21 June 2022

New Word Bank research tells us how to make Global Value Chains more resilient

by Paul Brenton, Michael Ferrantino and Maryla Maliszewska / in Op-ed

This article draws on a recent World Bank publication by the authors and titled "Reshaping Global Value Chains in Light of Covid-19” 

The past two decades have seen the share of global exports from low- and middle-income countries almost doubling to 30% and the world’s population living in extreme poverty falling from 36% to 9%. These dramatic expansions in trade, productivity and economic growth were propelled by the emergence of Global Value Chains (GVCs).  

GVCs also enabled an international division of labour, increasing efficiencies and economies of scale. Firms in low- and middle-income countries now can supply intermediate inputs to global production networks, benefiting from the industrial bases of other states. They can also import cheaper and better inputs, technologies, and improved management practices. This allows them to grow faster and create better, higher-paying jobs.

Lessons from Covid-19

During the pandemic, concerns grew about the propensity for GVCs to transmit shocks from one country to another as global trade fell by 8% in 2020, a drop similar to the one of the Great Recession of 2008–09. For example, a scarcity of microprocessors had knock-on effects in sectors like motor vehicle production. When firms in high-income countries abruptly cancelled clothing orders, garment factories in countries like Bangladesh closed, laying off thousands of mostly female workers.

The crisis also highlighted the risks low- and middle-income countries reliant on trade face in accessing essential items like medicine and food. Export restrictions on essential personal protective equipment, medicine, and vaccines bred scepticism about the fairness of trade. This compounded increasing uncertainty over the role of GVCs arising from other developments, such as China’s evolving role in the global economy, emerging policy responses to climate change and, most recently, geopolitical tensions from the war in Ukraine. There is also a greater awareness that, without appropriate flanking policies, not all will gain from trade.

Concentrated GVCs are especially vulnerable when shocks affect key nodes in production networks and opportunities to find alternative suppliers or buyers are limited. However, the pandemic also demonstrated that GVCs can help maintain trade relationships and allow stronger trade-led recovery. When the costs of establishing a network of suppliers are high, lead firms tend to maintain and support existing relationships. GVCs can also transmit recovery in one part of the world to other parts. Indeed, as the world has recovered from the pandemic, trade has powered growth, rebounding faster and stronger than any other component of global output.

Managing crisis and recovery

Recent work at the World Bank finds that maintaining and enhancing trade mitigates against crises. Our economic modelling shows supporting trade strengthens recovery while restricting and reshoring production weakens it. All countries are better off in a globalized rather than a fragmented world, during and after a crisis.

Our work suggests that creating a more “hostile” environment for GVCs through global reshoring to higher-income countries could drive up to 52 million more people into extreme poverty, 80% of them in Sub-Saharan Africa. In contrast, reducing barriers, streamlining procedures, and facilitating trade improve resilience to future shocks and could lift almost 22 million more people out of poverty by 2030 and improve the incomes of the bottom 40%. 

GVCs need strengthening, not weakening. There is a need to protect small exporters against the sudden cancellation of contracts, especially those not deeply embedded in trade networks, or those in countries with poor contract specification and enforcement. Governments can improve access to information and trade finance, strengthen contractual rules, and deepen relationships with overseas buyers and sellers. Development partners can promote corporate social responsibility among buyers and lead firms in GVCs to honour contracts during crises.

Meanwhile, climate change is already affecting trade in low- and middle-income countries. The latter are most affected and least able to afford its consequences. More frequent and extreme weather events, rising temperatures, and changing precipitation levels are altering traditional comparative advantages.

Emerging policy responses to climate change will affect exporters in many countries. Under the European Union (EU) Green Deal, for example, coal imports could be cut by almost two-thirds. This shows the need for diversification in countries highly reliant on fossil fuel exports and carbon-intensive manufactures, as well as for heightened investment in greener GVCs.  

Policy interventions

Policies to maintain trade flows can limit and overcome global shocks. A crisis is a bad time to raise trade barriers, as the need for imports may increase, and exports are an important stabilizer and a source of jobs and incomes. Trade policy reforms, such as tariff reductions, cut the cost and improve the availability of essential goods and services. In so doing, they help restrain inflationary pressures, once again with positive distributional consequences for poorer households and workers. Trade reforms also reduce tax and administrative burdens and support eventual economic recovery and improved resilience through greater diversification of imports and exports. 

Making trade easier

Streamlining procedures and facilitating trade can mitigate against a crisis. Making logistics operations more efficient also reduces disruptions to distribution networks and regional and global value chains. The strain global supply chains have experienced as global demand recovers highlights the need for digitalization to increase transparency, flexibility, collaboration, and quicker decision-making. Digital platforms can coordinate and forecast logistics in ports, like rail and trucking capacity before ships arrive.

Access to finance and contract enforcement  

Small exporters not deeply embedded in networks with lead firms face higher risks of contract cancellation during a crisis. When there is no support from the network, the financial system and government are the backup, but in the poorest countries, these may not have the strength to play this role. Therefore, international development institutions could consider offering some form of insurance for exposed firms in low-income countries. Reforms to contract enforcement that clearly spell out how risk is to be distributed in an unforeseen situation would also help. 

Better supply chain mapping

Many supply chain disruptions come from not knowing how GVCs are constructed and where lower-tier suppliers of major products are located. Improved mapping and better information within firms, aided by improved managerial techniques, can help. Digital technologies providing end-to-end visibility, as well as Big Data and artificial intelligence, can identify weaknesses and remedy potential choke points along complex value chains.  Governments should become more aware of the interlinkages within their own economy and with economies elsewhere, scaling up information about stockpiles of key supplies.   

Better coordination and discipline

A major international policy challenge arising out of the Covid-19 crisis has been how to avoid countries from restricting the exports of essential medical products, vaccines, and food. Economists agree that export restrictions and precautionary purchases of essential goods by a small number of key countries can lead to rapid rises in prices and severe shortages elsewhere. Such measures call for better coordination, including improved monitoring of market conditions for strategic goods, more effective global disciplines on the use of export restrictions, and opening up import markets that provide greater certainty of access. 

Support for greener growth

Low- and middle-income countries need support to adjust to trade measures that are being introduced to meet climate change objectives. These measures bring challenges, especially for exporters of carbon-intensive products, as well as opportunities to diversify into new products based on low-carbon technologies. Aid-for-trade programs can be recalibrated and enhanced to support the technical assistance and capacity building that countries will require to identify and exploit areas of carbon competitiveness effectively.  

GVCs have helped make the world more prosperous. Making them more efficient will make the global economy more resilient to future shocks.

Any views and opinions expressed on Trade for Development News are those of the author(s), and do not necessarily reflect those of EIF.