Friday, July 3, 2020

COVID-19 doesn’t spell the end of supply chains

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Author: Ken Heydon, LSE

Well before the COVID-19 pandemic, global value chains (GVCs) were losing their impetus as drivers of world growth. Between 2012 and 2015, GVCs were already playing a lesser role in stimulating trade than they had in earlier cycles. Concerns about the environmental footprint of globally-fragmented production were one thing. But rising protectionism was the principal reason.

This became more apparent with the onset of US punitive trade action against China under the Trump administration. Among many examples, penalty tariffs against China led Japanese firms Toshiba and Komatsu to shift the assembly part of their supply chain (at considerable cost) from China to Thailand, Mexico and, in a form of onshoring, to Japan itself.

COVID-19 has transformed and accelerated these trends, triggered by factory closures, transport restrictions and mounting national security concerns. The impact in some cases may be temporary, like the export restrictions impeding and distorting the supply chain for surgical facemasks. But elsewhere the effects will be far-reaching and persistent.

Over 200 of Fortune global 500 firms have a presence in Wuhan. Disruption to China-centred supply chains has seen plant closures affecting firms as diverse as Apple, Hyundai and Airbus. The UN Conference on Trade and Development (UNCTAD) expects global foreign direct investment — a key facilitator of globally fragmented production — to fall by 30–40 per cent in 2020–21.

To be clear, this does not spell the end of globalisation nor global supply chains. David Ricardo’s foundational insight that a country will export the product in which — on the basis of domestic opportunity cost — it has a comparative advantage and import the product in which it has a comparative disadvantage has proved remarkably robust.

One important application of this principle is the vertical specialisation of the GVCs, or specifically the location of skill-intensive production in high-wage countries and the movement of labour-intensive stages to low-wage countries. This enables goods to be produced where cost is lowest.

As former UK Treasury minister Jim O’Neill said recently, as long as firms seek to satisfy customers with the highest quality products at the lowest possible prices, globalisation will remain a fact of economic life.

A global shock also does not mean that supply chains in all sectors are being affected identically. OECD research on recovery rates after the 2008–09 global financial crisis suggests that supply chains in mining and quarrying are much less prone to external shocks than are those in, for instance, motor vehicle production. This is because they have a relatively higher services component, typically less prone to cyclical movements than manufacturing, and are composed of a less diverse bundle of technologically complex products.

Although in the aftermath of COVID-19, the global fragmentation of production will continue and some supply chains will be relatively less disrupted, it won’t be business as usual — and certainly not in the Asia Pacific region.

Over time — and probably only at the margin — there will be attempts to reduce dependence on GVCs through onshoring based on 3D printing and accelerated automation of labour-intensive activities. More immediately, the GVC itself will be radically reconfigured with the introduction of digital supply networks based on functional silos linked via the use of big data analytics to better anticipate and deal with disruption.

This could enhance efficiency, but other likely changes may not. There will be moves to shorten and regionalise supply chains, strengthening links to the distorting preferences of regional trade agreements. COVID-19-driven ‘sovereignty’ policies compelling firms to relocate their data within national borders — as already happens in China and India — could reduce future gains from digitalisation. And accelerated moves, backed by government funding, to reduce dependence on China will come at a cost.

The desire of countries to reduce supply chain dependence on China will be profoundly affected by changes taking place within China itself. Part of the dynamic of China’s rise is the goal of capturing more value-added within the supply chain. This was seen when Chinese smartphone manufacturers shifted production towards more sophisticated components, with Xiaomi launching its first processor and Huawei its own chip and memory. Still, Chinese firms developing in-house competencies will also seek benefit from global fragmentation by…

Read the rest of this article on East Asia Forum

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