The role of the global supply chains in the COVID-19 pandemic and beyond

Over the past four decades, global supply chains have become an increasingly central part of the world economy. In the wake of the COVID-19 pandemic, there are concerns about the current role of these chains, in particular given the widely held belief that they have facilitated the transmission of the crisis across countries.1 Now, as many countries start to reopen their economies and look ahead to recovery, there is speculation that companies may seek to reduce exposure to risk by reshoring all or part of their operations.2 If countries turn inward towards more protectionist policies as a result of the pandemic, this tendency to bring production closer to home could be further accentuated.3

The quantification model

To answer these questions, we built a model of world production and trade data covering 64 countries on six continents and 33 sectors spanning all economic activities, using the OECD Inter-Country Input-Output (ICIO) database that provides matrices of domestic and international intermediate inputs and final use trade.

We start by simulating a global lockdown as a contraction in labour supply. To discipline the size of the labour contraction, we used results from a recent study by Dingel and Neiman (2020) measuring what fraction of the work of different occupations that can be done at home.4 A variation in the prevalence of particular occupations in the economy and on how these occupations are used by the different sectors within the economy means that the level of the shock varies across countries. Countries also differ in the stringency of lockdown measures. To reflect this, we incorporated an index from the Oxford Blavatnik School of Government Coronavirus Government Response Tracker, capturing the severity of measures by country5into the model.

The chart below displays the fall in GDP across all countries predicted by our baseline model following the labour supply shock. The GDP reductions are dramatic, at 31.5 per cent on average. There is, however, a significant variation between countries, with the drop in GDP ranging from 21 per cent in China (Taiwan Province) and Sweden (which famously imposed one of the most lenient lockdown policies) to 40 per cent in Viet Nam.6

Focusing on the role of the global supply chains in particular, we used tools from Huo, Levchenko, and Pandalai-Nayar (2020)7 to calculate how much of the contraction in each country’s GDP is due to external rather than domestic shocks, as highlighted in the bar chart above.

External shocks transmitted through the global supply chains account, on average, for about a third of the overall fall in GDP. That is, an average country would experience an 11 per cent GDP contraction purely due to lockdowns in other countries, even if it did not impose any lockdown on its own economy.

The model also shows that the more fully integrated economies are to global supply chains, such as in the case of Brunei Darussalam and Kazakhstan, the larger the contribution from external shocks to the overall all drop in GDP (in proportional terms). Among the five countries most affected by foreign shocks, transmission accounts on average for 57 per cent of the total contraction in GDP.

Would supply chain repatriation have made a difference?

We next tackle the more substantive question of whether participation in global supply chains exacerbated or alleviated the pandemic-induced contraction in labour supply. It is not clear whether supply chain renationalization will actually make GDP more resilient to future pandemic-type shocks. Figuring this out requires comparing the pandemic-induced GDP change in the baseline model to the pandemic-induced GDP change in an alternative world without international trade, where supply chains have adjusted to use only domestic inputs. Naturally, renationalization of global supply chains would change the relative size of domestic sectors, as input users shift from foreign to domestic intermediates. 

The answer is that, by and large, severing global supply chains will not make countries more resilient to pandemic-style labour supply shocks. The light blue bars in the chart below plot counterfactual declines in GDP for the same shock in a world where supply chains are domestic.

It turns out that on average in our sample of 64 countries, the downturn would actually be slightly worse with renationalized supply chains (down 32.3 per cent on average) than under current levels of trade. The intuition for this finding is simple: eliminating reliance on foreign inputs increases the reliance on domestic inputs. Since any national pandemic-related lockdown also affects domestic sectors, there is generally no resilience benefit from renationalizing international supply chains.

There is a modest distribution of differences around the average. In some countries, GDP would drop by 4 percentage points more if supply chains were renationalized, whereas in others GDP would fall by about 4-6 percentage points less. The cross-country variation is well explained by differences in lockdown severity across countries. Some countries – most prominently Japan, China (Taiwan Province) and Sweden – imposed less stringent lockdowns in response to the pandemic shock. The domestic pandemic-induced shock is therefore smaller in these countries than the shock in their trading partners with more severe lockdowns.

Separating from global supply chains would make these countries more resilient to lockdowns by eliminating the transmission of the relatively larger shock from other countries. By contrast, a country with the most severe lockdown will reduce its own domestic labour supply by more than its average trading partner. In that case, the supply of the domestic intermediate inputs falls by more than the supply of foreign ones, and thus the GDP contraction is larger when supply chains are renationalized.

Another potential channel that may affect the benefits of supply chain renationalization is a shift of the relative size of sectors within a country. All else being equal, a country would be better off if renationalization leads to expansion of sectors that are less exposed to negative labour supply shocks. A sector is less exposed to the pandemic-related lockdown if much of its labour input can be provided from home, as would be the case with publishing or financial services, for example. Though plausible, we found that this channel is quantitatively less important compared to the aforementioned effect of shifting from foreign to domestic inputs.

In all, our results show that global supply chains clearly transmit the economic effects of the lockdowns across borders. However, that does not mean that the presence of global supply chains uniformly exacerbates the downturn. Whether renationalizing supply chains insulates a country from the pandemic depends on whether it plans to impose a more or less severe lockdown than its trading partners.

This opinion piece was originally published by VoxEU on 25 May 2020.