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IMF: Diversification, substitutability build resilient value chains
The IMF says that in the early days of the pandemic in 2020, the GVC-intensive trade collapsed but rebounded very quickly showing remarkable resilience.
Diversification of supply sources across countries and substitutability of components, rather than re-shoring i.e. bringing inputs or intermediates production facilities closer home, build resilient Global Value Chains (GVC), says the International Monetary Fund (IMF) in its latest Global Economic Outlook (GEO) report. The report, which devotes an entire chapter on global trade and value chains during the pandemic, draws on the data analysis models developed by the IMF researchers and various studies by economists and says that the proposals to reduce dependence on foreign suppliers in the GVCs are misguided.
The IMF says that in the early days of the pandemic in 2020, the GVC-intensive trade collapsed but rebounded very quickly showing remarkable resilience. The countries that imposed stringent lockdowns increased their imports sharply and their partner countries faced disruption in supply of inputs to carry on further production. However, such partner countries could quickly diversify their procurement from suppliers of intermediate inputs from other countries, minimising the impact of disruptions and enhancing resilience.
The GEO report says that substitutability can be achieved through greater flexibility in production, the way Tesla rewrote software to enable its cars to use alternative semiconductors in response to the semiconductor shortage or the way General Motors is working with semiconductor suppliers to reduce the number of unique chips that it uses by 95 per cent, down to just three families of microcontrollers, bringing about standardisation that would replace a host of chips, eliminating the costs of substituting between them.
The IMF researchers simulated the effects of disruptions in a global economic model and compared outcomes under higher levels of diversification, or higher substitutability (how easily a producer can switch inputs from a supplier in one country to another) and considered supply disruption in a single, large input supplier country and supply shocks to multiple nations. The analysis shows diversification significantly reduces global economic losses in response to supply disruptions.
Following a sizable (25 per cent) labour supply contraction in a single, large global supplier, gross domestic product for the average economy falls by 0.8 per cent under the baseline. In the high-diversification scenario, this decline is reduced by almost half.
The sizeable “home bias” in the sourcing of intermediates is that any re-shoring or near-shoring of
production would lower diversification even further, thereby increasing concentration risk that would result in more volatile economic activity, even after the economy adjusts structurally by expanding some sectors and shrinking others, says the report.
The recommendations for policymakers from the IMF include upgrading and modernising port infrastructure on key global shipping routes to reduce global choke points, advancing digitalisation of document filings, such as tax returns, that can help generate useful information on inter-firm transactions and supply chain networks that help stress-testing exercises to identify supply chain weaknesses and providing an open, stable, and rules-based trade policy regime that reduces tariff and non-tariff barriers and trade policy uncertainties thus supporting greater diversification.
In theory, India should benefit through diversification of GVCs, especially away from China, by global manufacturers. However, India is not best placed to integrate with the GVCs or production networks because of its protective trade policies and aversion to Regional Trade Arrangements. The bilateral trade deals are unlikely to change that position. A rethink on taking advantage of diversification of GVCs through trade policy reforms is overdue.
email: tncrajagopalan@gmail.com
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