A protracted slowdown in international trade may push some countries to reconsider the relative dependence of their economies on internal factors and control potential losses by spreading the risks that arise from distributed production facilities.
This article was originally published on BW Businessworld.
Governments around the world instituted a broad range of strict social controls to slow the spread of the covid-19 pandemic. Although these measures helped to save lives, they led to a drastic decline in global economic output and constrained international trade volumes. The pandemic also adversely affected the global value chains of major countries. The consequences of these events are likely to have long-term implications with the unprecedented economic turmoil expected to act as a catalyst in impacting changing demand patterns, trade policy uncertainties or shift in production facilities. How these factors take shape will determine how future value chains evolve.
Global value chains are extremely important for driving increased manufacturing capabilities and boosting investment and employment for supporting economic growth and improved standards of living. Each part of a supply chain is interconnected with the other. If activities in one part of the supply chain are impacted, the contagion spreads across the supply chain with ripple effects observed across global economies. Nevertheless, the covid-19 crisis helped raise awareness about risk management arising from shifting of production facilities and need to unravel some degree of economic interdependence, key factors in determining the structuring of future value chains. A keen understanding of how these changes unfold will help businesses manage risk efficiently and allow manufacturers to expand their global market presence.
Covid-19 has precipitated a sharp contraction in global trade. The world economic outlook is appearing uncertain with every country struggling against headwinds on both the supply and demand sides of the market. The global economy has been recovering at a staggered pace, with different countries rebounding at different rates. An analysis of forecast growth in exports from 2020 to 2025 indicates that income-sensitive industries (those producing goods with a high price elasticity of demand) will lead the recovery. Supply chains over the past three decades, have become increasingly global. This change has been driven by an increase in the number of tradable goods and services. Tradability is determined by the extent to which items can be produced slightly from the market where they are anticipated to be consumed. The main factors in tradability are transportation costs and perishable nature of products. For goods with high value relative to their size and shipping cost, it makes sense to manufacture them in a low-cost region and ship them. A steady decline in these costs (coupled with improved efficiency in international transportation) has encouraged many companies to shift to a global sourcing model, enabling them to leverage the benefits of lower costs for labor, materials and land.
The increased use of subcontracting has been a contributing factor in the growth of supply chains. Factors like highly sophisticated components, manufacturing processes requiring specialists and producers realizing the importance of flexible capacities that can be tuned to cater to demand fluctuations have prompted businesses to implement subcontracting.
Transformation of Global Value Chains
In the short term, the outbreak forced many countries into national lockdowns as they strived to lower domestic transmission rates. This, in turn, caused a slowdown in economic activity, rise in unemployment, and fall in consumption levels. Coupled with a slump in imports and exports, many economies naturally slid into deep recessions. Over the long term, the epidemic may also leave deep scars on global economies, though a transformative impact is foreseen. This is because labor productivity has fallen and economic growth may drop below its potential, leaving an unrecoverable gap in output. Businesses will need to be more flexible and agile in responding to future challenges. A protracted slowdown in international trade may push some countries to reconsider the relative dependence of their economies on internal factors and control potential losses by spreading the risks that arise from distributed production facilities. These factors will play a pivotal role in shaping future global value chains.
These profound changes in the world economy, together with COVID-19 consequences, are now determining the changes in global value chains. Corporations are thus now attempting to unpick some of the intricacy, while also trying to shorten the distance between production sites and their home country. They are also aiming at setting up production bases across offshore sites to reduce the risk of losses in the event of another crisis.
Countries are now looking for distribution channels for goods that are closer to production sites. Going forward, we are likely to witness the restructuring of value chains, making them shorter, increasingly diversified, and more regionalized.
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