Future Shocks 2023: De-risking Europe’s global critical supply chains [Policy podcast]

The hardening geopolitical environment, rising protectionism and the pandemic have led to increased prominence of the debate on decoupling supply chains in order to increase their resilience.

© European Union, 2023, EPRS

Written by Marcin Szczepański.

This paper is one of 10 policy responses set out in a new EPRS study which looks first at 15 risks facing the European Union, in the changed context of a world coming out of the coronavirus crisis, but one in which a war is raging just beyond the Union’s borders. The study then looks in greater detail at 10 policy responses available to the EU to address the risks outlined and to strengthen the Union’s resilience to them. It continues a series launched in spring 2020, which sought to identify means to strengthen the European Union’s long-term resilience in the context of recovery from the coronavirus crisis. Read the full study here.

The issue(s) in short: The challenge and the existing gaps

The hardening geopolitical environment, rising protectionism and the pandemic have led to increased prominence of the debate on decoupling supply chains in order to increase their resilience. Recently, the tone of this debate has shifted to de-risking (particularly in the context of relations with China), which points towards a more nuanced way of ensuring Europe’s ambitions for increased resilience and strategic autonomy in its supply chains. It can be achieved by increasing domestic production, greater autonomy in critical raw materials (CRMs), use of trade tools and cooperation on the global stage. Such de-risking is becoming increasingly prioritised, so that the EU avoids overdependence on third countries, particularly on coercive or hostile authoritarian states. This is especially the case for green and digital technologies, which are quickly becoming the main determinant of long-term resilience and competitiveness. For example, China provides 100 % of the EU’s supply of heavy rare earth elements, which are key components of electric vehicles’ motors and wind turbines, two key technologies to deliver on the EU’s green transition. Particular vulnerabilities exist in the CRM supply chains, but they are also spread across the clean tech industry that is crucial for the EU’s future.

Supply chain risks
Figure 46 – Supply chain risks

The EU is an open economy, reliant on global supply chains to a greater extent than the US and China. At the same time these complex chains are subject to increasing disruptions and uncertainties, with many areas of fragility. This exposes the fundamental vulnerability of the EU’s industry and economy to the adverse effect of segmented and non-diversified key supply chains. As manifested during the pandemic, maintaining sustainable supplies of resources, goods and services is crucial, even when supply chains are severely disrupted by unexpected events. However, as the critical supply chains are global in nature and inherently complex, they are particularly exposed to precisely this type of unexpected and/or rapidly occurring event. Disruptions may be caused by natural and man-made disasters, geopolitical uncertainties, inter-state and inter-regional conflicts, cyber-attacks, health crises, labour shortages, new technologies, macroeconomic developments such as inflation or recession, or intentional actions such as terrorist attacks, sabotage, or blockages by activists. The bulk of risk-mitigating strategies focus on preventing severe risks that have a high likelihood of occurrence, which constitutes a weakness in itself for these approaches.

As the COVID-19 pandemic has demonstrated, there is a policy gap regarding measures that can be used to address severe risks with a low likelihood of occurrence (Figure 46). All in all, supply risks are compounded by the evolving wider circumstances, such as escalating tensions among the great powers (such as a US-China trade war), challenges to multilateralism, crisis at the WTO, slowing globalisation, the rise of protectionism, weaponisation of energy dependencies, growing demand, and the increasing use of economic tools to advance geopolitical objectives.

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Position of the European Parliament

The Parliament is also a longstanding proponent of holistic, cross-policy approaches to solving complex issues of supply chain risks.

In its resolution of February 2023 on an EU strategy to boost industrial competitiveness, trade and quality jobs, the Parliament called on the Commission to assess current dependencies and find alternative sources to diversify supply chains for critical technologies and raw materials. It also highlighted the need for improved coordination and joint efforts to create resilient supply chains. The Parliament is a supporter of the idea of a European Sovereignty Fund – mobilising investments across the key sectors, including raw materials, to support the twin green and digital transition – and also encourages the Commission to help diversify supply chains.

In its resolution of November 2020 on a new industrial strategy for Europe, the Parliament stressed the need for significant investment in key value chains. To reduce over-reliance on a few markets and increase resilience, it also recommended strengthening, shortening, and diversification of supply chains (also through strategic use of public procurement) as well as increasing their sustainability. It called on the Commission to include, in its recovery plan, concrete measures to attract industries to Europe, and to increase, strengthen and promote relocation and diversification of strategically important EU industries. It also asked for a review of the antitrust rules, seeking a balance between the need to cope with global-scale competition and the protection of the supply chains.

In its resolution of November 2021 on a European strategy for CRMs, the Parliament stated that an integrated approach throughout the value chain, from waste collection and product design for recyclability to material recovery, is an essential strategy to increase their supply. It called for funding to support research and innovation and skills development. To reduce criticality and dependence, it also called for the establishment of an Important Project of Common European Interest (IPCEI) on CRMs and recommended diversifying supply sources and launching responsible and sustainable mining of CRMs in the EU. The Parliament is also a supporter of transparency and accountability in supply chains.

In its resolution of March 2021 on corporate due diligence, the Parliament advocated the prohibition of imports of products related to severe human rights violations. It wished to see rules in place allowing for effective due diligence of supply chains by the importing firms, to ensure that products that they place on the internal market are in conformity with environmental standards and human rights; due diligence helps to identify and mitigate risks along supply chains.

In its resolution of 16 September 2021 on a new EU-China strategy, MEPs highlighted that the EU is particularly dependent on China in some key supply chains and advocated mitigating this and investigating the use of forced labour in the supply chains of European companies in China.

Pyramid of instruments at the disposal of the EU and its Member States
Figure 47 – Pyramid of instruments at the disposal of the EU and its Member States

EU policy responses (Commission and Council responses so far)

Increasing resilience of global critical supply chains has been carried out so far through a mix of domestic and external policy measures. The 2020 new industrial strategy for Europe focuses on the monitoring and support of key industrial ecosystems.

The particularly pressing issue of CRM supply is tackled in a multipronged way. The 2020 action plan focused on: (i) developing resilient value chains for EU industrial ecosystems; (ii) reducing dependency on primary CRMs through circular use of resources, investment in research and innovation, and more sustainable products; (iii) promoting sustainable and responsible domestic sourcing and processing of raw materials in the EU; and (iv) diversification of supply coming from third countries. The plan resulted in the establishment of a European raw materials alliance (ERMA), a dedicated industrial alliance to address the numerous challenges faced in raw materials value chains. Its mission is to close the gaps in existing supply chains, securing access to CRMs and other advanced materials and ‘breaking’ deficiencies such as the lack of technologies, capabilities and skills in the EU. Similarly, EIT RawMaterials works on securing a sustainable raw materials supply by driving innovation, education and entrepreneurship across European industrial ecosystems.

Regarding financial support, the InvestEU programme provides long-term funding to back activities of strategic importance to the EU, including those targeted at enhancing resilience and strengthening strategic value chains; examples include promoting on-shoring and developing sustainable capacities, abroad and domestically. It is expected to mobilise at least €372 billion of public and private investment. The Recovery and Resilience Facility, with its €724 billion financial envelope, also funds the implementation of reforms and investments in digital technologies and infrastructure, which will increase the EU’s global competitiveness and make it more autonomous, resilient, innovative and less dependent – by diversifying key supply chains. There is also a host of EU programmes supporting research and innovation efforts as well as infrastructure to reduce strategic dependencies, which, together with boosting cybersecurity, also have de-risking effects on key supply chains. These include Horizon Europe, the Connecting Europe Facility, Digital Europe, the European Defence Fund, the Innovation Fund and the European space programme, in addition to financing from the European Investment Bank.

Shifting to trade instruments, a May 2023 European Parliament study examines their role in increasing security of critical global value chains for key raw materials, commodities and goods. It concludes that most recent legislative acts play a role in securing existing supply chains: the FDI screening framework and the anti-coercion instrument are focused solely on this. Other instruments also have supplementary purposes: apart from securing the key supply chains, they help to develop their sustainable capacities (the Foreign Subsidies Regulation, the proposal for a Directive on Corporate Sustainability Due Diligence, CBAM), to diversify foreign sources (the International Procurement Instrument), or to safeguard the implementation of trade agreements, which also has an impact on supply chains (the Enforcement Regulation).

Regarding free trade agreements (FTAs), those already in force cover around 27 % of CRM imports, while those waiting for ratification or under negotiation may allow for more than double this coverage. The study also analysed the texts of recently signed FTAs and the proposed texts of those under negotiation, and found that the EU insists on including various measures such as an explicit chapter for trade and cooperation relating to energy and raw materials in reference to supply chain vulnerabilities and risks. On the other hand, another recent study for the ITRE Committee takes a more critical stance and sees limited scope for FTAs to influence significantly the EU’s CRM dependencies.

In terms of international agreements, the EU has deployed raw materials diplomacy to improve supply chains for over a decade. Recently, it concluded two strategic partnerships with Canada and Ukraine on raw materials. This was followed by a strategic partnership with Namibia on sustainable raw materials and renewable hydrogen, a strategic partnership with Kazakhstan on raw materials, batteries and renewable hydrogen, and a strategic partnership on renewable hydrogen and preparing the ground for a just energy transition in Egypt. An important shared goal of these agreements is the integration of value chains. In July 2022, the EU and some of its Member States released a joint statement with 13 other major economies pledging cooperation on supply chains based on transparency, diversification, security and sustainability. This was followed by the efforts to enhance strategic coordination in the G7 format to support resilient and sustainable value chains. In addition, the EU launched three digital partnerships with Japan, South Korea and Singapore that aim to reinforce crucial global supply chains. The EU has also engaged with Latin America and the Caribbean, prioritising issues of supply chains and CRMs in its new agenda for these regions. A similar strategic focus was taken in its agendas for Africa and the Southern Neighbourhood. In June 2023, the Commission proposed to start formal negotiations with the US on the Critical Minerals Agreement to foster the supply chains of CRMs needed in the production of EV batteries.

One of the strategic priorities of the EU-US Trade and Technology Council (TTC) is to improve resilience of strategic supply chains. The partners identified common vulnerabilities in supply chains for solar panels and initial cooperative steps to address them, such as promoting supply chain transparency, and joint work on project development and the design of financing tools. Both sides also identified shared risks in supply chains for rare earth magnets and announced possibilities for future collaboration in research and development in areas such as mining and recycling. Importantly, they launched an early warning mechanism to address and mitigate semiconductor supply chain disruptions through cooperation. They also committed to unprecedented levels of reciprocal transparency on semiconductor subsidies, to avoid a subsidy race. In May 2023, the EU-India TTC had its first meeting and announced the deepening of joint work on resilient value chains.

Timeline of measures to de-risk Europe's global critical supply chains
Figure 48 – Timeline of measures to de-risk Europe’s global critical supply chains

Obstacles to implementation of response

Complex global supply chains take a considerable time to establish, and during this process their integration deepens. This, in effect, means that they are not very flexible and are difficult to reconfigure. However, unforeseen events may unfold quickly, leading to sudden materialisation of supply chain risks. At the same time, many of the policy responses described above will take a long time to implement: increasing domestic capacity, improving infrastructure and developing new skills for the workforce are not quick fixes. In addition, significant opposition exists to mining activities in Europe. This is in stark contrast to China, whose economic nationalism is manifested by its determination to further dominate the global supply chains for raw materials.

Furthermore, the main actors in control of many key supply chains are private enterprises that may not share the same objectives as, or may assess the risks differently to, public bodies. They are also more likely to take into consideration short-term economic parameters instead of geopolitical concerns. As supply chains are increasingly being affected and shaped by new disruptive forces, ranging from the rise of new technologies to changing geopolitical circumstances, the risk of policy not catching up with the unfolding reality is higher than ever. It could also go the other way, where realistic timeframes for reconfiguring supply chains make it impossible to deliver the prompt responses expected by political decision-makers, despite policy frameworks being in place. This is particularly risky where chains are long and complex, which makes it difficult to understand them and to map their risks correctly. Slow political decision-making can indeed be a risk in itself when confronted with rapid risk materialisation.

Since the global supply chains are facing a rising number of multiple dynamic challenges, their de-risking is based on a holistic approach implemented across various policy fields. They also vary significantly depending on their deliverables or objectives. For example, energy supply chains are fundamentally different to semiconductor supply chains. This creates its own challenges: coordinating efforts in multiple areas and subjects is complicated and difficult to oversee strategically. Setting clear monitoring frameworks is also challenging. Similarly, the funding programmes which are focused on very different areas may miss closing the funding gaps: linking financing areas such as infrastructure, digitalisation, innovation and skills in a coherent way is complex.

The very fundamental concepts behind supply chain security remain debated and point to the careful balancing act that is needed if the policy is to be effective. The trade policy review mentioned the need to understand ‘the right policy mix in terms of diversification of domestic and external sources of supply and the build-up of strategic production capacities and reserve’. Similarly, there is a longstanding debate on efficiency vs resilience of supply chains: efficiency is pivotal to compete in a fiercely contested business landscape, whereas resilience is required to shield the supply chain from unforeseen disruptions. Furthermore, the implementation of the majority of the trade legislation mentioned above depends on action by both the EU institutions and signatories (e.g. Member States). This reliance on collaborative effort poses risks to their efficiency – actions dependent only on EU activity can be less complex to launch and enforce. Many actions also contain recommendations or requests for best efforts, not just the legally enforceable provisions.

The global demand for CRMs is highly likely to skyrocket in the future, and it is uncertain whether supply will be able to keep up. This may make diversification of supply chains even more difficult, since there will be more actors interested in competing for the finite number of resources. This even concerns countries that the EU considers allies: a sign of things to come may be the recent tensions around the US Inflation Reduction Act. Further on in transatlantic relations, the TTC may fail to deliver on its ambitious cooperative agenda or even cease to exist if the US elections in 2024 bring about a change of power. There are also important nuances in the approach of both sides to China, which may diminish the TTC’s effectiveness. As the TTC progresses not through major breakthroughs but in incremental steps, it may not deliver on reducing both partners’ strategic dependencies in supply chains before business and policymakers lose interest in influencing difficult industrial adjustments through this transatlantic forum.

The global framework conditions are also becoming more and more difficult. To de-risk its key global supply chains, the EU relies on the openness of the global trade system. This is because, by bolstering and diversifying its trade, the EU strengthens its position in these chains. Diversifying import sources is also key to ensuring that the EU meets its need for crucial goods, materials and production inputs; this is easier to achieve using multilateral cooperation and coordination. However, many share the view that, with the mounting tensions in the world, multilateralism is in crisis, an oft-mentioned symptom of this being a weakened WTO. As worldwide trade and financial flows have fallen below their peaks, the globalisation process has slowed down, and different supply chain actors may have found themselves in conflicting or competing geopolitical camps. Working via fora such as the G20 and WTO to monitor and sustain supply networks has become ever more challenging, in which context the election of the next US President in 2024 will be of fundamental importance.

In focus: Strategic dependencies and critical supply chains
In May 2021, the Commission published an update to its new industrial strategy, accompanied by an analysis of the EU’s strategic dependencies. It reviewed 5 200 imported products and identified 137 products in sensitive ecosystems for which the EU is highly dependent on external suppliers. About a quarter of these (34 products) are very vulnerable, given their low potential for diversification and substitution by EU products. The EU imports about half of these products from China (52 %), followed by Vietnam (11 %) and Brazil (5 %). The report also included six in-depth reviews of supply chains in strategic areas characterised by prevalent use of these materials: active pharmaceutical ingredients (APIs); batteries; hydrogen; raw materials; semiconductors; and cloud and edge technologies. Important dependencies vis-à-vis China particularly concern APIs, CRMs and products needed for the green and digital transition. The updated industrial strategy suggests that, where common dependencies exist, ‘the EU may choose to pool resources and build stronger and more diverse alternative supply chains with our closest allies and partners’.
In February 2022, the Commission published the second edition of an in-depth analysis of Europe’s strategic dependencies. The report examined a further five areas – rare earths and magnesium, solar panels, chemicals, cybersecurity and IT software – and concluded that, for the first three areas, vulnerabilities are driven by a strong concentration of global production in China, with limited options for supply diversification, including from within the EU. The March 2023 assessment of supply chain dependencies for 15 critical technologies across five strategic sectors (renewable energy; electric mobility; industry; information and communication technologies (ICT); and aerospace and defence) determined strong vulnerabilities along all these supply chains. As many as 53 of the 70 steps examined in the chains showed vulnerability. However, as the supply chain got closer to the finished products these vulnerabilities diminished, underlining that the EU is weak in raw materials but strong in manufacturing of the final technologies. On the other hand, five technologies (batteries; solar PV; data storage and servers; smartphones, tablets and laptops; and drones) show vulnerability along the entire supply chain, thus highlighting the EU’s dependency even in the case of final products.

Policy gaps and pathway proposals

EU industry faces numerous challenges created by supply chain disruptions, which are coupled with high inflation, labour shortages, rising interest rates, and spikes in energy costs and input prices, as well as strong and sometimes unfair global competition. To address them in a strategic and structured way the Commission proposed in June 2023 the Strategic Technologies for Europe Platform (‘STEP’). The STEP will increase (by €10 billion) and leverage existing EU instruments financial envelopes to swiftly deploy financial support for investments in critical technologies. The Commission is expecting that this will lead to total additional investments of up to €110 billion. The STEP aims to direct funding towards strategic technology fields to boost their uptake and scaling up their development and manufacturing, particularly of the digital and deep tech, clean tech and biotech.

On 16 March 2023, as part of its Green Deal Industrial Plan, the Commission adopted a proposal for a regulation on CRMs. The Critical Raw Materials Act introduces the concept of strategic raw materials (SRMs), which are pivotal for strategic technologies underpinning the green and digital transitions and prone to shortages. The proposed regulation aims to establish a framework ensuring the EU’s access to a secure and sustainable supply of CRMs. To achieve this, the proposal focuses on four objectives: (i) boosting the SRM value chain; (ii) diversifying imports of SRMs (so that, by 2030, no third country would supply more than 65 % of the EU’s annual consumption of each SRM); (iii) enhancing the monitoring and mitigation of CRM supply risks; (iv) ensuring the free movement of CRMs and products containing CRMs in the single market as well as a high level of environmental protection, through better circularity and sustainability.

In March 2023 Net-Zero Industry Act has as one of its key goals improving the security of supply for net-zero technologies and fostering investment in their supply chains. The accompanying communication promotes the role of trade in de-risking supply chains by supporting trade openness and sustainable investments, and launching new initiatives with like-minded partners. The temporary state aid framework has been extended until 2025 (and transformed into a ‘temporary crisis and transition framework’) to support the actions in the Act. The proposed regulation introduced a requirement that the projects supported would need to either (i) contribute to the technological and industrial resilience of the EU’s energy system by increasing the manufacturing capacity of a component or a part of the value chain for which the EU depends heavily on imports coming from a single third country, or (ii) have a positive impact on the EU’s net-zero industry supply chain by contributing to the competitiveness of and creation of quality jobs in this supply chain.

Possible action

De-risking Europe's global critical supply chains - Possible action

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