exports stood at 21%, compared with 9% for the United States, 17% for China, and 25% for the European Union average (Alsif et al., 2019). However, it should be noted that this indicator is partly linked to the size of the country in question. The smaller the country, the more dependent it is on external supplies. In the case of industrial companies, their level of participation in GVCs can also be assessed by considering the share of foreign inputs in production. According to a recent Treasury note (Bonneau and Nakaa, 2020), this share has increased from 29% to 39% over the last twenty years.

Integration into GVCs allows French companies to take advantage of the comparative advantages of partner countries in certain segments of their production. Schematically, companies locate their high value-added activities (R&D, design, management, etc.) in high-income countries and production activities in low-income countries. Economic literature has amply demonstrated that this international division of production processes results in gains in competitiveness for companies and gains in purchasing power for consumers. But this idyllic view of international trade needs to be qualified: the fragmentation of production processes has naturally increased our dependence on foreign countries for manufactured goods. This is particularly true with regard to China.

Over the past few decades, China’s rise to power has led to an intensification of trade between China and the European Union. For France, China is its second largest supplier, with a total of €49.9 billion in imports in 2018^[1], representing 9.1% of imports. However, trade relations between France and China are marked by a certain imbalance: France’s trade balance with China is structurally in deficit (Figure 1). From a business perspective, dependence on China is reflected both in Chinese imports of intermediate goods and in the Chinese value added contained in inputs from other countries.

According to a study by the Institute for Public Policy (IPP) (Gerschel et al., 2020), the health measures introduced in China in January 2020 have impacted French industrial companies both directly, through their imports of intermediate products, and indirectly, through the Chinese value added contained in other inputs. From the household perspective, dependence on China can be assessed by considering the geographical origin of the imported content of manufactured goods consumed in France. In 2015, the imported content of manufactured goods consumed by French households came primarily from Germany (14.6%), followed by China (12.6%) and the United States (7.4%) (Figure 2).

Figure 1: Evolution of France’s trade deficit with China (in billions of euros)

Source: OECD (Stan)

Figure 2: Imported content of manufactured goods consumed by French households in 2015

Source: INSEE estimates, results of the Avionic model for 2015 based on the TiVA 2018 database.

2) High integration into GVCs, a source of vulnerability for industrial companies

The Covid-19 pandemic has reignited the debate on the vulnerability of companies and countries that are heavily dependent on foreign supplies. The initial health measures introduced in China in January 2020 had a significant impact on French and European industries. The disruption to supply chains was proportional to China’s weight in certain sectors.

For example, the electronics industry, which is highly dependent on Chinese imports, was weakened by supply disruptions that led to production coming to a virtual standstill in early March 2020. According to a survey of its members conducted by the National Union of Electronic Subcontracting Companies, 91% of them encountered supply problems at the beginning of 2020^, while 30% were considering halting production. Furthermore, a disruption in the electronics industry’s supply chain had consequences beyond the industry itself. Electronics are found in many products, from cars to medical devices, production lines, aircraft, and even autonomous cranes on construction sites. Thus, any disruption in production, which initially affects a few companies, can spread to other sectors through a cascade effect.

But more than dependence on foreign countries, it is the concentration of production of certain goods in a small number of companies and countries that is a source of vulnerability. Based on an examination of international trade flows, Vicard and Jean (2020) show that in 2018, « nearly 6% of French imports were products for which a single country accounted for more than 50% of exports. » In two-thirds of cases, the predominant supplier was China. A recent CAE study (Jaravel and Méjean, 2021) identifies imported inputs that are potential sources of vulnerability based on three criteria: predominantly non-European production; a small number of producers; and 90% of exports concentrated in a single French company, which the authors consider to be a « heightened vulnerability. »

644 inputs meet the first two criteria, representing 4% of French imports for which supply is mainly outside the European Union and concentrated in a small number of supplier countries. Among these, 122 products are affected by a risk of « enhanced vulnerability. » This is particularly the case for semiconductors. However, the current shortage of semiconductors shows that the excessive concentration of production in a single company—TSMC^[3], which accounts for 70% of the integrated circuits used in the automotive sector—can cause the total shutdown of certain sites.

Nevertheless, the analysis of vulnerabilities must be accompanied by a reflection on strategic priorities in the industrial sector. Regardless of the potential for diversification of a good, the ability of an economy to produce certain key products itself allows it to adapt more easily in times of crisis, regardless of external constraints.

In this regard, a comparison between France and Germany is illuminating. Using trade data from the European Commission, Cohen (2020) shows that in 2019, Germany had a large trade surplus in products related to health risks (pharmaceutical components, medical devices, protective equipment), while France had a significant deficit in protective equipment and medical devices. This asymmetry between the two countries reflects that of their crisis management strategies at the very beginning of the epidemic. In the absence of domestic manufacturers of reagents for PCR tests, France was forced to play the lockdown card, while Germany was able to pursue a policy of mass testing from the outset of the health crisis.

3) Industrial sovereignty or resilience strategy?

The current crisis has brought the idea of regaining industrial sovereignty at the national and European level to the forefront, highlighting fifty years of French deindustrialization (Figure 3).

Figure 3: Evolution of the weight of French manufacturing industry between 1970 and 2019

Source: INSEE – Annual national accounts

For a country, industrial sovereignty means being able to meet certain essential needs without depending on the goodwill or will of another state (Bellit, Granier, and Mini, 2020). Industrial policy cannot be limited to economic considerations alone, as security of supply is essential to a state’s strategic autonomy. In this regard, a strategy aimed at (re)localizing or retaining strategic activities or certain links in the value chain that are considered critical makes sense. Such a policy would make it possible to respond more effectively to a future pandemic or major conflict.

In the context of the Sino-American trade war and « punitive » protectionist measures, dependence on foreign imports of essential goods exposes the country to a threat that could materialize in the form of export restrictions from the United States or China, assuming that a neutral position on the part of France and the EU is not tenable in the long term. This raises the question of the geographical scope and sectors of activity in which industrial sovereignty should be assessed. One might assume that the list of essential activities is similar to that of OIVs, operators of vital importance. These are around 250 public and private companies identified by the State as having an essential activity and a key role in the event of a crisis.

However, recent experience has shown that this system is not an adequate response to vital needs. In a recent note, the High Commission for Planning, created in September 2020, considers that an asset is strategic if it « ensures the security or continuity of the life of the nation in the event of a sudden crisis. » These include water, energy, the agri-food sector, telecommunications, and national defense. Also considered strategic are « those that ensure the sovereignty of the nation with regard to the priority objectives it sets for itself, » particularly those contributing to the energy and digital transition.

As part of the recovery plan adopted in France to deal with the Covid-19 crisis, €1 billion has been earmarked for (re)localization, including €600 million to secure supplies and relocate strategic activities, targeting the health, agri-food, telecommunications, electronics, critical industrial inputs, automotive, and aeronautics sectors. At the European level, a dynamic has been initiated to promote strategic autonomy in certain key sectors. Far from calling into question openness to trade, the European Commission has set itself the goal of « open strategic autonomy » and is proposing the development of tools to better protect European companies against unfair practices by third countries, including state subsidies, the closure of public markets, and the control of foreign direct investment.

However, a resilience strategy cannot be reduced to a policy promoting the (re)localization of strategic activities on national or European territory. Such a policy is futile when the technological gap with foreign competitors is too wide.

The European Union lags significantly behind the United States and several Asian countries in the digital field, particularly in the cloud and semiconductor industries. The European cloud market is now being « engulfed » by GAFAM. According to a recent study by Fondapol (2020), the market capitalization of the leading American companies in the cloudindustry isfifteen times higher than that of their European competitors. Similarly, the semiconductor industry is now dominated by three manufacturers: Intel in the US, Samsung in South Korea, and TSMC in Taiwan, with the latter accounting for nearly 50% of global semiconductor production. Relocating this type of highly capital-intensive activity is complex and economically inefficient. Europe has a few leading companies in this field, including ASLV in the Netherlands and STMicroelectronics in France and Italy. However, it accounts for less than 10% of the European semiconductor market and even less globally.

One possible strategy would be to encourage global leaders to invest in France and/or Europe. This is the option chosen by the United States, which is set to welcome TSMC’s first factory in Arizona in the coming years. Where possible, seeking greater diversification of suppliers and sources and building up strategic stocks are also appropriate measures for addressing industrial resilience issues.

Another strategy for catching up would be to enter the race for ultra-fine chips, which are still under development. The best way to bring about the emergence of leading European companies in this field is to target niche markets that are likely to become strategic in the coming years. Aware of these challenges, the European Union has announced a European alliance project aimed not only at increasing the share of semiconductor production in Europe by 10 to 20% by 2030, but also at financing R&D in new-generation chips. This project, combining public and private investment, could represent between €20 and €30 billion.

Conclusion

The health crisis has brought to light the weaknesses of a country marked by fifty years of deindustrialization. Shortages of vital products have revealed France’s dependence on other countries in areas considered strategic. This has given rise to much discussion about the need to regain our industrial sovereignty, with the relocation of strategic activities being presented as an appropriate response to this new challenge.

However, industrial sovereignty must be considered within a complex system where the realities of international trade and the technological gap that has sometimes accumulated in relation to foreign competitors do not always offer the possibility of rebuilding a viable production capacity in the short or medium term. It is therefore up to the public authorities to implement a tailor-made resilience strategy, combining solutions as varied as relocation aid limited to certain key areas, diversification of supplies, the creation of strategic stocks, and the attraction of foreign investors. However, these strategies must be coordinated with the first initiatives implemented at the European level on the strategic autonomy of the European Union.

Bibliography

Alsif A.S., Charlet V., Lesniak C., 2019, « Is France exposed to the risk of protectionism? », Paris, Presses des Mines.

Bellit S., Granier C. & Mini C., 2020, « From industrial sovereignty to relocation: what are we talking about? », Working paper, La Fabrique de l’industrie.

Bonneau C. and Nakaa M., 2020, « Vulnerability of French and European supplies, » Trésor-éco, No. 274, December.

Cohen E., 2020, « Industrial sovereignty in the light of Covid-19, » Politiques étrangères, 2020/3 (Autumn), pp. 71-83.

Gerschel E., Martinez A., Méjean I., 2020, « Propagation of shocks in international value chains: the case of the coronavirus, » Institut des politiques publiques, No. 53.

High Commission for Planning, 2020, « Vital Products and Strategic Sectors: How Can We Guarantee Our Independence? », Opening Note No. 2, December.

Hyppolite P.A, 2020, « Relocalising production after the pandemic? », Fondapol, September.

Jaravel X., Méjean I., 2021, « What resilience strategy in globalization? », Notes from the Economic Analysis Council, No. 64, April.

Jean S., Vicard V., 2020, « Relocaliser, réindustrialiser : dans quels buts ? » (Relocalizing, reindustrializing: to what ends?), La Lettre du CEPII, no. 410, September.