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An EU supply chain law hits the wrong people

By Gabriel Felbermayr
President of the Institute for the World Economy

A supply chain law burdens the wrong people if it makes European companies liable for human rights violations or violations of minimum environmental or social standards by their foreign suppliers. Thanks to the international division of labor, local companies have access to a huge and complex network of suppliers. If they were now subjected to far-reaching liability rules for supply chains that are de facto not fully controllable, they would have to reduce their risk. This would mean limiting supplier portfolios to larger suppliers that are active in countries where the risks of violations of social and environmental standards are lower.

At first glance, one might say: a good thing. After all, it could increase incentives for other countries to improve their standards to stay in business. At second glance, however, it means an increased closure of the European market to suppliers from developing and emerging countries, which often cannot guarantee the standards desired in Europe due to their economic and social history. However, the integration of these countries into Western supply chains has massively reduced poverty there in recent decades and thus also improved working and environmental conditions in the countries. If supply links there are now cut back, this positive effect threatens to be lost.

EU supply chain law helps China in Africa

New suppliers, for example from Africa will have a more difficult time to be integrated into supply chains of European companies. They will then have to rely on finding customers in countries that place less value on sustainable social and environmental standards, such as China or Russia. Companies from there will take the place of European buyers of goods from developing and emerging countries. This would probably not improve the situation there: The incentives to converge with European standards will fall away. China is already active in many of these poorer countries as a lender, for example for infrastructure projects, thus gaining geostrategic influence. If Chinese companies also increasingly become the main buyers of goods produced in these countries, their dependency on China will increase further. However, the EU actually wants to prevent such a development. With a strict supply chain law, it could counteract these efforts.

So should we stand idly by and let the companies violate social and environmental standards? By no means. But we should start with those who are actually responsible: The best way to punish misconduct by foreign companies is to impose direct sanctions on the offenders. The best way to do this is for a central EU institution, after consultations with all parties involved, to keep negative lists of all companies in the world that have been proven to have committed misconduct and ban these companies from participating in European value chains. This would provide transparency and legal certainty; the many European companies involved in foreign trade would not each be forced to monitor their supplier networks at great cost and with uncertain effectiveness; and politicians would not transfer their very own tasks – foreign policy – to companies that should play quite a different role. Incidentally, such an approach would also have strong extraterritorial effects: Who in another country, such as Switzerland or Australia, would want to work with a company that the EU has blacklisted?

US Magnitsky Act as a model

The EU is just beginning to use this approach to demonstrate to China that it is not powerless when the country violates human rights or other sustainability standards. For the first time, it has made use of the global human rights sanctions regime against China adopted by the European Council in December, which is modeled on the US Magnitsky Act. This means that the EU too can now impose global sanctions on individuals, companies, or organizations involved in human rights abuses. These sanctions are much better than general trade restrictions, which would always hit the wrong companies in China.

Whoever wants to do business with the EU now has this sword of Damocles hanging over them. Such targeted interventions can be much more effective than setting general incentives for less diversification of the supplier network through a strict supply chain law.

Smarter ways: ratify CAI

It is important for the credibility of the EU’s new sanctions instruments that they are also used when there are no other avenues left. Only in this way will they develop the intended deterrent effect. That China has now reacted very robustly with counter-sanctions is also logical. If the leadership in Beijing succeeds in getting the EU to back down, then the instrument would have run its course. The EU must therefore get through this phase. But it should also not overstretch the instrument because a political escalation between the EU and China is an enormous risk for the German economy.

Ratification of the investment agreement with China (CAI), which was adopted in December, could now become even more likely because the EU Parliament can show that it has very effective instruments at its disposal to punish human rights violations in China. It can therefore approve the agreement, even though it is in Hong Kong or Xinjiang, because it now has its own instruments for these issues. For Beijing, the agreement with the EU also remains key: The logic that got China to give in just before Christmas still applies. A strong shoulder between the EU and the US would be extremely difficult for China.

This shows that there are smarter ways for the EU to promote better social and environmental standards worldwide than restrictive laws for local companies, which in case of doubt tend to benefit or harm the wrong people.

Gabriel Felbermayr is President of the Kiel Institute for the World Economy since March 2019. At the same time, he holds a professorship for economics, in particular economic policy, at Christian-Albrechts-Universität zu Kiel.

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