Global trade needs more supply diversity, not less – IMF Blog

By Davide Malacrino, Adil Mohommad and Andrea Presbitero

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Countries with trading partners that have implemented stricter containment measures have seen a steeper decline in imports. Although trade flows have adjusted, more diversified global value chains could help cushion the impact of future shocks.

The demand and supply shocks triggered by the pandemic were expected to cause a dramatic collapse in trade, but international trade proved more resilient than in previous global crises.

While merchandise trade fell sharply in the second quarter of 2020, it rebounded to pre-pandemic levels later in the year. The decline in services in 2020 (such as tourism) was worse and recovered more slowly, given continued restrictions to contain infection in some countries.

International spinoffs

Pandemic-specific factors help explain these business patterns.

First, imports of goods have been larger in 2020 than demand (and relative prices) alone would predict, more so in countries under strict lockdowns or severe outbreaks.

Second, the lockdowns have had significant international spillovers, albeit unintentional. Countries whose trading partners have implemented stricter containment measures have seen larger declines in imports of goods. Blockades from trading partners accounted for, on average, up to 60% of the drop in imports in the first half of 2020. These impacts were greater in industries that depend heavily on global value chainsand are further downstream in the production process (like electronics).

The effects were short-lived, however, suggesting that global supply chains have been resilient. And remote working has also mitigated the business fallout from the shutdowns.

Despite this, the disruption caused by the pandemic has led to calls for more domestic production of goods (reshoring). our latest World Economic Outlook shows that dismantling global value chains is not the answer—After diversification, no less, improves resilience.

Adapted global value chains

Trade data confirms this. In mid-2020, Asian countries, which were hit early by COVID-19 but later managed to contain it (just as many European countries imposed severe restrictions on mobility), saw their share of market for GVC-related products increase by 4.6 percentage points in Europe and 2.3 percentage points in North America. These gains were large and rapid by historical standards, but as countries adapted to the pandemic they partially unfolded, suggesting the changes were likely temporary.

Although global value chains have adjusted, some industries such as automotive have faced significant supply disruptions, highlighting the need to build resilience. We analyze two options for building supply chain resilience: diversification of inputs between countries and greater substitutability of inputs.

Building business resilience

We simulated the effects of disturbances in a global economic model and compared the results with higher levels of diversification or higher substitutability (the ease with which a producer can switch inputs from one supplier from one country to another). other). We considered two scenarios: supply disruption in a single major input-supplying country; and provide shocks to multiple nations.

Our analysis shows that diversification significantly reduces global economic losses in response to supply disruptions. Following a significant contraction (25%) in labor supply at a single major global supplier, the gross domestic product of the average economy falls by 0.8% compared to the reference scenario . In the high diversification scenario, this decline is reduced by almost half.

Greater diversification also reduces volatility when multiple countries are hit by supply shocks. We estimate that the volatility of economic growth in the average country is reduced by around 5% in this scenario. Diversification, however, offers little protection when a major disruption hits all economies at once, such as the first four months of the pandemic.

Countries can diversify by sourcing more intermediate inputs from abroad. Currently, there is a significant “national bias” in the sourcing of these supplies. Companies in the Western Hemisphere, for example, buy 82% of their intermediate products domestically. The relocation of production lower further diversification.

Substitutability can be achieved in two ways: through greater flexibility in production, as when electric vehicle maker Tesla Inc. rewrote software to allow its cars to use alternative semiconductors in response to the shortage of semiconductors; or by standardizing inputs internationally. For example, General Motors Co. recently announced that it was working with semiconductor vendors to reduce the number of unique chips it uses by 95%, down to just three families of microcontrollers. This standardization would replace a host of chips, eliminating switching costs between them.

Considering again the scenario of a 25% labor supply contraction at a large global supplier of intermediate inputs, we find that with greater substitutability, GDP losses across all countries (other than the source country) are reduced by about four-fifths.

Political implications

Ensuring equitable access to vaccines and treatments remains the top policy priority. Recent targeted lockdowns in China are a reminder that pandemic-related restrictions continue to have an impact far beyond the affected country. It is in the interest of all countries, including those with high vaccination rates, to end the acute phase of the pandemic everywhere.

Amid growing concerns about global economic fragmentation and “friendshoring» Following the war in Ukraine, our analysis also shows that greater diversification and substitutability of inputs can build resilience. While business decisions will primarily shape the future resilience of global value chains, government policies can help by providing an enabling environment and reducing costs.

One obvious area is improving infrastructure. The pandemic has shown that infrastructure investments in certain areas are key to mitigating supply disruptions related to trade logistics. For example, upgrading and modernizing port infrastructure on major global shipping routes would help reduce global choke points. Better digital infrastructure to facilitate remote working can also help mitigate the spillovers to other countries.

Governments can also help make information more widely available, so businesses can make more strategic decisions. For example, automakers deal directly with around 250 Tier 1 suppliers on average, but this number increases to 18,000 suppliers across the value chain. Improving access to information on business-to-business transactions and supply chain networks, for example by digitizing business filings of documents, such as tax returns, can be helpful, especially for small businesses with fewer resources.

Finally, reducing trade costs can help diversify inputs. It is possible to reduce non-tariff barriers, which would provide a significant medium-term economic boost, particularly in emerging markets and low-income developing countries. In addition, reducing trade policy uncertainty and establishing an open and stable rules-based trade policy regime can promote greater diversification.

This blog, based on Chapter 4 of the April 2022 World Economic Outlook, “Global trade and value chains during the pandemic,” includes research by Galen Sher and Ting Lan, under the direction of Shekhar Aiyar, and the support of Shan Chen, Bryan Zou, Youyou Huang and Ilse Peirtsegaele. The analysis was concluded in early 2022, before Russia invaded Ukraine, and does not focus on the implications of the war for global trade and value chains.