Building more resilient global value chains

Where are we today

The COVID-19 pandemic emerged in a world characterized by high trade tensions and considerable inertia across the multilateral trading system. A number of countries were moving towards plurilateral, regional and bilateral trade arrangements, and some governments were already beginning to explore ways in which they might more actively shape domestic economic activity.

Whether these shifts were in response to the rise of state capitalism, concentration in digital markets, societal preferences for a more ambitious sustainability agenda, or all of the above, one consequence of COVID-19 has been an acceleration of the drift towards national policies that discriminate in favor of domestic suppliers

This drift is particularly evident in the current discussion in some policy circles around ''the need to re-shore global value chains (GVCs) post-COVID-19''. This is a solution in search of a problem. The available evidence suggests that GVCs have, overall, performed well to date, responding quickly to an unprecedented surge in demand for masks and other personal protective equipment, medical services, and information, communications, and telecommunications (ICT) equipment & services, and to a considerable shift in the nature of food demand. Are GVCs perfect - no; are there vulnerabilities in supply chains that need to be addressed - yes; will GVCs have to become more resilient - yes. The real issue is not whether, but how; specifically, what are the respective roles of the private sector and of governments in building more resilient GVCs?

Where are we coming from

The development and public release in 2013 of new trade in value-added (TiVA) data, encompassing 90% of global economic output, demonstrated clearly the increasingly interconnected nature of our economies. GVCs obviously pre-dated the availability of TiVA estimates, but these new data enabled governments to understand better where value was being created along internationally fragmented production networks. Over time, TiVA data also underpinned analysis to inform how countries at different stages of development and firms of various sizes could benefit more from participation in GVCs.

From a trade policy perspective TiVA highlighted the importance of reducing unnecessary trade costs, such as tariffs, inefficient border procedures, and ineffective or discriminatory domestic regulations governing both goods and services. Also highlighted was the reality that trade policy alone would not deliver more inclusive growth and jobs within and across countries. Early analysis of GVCs, including in the context of G20 discussions over successive years, strengthened the case for more open markets, but even more importantly drew much needed attention to the imperative of coherent structural policies, and in particular for increased investments in human capital, active labor markets, and social safety nets.

In the decade following the global economic crisis the expansion of GVCs stalled, owing in part to a combination of increased economic uncertainty and  growing trade protectionism, leading many firms to re-examine their supply chains, sourcing strategies, and investment plans. The nature and scope of GVCs primarily reflect evolving business strategies, rather than deliberate public policies to re-shape or re-shore economic activity. Is this business-led evolution of GVCs likely to change in favor of a state-managed model?

Where might we be tomorrow

GVCs are widely expected to be more robust, more resilient and better equipped for the next unexpected shock - whether driven by technology, security, climate, health, or any other 'low probability, high impact' event. How can these expectations be met - what can the private sector do, what can governments do?

Individual firms are well-placed to assess potential threats to their supply chains and to develop appropriate risk mitigation and management strategies. There is no single 'best approach'; even within the same sector, some firms will diversify sources of supply in order to provide the needed agility to withstand an unexpected shock, while other firms will favor fewer and deeper supplier relationships in order to rebound quickly following a shock. For the most nimble firms unexpected disruption will create new opportunities, such as rapidly growing markets for digital technologies and for a range of business and consumer services.

The private sector should be prepared for higher demands on them from governments seeking to ensure reliable access to essential goods and services, at all times. Businesses and governments could usefully work together to establish more robust foresight exercises, for example, to help identify unexpected events for which we are not yet prepared. And while larger firms may have the requisite capacity to identify and to correct vulnerabilities within their supply chains, small and medium sized firms may not; here too, private-public cooperation could contribute to better outcomes.

Businesses and governments will not always share the same level of tolerance for risks. Creating strategic stocks of 'essential goods', and maintaining redundant capacity to provide goods and services beyond normal levels of demand, will not be feasible for individual firms. Where governments see a need for such actions, clearly articulated policies and public funding will need to be in place.

In addition to incentivizing firm behavior in pursuit of better performing supply chains, an important role for government is to remove existing dis-incentives to building more resilient GVCs. Eliminating, or at least progressively reducing, tariffs, inefficient border procedures, undue restrictions on cross-border data flows, and unnecessary regulations would enhance the ability of firms to adapt more quickly and to mitigate the negative impacts of unexpected shocks. More sources of competitive supply mean not only more opportunities to diversify risks, but new opportunities to increase productivity, output, and jobs.

Such measures target the stated public policy goal - more resilient GVCs - and are in stark contrast to government policies that instead target re-shored production and shorter supply chains, presumably on the assumption that localized production is more stable and reliable. In fact, just the opposite is true. Policies that aim to 'force' re-shoring' (such as domestic subsidies, border protection, and local content requirements) imply higher costs, higher prices, lower output, and less - not more - stability of supply.

These policies also involve opportunity costs, meaning less funding is available for other policy priorities, from health and well-being to innovation and infrastructure. And the burden of higher prices, increased instability, and foregone public services will fall most heavily on vulnerable groups least able to bear the burden.

More broadly, governments can do much to reduce the uncertainty that overshadows global economic prospects, including by updating the rule-book for international trade and re-invigorating the shared commitment to mutually beneficial international cooperation. This is as easy to say as it is hard to deliver, but it is also less costly and much more likely to generate sustainable benefits than a return to nationalist policies that we already know will not work.

Ken Ash is an Independent Consultant, IIT Visiting Fellow, and former OECD Director of Trade and Agriculture.

The views expressed here are the author’s, and may not necessarily represent the views of the Institute for International Trade.