Labor Risk in Global Supply Chains

Nneka Chike-Obi is a Director in the ESG Research at Fitch Ratings

Modern slavery is the recruitment, movement, harbouring, or receiving of adults or children through the use of force, coercion, abuse, deception, or other means for the purpose of exploitation. Types of modern slavery include forced labour, debt bondage, and illegal child labour. Retailers and consumer goods manufacturers have fairly high exposure to modern slavery risk due to the amount of sourcing occurring in emerging economies where laws against these practices are poorly enforced. According to the International Labour Organisation (ILO), 26% of global forced labour occurs in manufacturing and agriculture. In the past decade, governments, consumers, and companies have grown increasingly aware of the impact of non-financial risks on businesses with global value chains, including social risks related to labour rights, human rights, and employee wellbeing.  

Outsourcing production overseas creates a number of operational risks within supply chains, many of which are typically accounted for alongside financial performance, such as logistics, transportation, and quality control. These are normally offset by the cost savings from employed lower cost workers. The savings can be significant – for example, the mean average minimum wage in India is around 80% less than the mean average in the EU.  

Countries with lower wages, such as those in South and Southeast Asia, have made efforts to build an export-oriented manufacturing sector and attract new customers from countries with higher wages. Since 2010, the EU has increased textile imports from Bangladesh, Cambodia, and Myanmar as the share of imports from China has fallen. In addition to lower wages, however, manufacturing workers in these countries typically also have fewer legal protections with regard to working hours, benefits, and safety than those in developed markets do. There is often a lack of protections for marginalised communities, women, and children in relation to employment.  

Sustainability considerations are growing in importance within supply chain management, including supplier transparency. Managing supply chain labour risk adds operational costs that increase with the number of suppliers, their distance from the home market, and the amount of sourcing that takes place from suppliers below Tier 1. Two-thirds of apparel purchasing executives surveyed by McKinsey in 2019 expected sustainable sourcing to add 1%–5% to their overall purchasing costs by 2025, and a similar share thought it likely that sustainability will become the main criteria in selection of new suppliers. 

The incremental shifting of some or, in more rare cases, all of a company’s manufacturing either to a country near the home country – nearshoring or proximity sourcing – or to the home country itself – reshoring – is a trend accelerated by the coronavirus pandemic. In a November 2020 report, Fitch identified reshoring and nearshoring as a key secular corporate trend that is expected to impact credit ratings through regulatory and policy shifts over the next decade. The primary drivers for this are related to bolstering resilience of operations and controlling costs amidst persistent geopolitical uncertainty. However, the relevance of labour oversight may become more prominent in light of more focus on modern slavery, adding another element to the drivers pushing companies to recalibrate supply chains. Proximity sourcing is it not in itself a means of eliminating forced labour from a supply chain, and many low labour cost countries located near major developed markets still have relatively poor workers’ rights. However closer economic and political linkages between neighbouring countries may support improved working conditions.  

According to the Minderoo Foundation’s Global Slavery Index, the ten countries with the highest prevalence of forced labour are all in Asia and sub-Saharan Africa. When considering a company’s exposure to modern slavery risk, how much of their production is in these regions compared to countries in Europe or the Americas is an important indicator. Companies may also begin to weigh the cost savings from low-cost overseas production more carefully against legal, operational, and reputational risks related to labour issues. 

The increase in disclosure driven by current and upcoming regulations could, however, lead to stronger responses from stakeholders on labour rights violations, such as shifts in demand from customers or due diligence policies of lenders. The difficulties in finding labour abuses throughout the supply chain, as well as understand the risk of potential abuses systematically, have limited the scope of such responses in the past. This could change as reporting in this area becomes more robust and standardised, particularly as pressure on companies to more diligently report on and audit their supply chains continues to grow –from governments and also from consumers, non-governmental organisations, and investors. 

The broader consequences of enhanced disclosure are already evident for some ESG issues, such as greenhouse gas emissions. Regulatory requirements for reporting or tracking emissions initially targeted specific sectors, such as oil and gas, and transportation. Over time, the range of companies providing detailed information to the public on their carbon footprints has widened beyond those that are required to do so. Today, large companies operating in North America, Europe, and developed Asia-Pacific, particularly publicly listed ones, are expected to not only to report their emissions but to have an associated strategy to manage negative environmental impacts. 

We expect a similar evolution in modern slavery risk management, given the size of the markets where mandatory reporting has been introduced and the companies covered under the legislation. Of the 248 companies that submitted inaugural statements under Australia’s law in 2020, 48 already have reporting requirements under UK or California law. The disclosure requirements have raised some serious labour rights breaches, even with limited enforcement powers. For example, British retailer Tesco PLC reported in its 2020 modern slavery statement that it had found evidence of abuse and debt bondage among migrant workers in its Malaysian and Thai supermarket businesses. The United States government under its Tariff Act has the authority to ban the import of any products suspected of being produced by forced labor, and in the past year has introduced new restrictions on items from Asian countries including palm oil, rubber, textiles, and vegetables.  

Nneka Chike-Obi, Director in the ESG Research at Fitch Ratings, will be joining Investing in socially sustainable and fair corporates: can Asian companies take the steps that investors are demanding on social issues? panel at RI Asia 2021 on Tuesday November 9. 
Tune in and register here.