Letter IEDI n. 1104—Risks and resilience of global value chains
Due to the disruptions and vulnerabilities evidenced during the COVID-19 pandemic, raising the resilience of global value chains (GVCs) has become a top priority for companies and governments. This Letter IEDI presents possible paths pointed out by UNCTAD (United Nations Conference on Trade and Development) to achieve greater resilience in the chains of multinational companies.
As we have seen so far, the pandemic has weakened value chains around the world. Firstly, those of health equipment and medicines, due to supply problems arising from restrictive measures to combat coronavirus’ outbreaks, but also from a low capacity to respond to peaks in demand and geopolitical factors that led to foreign trade restrictions, among other factors.
Then, problems appeared in the chains of a much broader set of sectors, becoming a cross-cutting issue to the global industry. The lack of semiconductors for the automotive sector and the rise in the prices of grains and staple foods (corn, rice, wheat flour) are notorious examples, with the latter compromising food and nutritional security in several countries, especially in the poorest.
Given the recent negative experience, companies became aware of the need to act to avoid new episodes of this nature. According to UNCTAD, several surveys with executives confirm the perception of vulnerabilities in global supply chains and indicate the need to change international production strategies to build greater resilience.
It is worth clarifying what is meant by resilience: the ability to return to normal operations in a reasonably short period of time after a given shock or rupture, even though this may imply some damage to productive efficiency as previously defined by the companies.
From the perspective of multinational enterprises, the ways to improve resilience, according to UNCTAD, are the restructuring of productive networks (involving investment and/or divestment decisions), supply chain management solutions and sustainability measures. On this last aspect, there is an intention and even a call on the part of governments to "rebuild better" and make the global economy more resistant to shocks, contributing, at the same time, to overcoming environmental and social challenges.
UNCTAD notes that risk management solutions are generally more agile and less costly. They may require substantial investments in technology to increase control and coordination of the chain, or require increases in production capacity or safety stock, or even imply a change in operating models from "just-in-time" to "just-in-case".
Despite this, these trends do not necessarily imply structural changes in the location of productive assets, according to UNCTAD, and therefore would have less impact on foreign direct investment (FDI) than the restructuring of the production networks.
However, the study argues that risk management solutions may not meet the challenges posed by growing competition and market conditions after the pandemic, such as the different incentives and restrictions on international trade and investment by countries. In UNCTAD's view, this will impact productive restructuring, via nearshoring, reshoring or diversification.
UNCTAD researchers’ believe that the nature of productive restructuring of global chains marks a new moment for the manufacturing industry, with substantial impacts on international trade and productive investment flows.
Therefore, the long-term effects of the search for greater resilience would become part of a process of broader structural change, which already started even before the COVID-19 pandemic, with the development and adoption of 4.0 technologies, geopolitical disputes—especially between the US and China—and the necessity of sustainability.
Reshoring and nearshoring movements meet the need to limit the complexity and interdependence of GVCs, making them shorter and bringing part of industrial manufacturing and its supplier base back to developed countries in order to minimize the exposure to risks and the propagation of adverse shocks across production networks.
On the other hand, regional production diversification strengthens complex and geographically dispersed networks, as a means of avoiding excessive productive capacity concentration and of building a certain degree of redundancy in the system. Thus, UNCTAD believes it would allow a diversification of suppliers, operations and distribution channels, increasing supply alternatives and their proximity to markets.
According to the UNCTAD mapping, the industries most exposed to risks that compromise resilience are the longer and more fragmented ones, such as the automotive, electronics, machinery and equipment, textiles and clothing chains. They correspond to 20% of total greenfield investment and 50% of the aggregate of the manufacturing industry. Therefore, they are important for the dynamics of developing economies.
As a consequence, decisions within these chains can have important effects on employment and income in these countries or in some of their regions, as in the case of the automakers that have closed their Brazilian operations. After all, the physical reallocation of fixed (tangible) assets involves sunk costs associated with the loss of productive capacity and labor, in addition to financing costs associated with the establishment of new facilities, particularly for more capital-intensive activities.
In general, UNCTAD emphasizes that measures to restructure productive networks to build resilience put significant pressure on the costs of multinational companies, and may eventually reach prohibitive levels. It concludes, then, that resilience should potentially lead less to productive restructuring and more to a gradual rebalancing of production networks.
In the short term, in UNCTAD's view, it is likely that the movements of reshoring, nearshoring and geographic diversification will only take place as a result of political pressures and incitements stemming from concrete economic policy actions. It is important, therefore, to closely monitor the post-COVID-19 economic policy agendas of the main world economies.