Masks made in Germany

The corona pandemic has severely affected international supply chains. Starting with the first production stoppages in China at the beginning of the year, production has also come to a standstill in Germany. In many sectors, important components and preliminary products from the most important supplier country for the EU and Germany were missing. However, the closing of borders within Europe has also considerably slowed down the movement of goods and economic activity.

Many industries are highly dependent on Chinese imports, such as the electrical and telecommunications industry. Here, around one-third of all components come from the People’s Republic of China. The dependency is particularly high for respiratory masks. Currently, almost 60 percent of the masks produced worldwide are made in China.

To reduce this dependency, Germany’s Health Minister Jens Spahn decided in April, when the supply situation was becoming increasingly threatening, to boost domestic mask production. The government also wanted to support the domestic economy by this action. How exactly, remains open for the time being. In this article, we discuss a few policy options to reduce the import dependency of systemically important goods.

Stockholding

In the case of non-perishable goods, larger stocks could be kept in reserve, which can be accessed at very short notice in times of crisis. In practice, this is already taking place to some extent. In Germany, the oil industry must by law maintain a strategic reserve for about 90 days to bridge supply bottlenecks. These reserves are stored in different warehouses across the country.

The Federal Ministry for Economic Affairs and Energy decides when and how much of this reserve is released. The last time this happened was in 2018 when the river levels of the Rhine and Moselle had fallen so much that the supply via the waterways came to a standstill. Otherwise, this reserve is only tapped in the event of natural disasters or international conflicts, such as the Gulf War.

In our opinion, however, stockpiling can only be one component. On the one hand, it is not possible to predict demand precisely, so it is unclear how large the stocks should be. Secondly, unlike oil, many goods have a limited shelf life. They age or at some point are no longer technically up to date.

Capacity reserve

Another proven way to avoid bottlenecks can be to invest in production capacities specifically for times of crisis so that they can be ramped up quickly. The electricity industry could serve as a model for this.

Out of concern about possible blackouts, politicians have obliged transmission system operators to maintain a so-called capacity reserve outside the electricity market. In extreme situations, when the electricity available on the market does not cover demand, it is intended to act as an emergency reserve. On the general electricity market, however, the reserve may not be used to avoid distorting competition there.

The capacity reserve is technology-neutral. They can form all power plants, storage facilities, and other loads that can activate their capacity in less than twelve hours. At present, only gas-fired power plants form the reserve capacity, as these can flexibly regulate their electricity generation and – unlike coal-fired power plants, for example – can ramp up quickly.

Transmission system operators put the plants in the capacity reserve to competitive tender every two years. The compensation comprises a fixed price for the loss in value of the plants as well as the running costs for maintenance, the plant’s own electricity consumption and the maintenance of the capacity reserve. In addition, in the event of actual use of the capacity reserve, a working price is paid to cover the variable costs, for example for fuel or emission rights. The capacity reserve should be awarded to the company that offers the most favorable combination of labor and performance price.

The costs of the capacity reserve are allocated to the network charges and thus ultimately to the end-users. The increase of the network fees is estimated at 0.01 to 0.02 ct/kWh or 0.35 to 0.70 € based on average annual electricity consumption of 3,500 kWh.

It is conceivable to transfer the capacity reserve model to other system-relevant sectors. For example, companies in the textile industry could reserve a certain proportion of their production capacity to be able to produce respirators at very short notice in times of crisis.

The German government could tender these capacities in a competitive procedure similar to the energy market. It would have to guarantee to cover the running costs of the capacities, which cannot be used for production on the general market. In addition, a premium would have to be granted to cover the opportunity costs of using the capacity elsewhere on the free market.

Should the reserve be used in times of crisis, the companies would receive a remuneration equal to the product of the contract value and the quantity bid in the tendering procedure. Such a solution could use competitive procedures to maintain capacity at a low cost without creating a continuous state or state-subsidized production that distorts competition. In any case, the chosen solution must ultimately be in line with state-aid law in order not to distort competition with other companies.

In principle, all political measures must take into account the entire supply chain. It is of little help to organize any kind of supply of the end product if important intermediate products are missing. The German government could, for example, oblige companies in the capacity reserve to disclose their entire supply chain in order to assess the susceptibility to failure along the chain and possibly counteract it.

European solution

Besides, relying solely on national solutions for systemically important goods does not seem to be helpful. Germany, too, can be hit by natural disasters or epidemics so that production could also fail here. If confidence in international supply chains is currently damaged, the production of systemically important goods should at least be coordinated throughout the EU.

This would have several advantages. For one thing, decentralized production at several locations can diversify the risk of production downtimes. For another, it is not very efficient if all 27 EU states each set up their own national production, especially if production is associated with high fixed costs that are difficult to amortize.

Allocating resources to a few European partner states would make better use of economies of scale and specialization advantages in production and thus reduce production costs compared to purely national production. Finally, in the European Union rather legally binding contracts can be locked than this is possible with third-party countries.

How should additional costs be financed?

Reduced dependence on imported inputs or end products is inevitably associated with higher prices for the products concerned. The cost advantage was precisely the reason to rely on imports instead of domestic production: Economic independence has a price.

For products that are essential from the company’s point of view, government support for production will be necessary. Since the corresponding measures are a safeguard against unforeseeable risks, this is a task for society as a whole that should be financed from tax revenues.

The provision should be organized in a transparent and competitive process to keep the tax burden as low as possible. Where companies receive subsidies, care should be taken to ensure that these are in line with the law on state-aid and compatible with the rules of international trade and the WTO.

Conclusion

The Corona pandemic has revealed the fragility of international supply-chains. Especially for important medical products, there was a dramatic shortage in some cases. But also the supply of many preliminary and intermediary products in the industry came to a partial standstill.

Currently, there is a discussion about how to increase resilience to crises such as the coronavirus crisis. In this paper, we have discussed options. Common to all solutions: A reduced dependence on imports has its price. Whatever form of production in Germany and Europe is generally more expensive than in Asia, for example. It must therefore be discussed for which products one is prepared to pay more in the future.

Note: This is a translation of the blogpost “Masks made in Germany?” which appeared in German on the blog “Inclusive Productivity” on October 14th 2020.