Kinks in the Global Supply Chain: Can Laws Keep Us Safe?

Mattel’s recall of nearly one million toys made in China sent the more than $71 billion global toy industry into a frenzy in August 2007.In the United States, the company’s revelations that some of its products were coated with lead paint and others contained magnets that could detach in a baby’s mouth, drove executives at other toy companies to their BlackBerrys.

“Given all the intense public scrutiny on this issue, everyone was hyper-focused on product safety—from the government, which wanted to be seen as doing something about it, to the manufacturers, who wanted to make certain that their supply chain quality control was adequate,” says Peter Winik ’80 (BA ’77), deputy managing partner and global co-chair of the product liability and mass torts practice group at Latham & Watkins in Washington, D.C. “It was all a little tense back then.”

China was feeling the pressure, too. Teams from the General Administration of Quality Supervision, Inspection and Quarantine, or AQSIQ, Beijing’s quality-control department, fanned out to inspect factories across the southern Guangdong province, where many of the toys on U.S. shelves are produced.

Back in the United States, lawyers were moving quickly as fears of foreign-made products made news headlines. By mid-August, even as Mattel continued to announce additional, larger recalls, outraged customers had filed a class-action lawsuit against Mattel and its Fisher-Price brand in a federal court in Manhattan. The California attorney general and the Los Angeles city attorney filed suit against Mattel, Toys“R”Us, and 18 other companies, alleging that they had made or sold products that contained illegal amounts of lead.

The recalls, and the flurry of activity that ensued, brought to light an uncomfortable reality: While shifting manufacturing of consumer goods overseas has saved money, it has also complicated the supply chain. And reports of child and forced labor used in developing countries to make goods for the American market fly in the face of labor standards developed in the West over the last century. In exchange for lower prices, companies—and the public—have relinquished control over the manufacturing process. Politicians, multinationals, and consumers are realizing that there are serious flaws in the monitoring of product safety and working conditions overseas—and they raise urgent questions about liability and responsibility when things do go wrong.

The Cheap Labor Dilemma 

Long before the recent debate over outsourcing and offshoring began, before CNN commentator Jack Cafferty called Chinese exports “junk,” and before members of Congress began pressing for tariffs on Chinese imports, U.S. retailers were quietly increasing their purchases of goods overseas.

Back in the 1950s, Japanese textiles and clothing were so cheap—including the famous “one-dollar blouse”—that they provoked an outcry from U.S. textile makers. In 1980, domestic manufacturers made 70 percent of the apparel purchased in the United States. By 2006, roughly 90 percent of apparel sold here was imported. Today, 99 percent of footwear sold in the United States is made overseas. About 85 percent of toys and 59 percent of electrical products are manufactured abroad. Many come from China, where export prices have been as low as one-fifth of the cost of goods made in Europe or the United States. In 2007, China exported $321.5 billion worth of goods to the United States.

But the risk with this type of manufacturing is that as the number of companies in the supply chain increases, transparency declines. Seungjin Whang, the Jagdeep and Roshn Singh Professor of Operations, Information, and Technology at Stanford’s Graduate School of Business, explains the inherent risk in what he calls the “double-O” model—offshore outsourcing. “Here is the challenge—there is still too wide a span of entities involved,” he says. “You can’t have control over your supplier’s supplier’s supplier, who may be 500 miles away from a major airport.”

These problems are not limited to China. In June, the BBC reported that Primark, a large U.K. discount retailer, had been relying on child labor in India. Primark canceled its orders from the three suppliers where underage workers had been found.

At the same time, companies are starting to acknowledge that their approach to monitoring labor abuses by their overseas suppliers, based on codes of conduct designed in the 1990s in response to anti-sweatshop campaigners, are not working.

“The companies that have been at this for the longest time, the apparel companies, think that monitoring is not working all that well, nor do the leading non-governmental organizations (NGOs) working on labor standards,” says Joshua Cohen, professor of political science, philosophy, and law and director of the Program on Global Justice at the Freeman Spogli Institute for International Studies (FSI). Cohen has launched a collaborative project, Just Supply Chains, with Richard M. Locke, an MIT Sloan School of Management professor, to explore alternative ways of improving conditions in global supply chains.

“There isn’t yet a sufficiently consistent and powerful set of forces aligned that say ‘fix this and if you do, we’ll give you benefits in the marketplace that enhance your competitiveness,’ ” says Robert H. Dunn, former chairman, president, and chief executive officer at Business for Social Responsibility, a nonprofit group of global companies that promotes more ethical business practices. Dunn, the former vice president of corporate affairs at Levi Strauss & Co., the first brand to introduce a code of conduct in the 1990s, is now president and CEO of the Synergos Institute, a nonprofit organization that works on poverty and social justice issues. He has also lectured on corporate social responsibility at Stanford’s Graduate School of Business.

Regulating Product Safety : Ex Ante or Ex Post?

In theory, the best way to control for supply chain risks would be for governments in developing countries to make tough laws and enforce them. But while developing countries have laws and regulations on product safety and working conditions, they are not consistently enforced. Other priorities, including attracting foreign investment, creating new jobs, and lifting millions of people out of poverty, generally come first.

“The reality is that there is no considered, thoughtful system of regulating global supply chains,” says Helen Stacy, senior lecturer in law and senior fellow at FSI’s Center on Democrocy, Development and the Rule of Law. Instead, a motley assembly of international institutions, domestic courts and government agencies, bilateral trade agreements and multinationals now oversees the conduct of the millions of factories making goods for Americans.

The task of policing U.S. international supply chains, then, has fallen through the cracks.

At the national level, laws like the Toxic Substances Control Act of 1976 regulate the dangerous chemicals in products. The U.S. Food and Drug Administration monitors pharmaceuticals manufactured abroad, conducting inspections of factories before drugs are approved for import. But before more than 90 deaths in the United States were linked earlier this year to heparin, a blood thinner made in China, the FDA’s funding for preapproval overseas inspections had been cut.

The Consumer Product Safety Commission (CPSC) is the main organization through which consumers can raise their product safety concerns. Based in Bethesda, Md., the CPSC develops standards, recalls dangerous products, and informs consumers about potential risks. It has even banned certain products containing lead. But it is severely understaffed; the CPSC’s 420 employees are responsible for monitoring more than 15,000 types of consumer products.

By contrast, the European Union has introduced the Rapid Alert System for non-food consumer products (RAPEX) to circulate information about dangerous consumer products throughout Europe. Europe also has tough standards on the chemical content of toys. In 2006, the EU introduced the RoHS standard, which limits the amount of six hazardous substances including lead, cadmium, and mercury in electronics.

Still, Alan O. Sykes, James and Patricia Kowal Professor of Law, questions the need for more regulation, arguing that the United States has “the strictest product liability laws in the world.” He explains that any product sold in the United States that causes injury is subject to American laws—no matter where it was made. “There’s no question about it,” says Sykes. “The domestic sellers are hit directly by the tort system and they will pass the effects of that up to whomever they’re dealing with abroad in the supply chain.”

The only caveat, he adds, is that in the tort system, injuries must be traced confidently to the product that caused them.

“It’s not obvious that a big federal regulatory bureaucracy will solve what is essentially a problem outside of the U.S. And when things do go wrong, we have a much more vigorous tort system here than in Europe and other countries—and an expensive one for the manufacturers. So there’s a strong motivation for domestic sellers to ensure that their products—no matter where they are made—are safe,” says Sykes.

And the U.S. government is putting more muscle behind the system. Under legislation signed into law in August, mandatory federal standards governing product safety will get a lot tighter and the CPSC will get new resources to do its job. The beefed-up standards are focused primarily on children’s products and include, among others, the amount of lead and hazardous chemicals allowed in the manufacturing of toys and cribs. Mandatory testing and safety certifications for children’s products, as well as detailed tracking labels that indicate where and when the goods were made, will be required. These laws also strengthen the power of the CPSC to notify the public more quickly about product hazards. And penalties for faulty or unsafe products will rise to $15 million. These penalties should also apply to manufacturers, distributors, and retailers that fail to report dangerous products.

“This is the most profound overhaul of product safety laws in decades,” says Winik. “And they’re only going to get tighter from here.”

In contrast to the product safety laws, U.S. legislation holding manufacturers to account for labor abuses in their supply chains abroad is much less clear. Critics maintain that the institution charged with setting labor standards has no real power. This group, the International Labour Organization (ILO), includes representatives from management, government, and labor and 182 member states. It can name and shame countries that violate its core standards, known as ILO Conventions. But the ILO cannot punish countries or companies for these violations.

Kinks in the Global Supply Chain: Can Laws Keep Us Safe? 4
“THE REALITY IS THAT THERE IS NO CONSIDERED, THOUGHTFUL SYSTEM OF REGULATING GLOBAL SUPPLY CHAINS.”
Kinks in the Global Supply Chain: Can Laws Keep Us Safe? 5
“THERE IS A MISMATCH BETWEEN THE ORGANIZATION OF PRODUCTION AND THE DISORGANIZATION OF LABOR MARKET REGULATION.”

Diverging Needs

“There is a mismatch,” argues Cohen, “between the organization of production and the disorganization of labor market regulation.”

Trade agreements similarly offer little recourse for workers. The North American Free Trade Agreement (NAFTA) and the Central America–Dominican Republic Free Trade Agreement both include labor accords. So do U.S. trade agreements with Cambodia and Jordan. But these labor clauses are still controversial.

“Business has resisted the idea of doing anything that would mix labor and trade,” says William B. Gould IV, Charles A. Beardsley Professor of Law, Emeritus. Opponents of tougher legislation argue that it would handicap U.S. companies when competing with those from other countries. At the same time, U.S. trading partners that are vital to global supply chains, such as China and India, insist on a separation of the two issues. And the issue is even more contentious for developing nations.

“In the course of recent trade negotiations, there have been efforts to include labor standards in the trade agreements, such as with NAFTA and the U.S./Peru agreement,” notes Sykes. He explains that the developing nations strongly resist having the labor standards of wealthy countries imposed upon them for the simple reason that they can’t afford to. But they also see it as an effort by interest groups in developed countries to in effect be protectionists, to raise the cost of production in developing countries in a way that makes them less competitive.

“The developing countries fight tooth and nail against more enforceable labor standards and things of that nature in international agreements,” says Sykes. “And that’s why the effort to link labor to the World Trade Organization was a complete failure. And the labor agreement in NAFTA is just window dressing—it doesn’t really do anything to speak of. And there’s a continual fight going on, even now, on Capitol Hill with the new free trade agreements as to whether there will be any meaningful labor standards in them.”

For now, the only law that can hold companies accountable for labor conditions in their overseas suppliers is one that has been on the books for centuries. The 1789 Alien Tort Claims Act (ATCA), also known as the Alien Tort Statute, gives U.S. federal courts jurisdiction over “any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.” The law of nations, or international law, refers to commonly agreed human rights and labor standards. But barriers to its application are high, despite repeated attempts.

Though lawyers are increasingly filing cases against U.S. companies for labor violations abroad, use of the ATCA for human rights and labor cases remains controversial.

“While there have been efforts to use the ATCA to address labor issues in the supply chain such as underage or forced labor, the statute has not thus far proved a very effective tool for addressing such issues,” says Jenny S. Martinez, associate professor of law and Justin M. Roach, Jr. Faculty Scholar. “The barriers for proving liability under the statute are quite high, and plaintiffs must show that a defendant violated a clearly established norm of international law, which is often very difficult.”

“This is not a way of changing people’s lives here and now,” argues Stacy of efforts to apply the ATCA to international labor cases. “It’s a way of saying there are bigger principles at stake.”

The legal remedies in U.S. courts for abuses in global supply chains remain weak. “Until we get some kind of consensus on regional trade agreements or until we get these Alien Tort Claims Act cases advancing,” says Gould, “we’re really not going to have an opportunity for the kind of symbiosis that we need between public law and private mechanisms.”

Self-Monitoring: Reality v. Theory

Filling the vacuum in the law are the codes of conduct retailers and brands have been using to monitor their overseas suppliers for the past decade and a half. Most codes include requirements that factories follow the local labor laws, not use child labor, and work a maximum of 60 or 72 hours a week. Discount retailer Target, for instance, mandates a safe and healthy workplace and “wages and benefits in compliance with local laws.”

While this looks good on paper, in reality most companies’ sourcing strategies—which involve pressing factories for continual price declines, switching orders between factories, making last-minute changes to designs, and shortening the lead time for products—make their codes of conduct hard to enforce. To meet the dual demands for low prices and good working conditions, some factories have reportedly evaded the codes of conduct by forging fake timecards and coaching workers to tell inspectors what they want to hear. Retailers and brands, facing intense competition at home, remain unconvinced about the bottom-line benefits of these compliance programs—a factory that pays higher wages and provides safety equipment for its workers may well have to raise its prices as a result.

Social auditing is “onerous, it’s costly, and it’s not necessarily effective,” says Dunn. “It satisfies no one.”

Some brands, such as Nike and Adidas, which faced the most pressure from anti-sweatshop activists in the 1990s, have acknowledged that traditional compliance programs are not doing enough to improve working conditions in their suppliers.

Gould believes that the missing link is an international court of labor justice, along the lines of the International Court of Justice in The Hague, where workers could file their complaints. But he concedes that today, “we’re light years away from” being able to establish such an institution.

Consumer as Last Resort

In the meantime, lawyers, product-quality specialists, and activists agree that the only way to make progress on these issues is to change the mentality of both managers in developing countries and buyers from the West. As multinationals’ supply chains have gotten longer and more complex, factories have moved increasingly far away, both geographically and mentally, from the consumer.

An underlying problem in product-safety cases, says Winik, is a “lack of awareness on both sides of the ocean. Companies in China should not be making lead jewelry for any market and one wonders why those products are still being imported.”

Other observers argue that the best way to control suppliers is to use fewer of them. “One option,” says Whang, “will be to shorten the supply chain. Another option will be to reduce the number of suppliers so that we can trust them.” He points to Japanese companies that have a network of 250 suppliers, but work most closely with 10.

Monitoring of the overseas production of drugs such as heparin, the blood thinner, should improve since the FDA agreed in July to team up with Australian and European officials in inspecting facilities. In June, the FDA asked Congress for more funds to beef up inspections abroad, including opening new offices in China.

In the long term, the most fundamental solution must start with consumers. Stacy, for one, is optimistic that this will come to pass. “The long-term trend is that global trade, connected to increasingly sophisticated electronic communication, will lead to an increasing internationally aware buying public, which will increase pressure from consumers on manufacturers and importers to market ethically produced goods.”

Dunn believes that progress toward a solution is likely to be slow. “Unfortunately,” he says, “in the absence of crisis, it can be hard to move the agenda for some of these kinds of problems other than in a very slow and incremental fashion.”

Alexandra Harney spent nine years at the Financial Times, covering China, Japan, and the UK. She is the author of The China Price: The True Cost of Chinese Competitive Advantage.