Pandemic and Global Value Chains

The outbreak of the pandemic in early 2020 in China and the subsequent disruption of supply chains during the first months of last year raised alarms around the world. Many issues arose, including the risks of excessive concentration of production and dependence on medical and hospital equipment, medicines and other goods manufactured in China, excessive interdependence of industrial production, and the transmission of economic shocks caused by the pandemic to the world economy through trade.

Governments reacted to the limitations in importing healthcare products and declared the issue a matter of health security, similar to food security, and began to advocate for the diversification of supply chains and local production of these and other goods and services. Some countries have gone even further and taken steps to interfere with foreign investment and trade and have taken actions to reclaim their multinational companies operating in China. Furthermore, industrial policy agendas have been revived.

These concerns have led to an intense debate about the future of global value chains (GVCs). Questions emerge as to whether government reactions will end the globalization of production and whether multinationals will actually leave China. Whatever the answers, the prevailing sentiment is that GVCs may have gone too far and exposed their limits and that they should now be transformed.

But evidence shows that the GCVs have undergone a process of transformation since long before the pandemic, toward regionalization. The reasons for this include the increasingly important value-added services, such as R&D, distribution and brands; the popularization and widespread use of labor-saving technologies, such as robots and artificial intelligence; the growing relevance of customizing production and regionalizing sales and marketing strategies; growing concern about carbon footprint; lessons from the 2011 earthquake in Japan for supply chains; and increasing the participation of intangibles in consumer baskets. Therefore, the transformation of GVCs is apparently associated with technological changes and business strategies.

In this regard, should we expect a fall in GVCs and their strong presence in China? Except for medical-hospital equipment and other politically sensitive elements, there are reasons to expect little to change in the short term in addition to the process already underway. And the reasons for this abound:
China is seen by multinationals as a very appealing location to develop, produce and distribute worldwide. It should be noted the main determinants for the location of important activities of value chains include collaboration and relationship networks, logistics and diversity of suppliers, which are factors that abound in the Asian giant. Relocating industrial plants, distribution centers and research laboratories would be costly and time-consuming, especially in today’s difficult business environment.

In addition to the issue of efficiency, the presence of multinational companies in China is increasingly justified by the size of the Chinese and Asian markets, which are becoming the hub of the global economy. 

Lastly, although China is already developing advanced technologies, brands and even leading major GVCs, the country still needs the presence of multinationals and foreign investment in several areas, which suggests that the government should continue with recent policies of market-specific liberalization. thus encouraging new investments.

These reasons help explain why China has become the main destination for global foreign direct investment and the recent conclusion of the ambitious China-European Union agreement on investment (CAI).

Furthermore, politicization of trade issues, investments and resource and data flows can influence GVC destinations. There are many measures being taken in this direction, including protectionist actions; measures that compromise existing commercial contracts; sanctions and asset locks; restrictions on payments and transfers; laws that curb mergers and acquisitions; measures that jeopardize the free functioning and integrity of the internet. The implications of these actions for GVCs are clear and profound, and include a declining legal certainty, rising production costs and higher consumer prices.

Which of the two sets of factors will prevail in deciding the destination of the GVCs: the commercial bias or the political bias? There are indications in favor of both, but it would be reasonable to expect that businesses will be favored.

One thing is for sure: For Latin America, which generally participates in GVCs through the production and export of commodities and imports a significant portion of the manufactured goods and inputs it needs, these barriers will impinge on regional exports. It is therefore necessary to consider raising import prices to meet national interests, with potential impacts on growth, productivity, competitiveness, well-being, jobs and poverty.