POLICIESTO

STRENGTHENTHE

RESILIENCEOF

GLOBALVALUECHAINS

EMPIRICALEVIDENCEFROMTHE

COVID-19SHOCK

OECDSCIENCE,TECHNOLOGY

ANDINDUSTRY

POLICYPAPERS

February2023No.141

2|POLICIESTOSTRENGTHENTHERESILIENCEOFGLOBALVALUECHAINS

OECDSCIENCE,TECHNOLOGYANDINDUSTRYPOLICYPAPERS

OECDScience,TechnologyandIndustryPolicyPapers

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Policiestostrengthentheresilienceofglobalvaluechains:

EmpiricalevidencefromtheCOVID-19shock

CyrilleSchwellnus,AnttonHaramboure,LeaSamek(OECD)

WidespreadsupplydisruptionsinthewakeoftheCOVID-19pandemicandtheRussianFederation’slarge-scaleaggressionagainstUkrainehaveraisedconcernsamongpolicymakersthatglobalisedvaluechainsexposedomesticproductiontoshocksfromabroad.Thispaperusesnewindicatorsofglobalvaluechaindependenciesandexogenouspandemicshockstoeconometricallyestimatetheeffectsofsupplydisruptionsabroadondomesticoutput.Theresultssuggestthattheadverseeffectsofsupplydisruptionsareparticularlylargewhenconcentrationofsupplyingcountriesandsupplyingfirmsishigh.Counterfactualsimulationsoftheeconometricmodelsuggestthatdiversificationofsupplierswouldhavesizeablebenefitsintermsofshieldingdomesticproductionagainstcountry-specificsupplyshocks,withpartialonshoringofproductionhavingonlysmalladditionalbenefits.Technologicalinnovationthatreducesforeigndependencies,suchasthesubstitutionofrenewableenergiesforfossilfuels,canhavesimilarbenefitsasdiversification.

Keywords:GlobalValueChains,Internationaltrade,Resilience

JELcodes:F14,F68,L52

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Acknowledgments

TheauthorswouldliketothankKezbanAkkurt,WenyinCheng,ChiaraCriscuolo,GabrieleCiminelli,LelioIapadre,SatoshiInomata,SebastienMiroudot,JensLundsgaard,BoMeng,DirkPilatandColinWebbforvaluablecomments.ThepapergreatlybenefittedfromdatasharedbyPeterHorvat,SaraCalligaris,AndreaGreppi,aswellastheexpertiseofAgnèsCimperandNorihikoYamanoonICIOdata.Theauthorsarealsogratefulforhelpfuldiscussionsatthe2022ISGEPWorkshop,theWorkingPartyonIndustryAnalysis(WPIA),aswellastheCommitteeforIndustry,InnovationandEntrepreneurship(CIIE)oftheOECD.ThesupportofMárcioCarvalhoinputtingtogetherthedocumentisgratefullyacknowledged.

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Executivesummary

WidespreadsupplydisruptionsinthewakeoftheCOVID-19pandemicand,morerecently,theRussianFederation’s(hereafter,‘Russia’)large-scaleaggressionagainstUkrainehaveraisedconcernsthatglobalisedvaluechainsexposedomesticproductiontoshocksfromabroad.Thispaperanalyseseconometricallytheresilienceofglobalvaluechainsusingnewindicatorsofdependenciesanddiscussestheimplicationsforpublicpolicies.Themainupshotsfromtheanalysisareasfollows.

.Newindicatorsofglobalvaluechaindependenciesusedinthispaperareaccuratepredictorsofthetransmissionofforeignshocks:

oTheimpactofforeignsupplydisruptionsondomesticoutputissystematicallylargerwhenforeigndependenciesasmeasuredbythenewindicatorsishigh.

oIntheaveragecountryandindustry,aforeignsupplydisruptioncorrespondingroughlytotheaveragetighteningofmobilityrestrictionsobservedbetweenFebruaryandApril2020reducesoutputofdownstreamproducersbyabout5%inthequarteroftheshock.

.Foreignsupplydisruptionshavelargeradverseeffectswhensuppliersarehighlyconcentrated:

oInindustrieswherebothgeographicconcentration(largemarketsharesofthemainsupplyingcountries)andindustryconcentration(largemarketsharesofthemainfirmswithintheindustry)ofsuppliersishigh,theeffectofsupplydisruptionsisabouttwicetheaverageeffect.

oBycontrast,thereisnostatisticallysignificanteffectinindustrieswheresuppliersaregeographicallydiversifiedandindustryconcentrationislow.

.Anillustrativestresstestthatsimulatesalargeshock(correspondingroughlytothetighteningofmobilityrestrictionsbetweenearly-Marchandearly-Aprilof2022)inthePeople’sRepublicofChina(hereafter,‘China’)suggeststhat:

oInmostcountriesthatarehighlyreliantonChineseinputs,disruptionsofsupplywouldreduceoutputinkeymanufacturingindustries,includingmotorvehicles,byaround1-4%.

.Publicpoliciescanenhanceglobalvaluechainresiliencebyfacilitatingaquickreboundafterashockoccurs,orbymitigatingtheriskofshocksfromabroad:

oArapidreboundcanbepromotedbyagilitypoliciesbeforeashockoccurs,orbyadaptationpoliciesafteritmaterialises.

?Amongthestatisticallyandeconomicallysignificantagilitypolicies,thepromotionof

managementandworkerskillsappearstobecrucialtoallowforarapidrestructuringofproduction.

?Amongtheex-postmeasures,well-targetedgovernmentfiscalsupportintheformof

grants,loanguaranteesandsupportforworkersstandsoutashighlysignificant.

oRiskmitigationincludesmeasurestodiversifyorpartiallyonshoreglobalvaluechainsandtoreducetechnologicaldependencies.

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?Diversificationwouldreducetheadverseeffectsonoutputofthesimulatedshockto

Chineseproductioninthemostaffecteddownstreamindustriesbyabout25%.

?Thepartialonshoringofproduction(inadditiontodiversification)wouldonlyhavevery

limitedadditionalbenefitsintermsofshieldingdomesticproductionfromshocks.

oTheshieldingeffectsoftechnologicalinnovationthatreducesdependenciesonspecificinputs(e.g.fossilfuels)arecomparabletodiversificationbutrequirelargetechnologicalshiftsthatmaytaketimetomaterialise.

.Policiestoaddressriskshouldbetailoredtothedegreeofconcentrationandstrategicimportanceoftherelevantvaluechain:

oInvaluechainswithfewpotentialsuppliers(orbuyers)thatareofhighstrategicvalue(suchasenergy,criticalminerals,essentialmedicalequipmentandpharmaceuticals,semiconductors)riskmitigationmaybeneededbutpotentialbenefitsneedtobebalancedwithpotentialcosts.

oInvaluechainswithmanypotentialsuppliers(orbuyers)orthatareoflowstrategicimportance,agilityandadaptationpoliciesmaybesufficienttoensureresilience.

oThevastmajorityofglobalvaluechains(about96%)areeitherdiversifiedintermsofsuppliers(orbuyers)and/oroflimitedstrategicimportance.

Overall,theanalysisinthispapersuggeststhatintheoverwhelmingmajorityofvaluechains,publicpoliciesshouldfocusonmeasurestopromotearapidreboundfollowingshocksratherthanmitigatingriskbyreducingforeignexposures.GeographicaldiversificationofvaluechainsandtechnologicalinnovationcanhavelargebeneficialeffectsintermsofshieldingdomesticoutputfromGVCshocks.Additionally,onshoringproductionmayhaveonlysmalladditionalbenefitsandmustbebalancedwithpotentiallylargecostsintermsofeconomicefficiency.

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Tableofcontents

Acknowledgments 4

Executivesummary 5

1Introduction 9

2Thepolicyissue 11

Agilityandadaptation 11

Mitigatingtheriskofvaluechainshocksfromabroad 12

3Methodologyanddata 13

Baseline 13

Extensions:Accountingforconcentrationandpolicies 14

Data 15

4Results 17

Upstreamvaluechainshocks:Descriptiveresults 17

Upstreamvaluechainshocks:Regressionresults 17

Policyanalysis 19

5Policyimplications 24

Highly-concentratedandstrategically-importantvaluechains 24

Non-strategicorgeographicallynon-concentratedvaluechains 26

Overallassessment 26

6Conclusions 27

AnnexA.Supplementarytechnicalmaterial 33

FIGURES

Figure1.Policychannels11

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Figure2.Outputgrowthisnegativelycorrelatedwithnegativeupstreamvaluechainshocks17

Figure3.OutputresponsetoupstreamGVCshocks18

Figure4.ArangeofpoliciesdampennegativeeffectsonoutputofnegativeupstreamGVCshocks20

Figure5.AsupplyshockfromChinawouldhavesizeableeffectsondownstreamindustries22

Figure6.A40%reductionintechnologicaldependencyisbroadlyequivalenttodiversification23

Figure7.Policyprioritisation25

FigureAA.1.Mobilityrestrictions36

FigureAA.2.Requiredphysicalpresenceofworkers37

FigureAA.3.Salesconcentrationbyindustry38

FigureAA.4.OutputresponsetoupstreamGVCshock39

FigureAA.5.Valueoftradeineachquadrant(%)43

TABLES

TableAA.1.Listofcountriesandindustriescoveredintheregressionanalysis35

TableAA.2.Domestic,upstreamanddownstreamvaluechainshocks40

TableAA.3.Upstreamvaluechainshocks&concentration41

TableAA.4.Adaptationchannelsandupstreamvaluechainshocks42

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1Introduction

Theglobalisationofsupplychains–looselydefinedasanincreasingshareofimportedintermediategoodsandservicesinoutput–hasraisedproductivityandboostedtheparticipationoflower-incomecountriesininternationaltrade(OECD,2013[1]).ButwidespreadsupplydisruptionsinthewakeoftheCOVID-19pandemichaveraisedconcernsthatglobalisedvaluechainsexposedomesticproductiontoshocksfromabroad,includingbycreatingstrategicdependenciesonasmallnumberofkeyplayers(OECD,2021[2]).Forinstance,widespreadshortagesofcriticalmedicalequipment(e.g.respirators)andcriticalinputsintomanufacturing(e.g.semiconductors)duringtheCOVID-19pandemichavetriggeredadebateaboutthedesirabilityofonshoringandthegeographicaldiversificationofinputs.

Thispaperanalysestheresilienceofglobalvaluechains(GVCs)inthewakeoftheCOVID-19pandemicwithaviewtoprovidinginsightsforpublicpolicies.Ittakesanindustry-levelperspectiveinthesensethattherelevantunitofobservationisanindustryinagivencountry.Fromanindividualfirm’sperspective,supplychainriskcanarisefromdependenceonasinglesupplyingfirm.Fromapolicyperspective,however,therelevantsupplychainriskissystemicdisruptionatthelevelofanentireindustryormarket.Forinstance,fromapolicyperspectivetherelevantriskisthedisruptionoftheentireautomotiveindustryinacountrybyshortagesofcriticalsemiconductorsratherthanthedisruptionofasinglecar-makerbytheshortageofasemiconductorproducedbyaspecificcompany.

1

Privatebusinessesdonotfullyaccountforsystemicriskintheirsupplychainmanagementdecisions,suggestinganeedforpublicpolicyintervention.First,privatebusinessesonlyaccountforrisktotheirownoperationswhentakingdecisionsabouttheirsuppliernetworkandinventorymanagementbutignorepotentialexternalitiesontheirdownstreamclientsandupstreamsuppliers.Forinstance,asemiconductorproducermayacceptdependenceonasinglesupplyingcompanydespitetheriskstoitsprofitsfromtemporarydisruptionsbecauseitdoesnotinternalisetheinducedlossesofdownstreamautomotiveindustries.

2

Second,privatecompaniestypicallyhaveverylittleinformationontheirsupplychainbeyondtheirimmediatefirst-tiersuppliers,whichcanleadtotheunder-estimationofrisks.Arecentsurveyofseniorsupply-chainexecutivesacrossmultipleindustriesandcountriessuggeststhatonlyabout20%ofcompanieshavevisibilityontheirsecond-tiersuppliers,andonlyabout2%ontheirthird-tiersuppliers(McKinsey&Company,2021[3]).

TheanalysisinthispaperisbasedontheupdatedOECDInter-CountryInter-Industry(ICIO)databasethatcovers66countriesand45industriesupto2018,aswellasnearreal-timedataontradeandoutput.Itprovidesestimatesoftheextenttowhichdisruptionsabroadaffectdomesticoutputthroughinput-outputlinkages.ExogenousmeasuresofoutputdisruptionsareconstructedbyexploitingdifferencesintheseverityoftheCOVID-19pandemicacrosscountriesandovertime,aswellasdifferencesinrequiredphysicalpresenceofworkersacrossindustries.

AmajorinnovationofthispaperwithrespecttopreviousstudiesisthatitnotonlyusesnewindicatorsofGVCdependencies(BaldwinandFreeman,2021[4];Schwellnusetal.,forthcoming[5])butestimatestheextenttowhichGVCdependenciesactasatransmissionchannelofshocksabroad.ThisallowsstresstestingGVCsbysimulatingdifferenttypesofshocks,analysinghowtheypercolatethroughGVCs,andthusidentifyingvulnerabilitiesrelatedtolimitedsubstitutabilityand/orgeographicconcentrationofinputs.

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Itfurtherallowstheanalysisofarangeofcounterfactualscenarios,suchasdiversificationofsuppliers,partialonshoringandthetechnologicalsubstitutionofspecificinputs.

Themainupshotsfromtheanalysisareasfollows.First,adverseeffectsondomesticproductionfromforeignsupplyshocksareparticularlylargewhenconcentrationofsuppliers,bothintermsofsupplyingcountriesandsupplyingfirms,ishigh.Second,anumberofpublicpoliciesfacilitatetherapidreboundofdomesticproductionfollowinganadverseforeignsupplyshock,includingex-antemeasuressuchasthepromotionofmanagementandworkerskillsandex-postmeasuressuchasfiscalpolicysupport.Third,counterfactualsimulationsoftheeconometricmodelsuggestthatdiversificationofsupplierswouldhavesizeablebenefitsintermsofshieldingdomesticproductionagainstcountry-specificsupplyshocks,withpartialonshoringofproductionhavingonlysmalladditionalbenefits.Technologicalinnovationthatreducesforeigndependencies,suchasthesubstitutionofrenewableenergiesforfossilfuels,canhavesimilarbenefitsasdiversification.

Overall,theanalysisinthispapersuggeststhatintheoverwhelmingmajorityofvaluechains,publicpoliciesshouldfocusonmeasurestopromotearapidreboundfollowingshocksratherthanmitigatingriskbyreducingforeignexposures.GeographicaldiversificationofvaluechainsandtechnologicalinnovationcanhavelargebeneficialeffectsintermsofshieldingdomesticoutputfromGVCshocks.Additionally,onshoringproductionmayhaveonlysmalladditionalbenefitsandmustbebalancedwithpotentiallylargecostsintermsofeconomicefficiency.

Theremainderofthepaperisorganisedasfollows.Section2setsthescenebyframingthepolicyissue.Section3describestheempiricalframeworkandthedata.Section4presentstheempiricalresultsonthepropagationofupstreamGVCshocks,includingtheroleofinpromotingadaptation;analysesascenarioinvolvingalargeshocktoChina,whichisamajorchokepointinGVCs(Schwellnusetal.,forthcoming[4]);anddescribesarangeofcounterfactualscenarios,includingvaluechaindiversification,partialonshoringandtechnologicalsubstitutionofspecificinputs.Section5outlinesthekeypolicyimplicationsfromtheanalysisandSection6concludes.

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2Thepolicyissue

ShockpropagationthroughGVCsmaycallforapublicpolicyresponsefortwobroadeconomicreasons.First,privateandpublicinterestsmaybemisalignedbecauseprivatecompaniesdonotinternalisethecostofdisruptionstotheirdownstreambuyers,includingtofinalconsumers.Forinstance,semiconductorcompaniesaccountfortheirprivateprofitsandlosseswhendecidingaboutoptimalinventorylevelsbutdonotinternalisethecostofdisruptionstodownstreamautomotiveproducers.Second,privatecompaniesmaylackinformationonthecomplexityoftheirsupplychains,leadingtotheunderestimationofrisk.Apartfromthesemarketfailurerationalesforpublicpolicyintervention,policymakersmaywanttolimitstrategicdependenciesforgeopoliticalreasons.

Agilityandadaptation

ArangeofpublicpoliciescaninfluencetheresilienceofGVCsbyfacilitatingaquickreboundafterashock.Thesepoliciesacceptadegreeofrisktodomesticproductionbutachievehighaveragegrowth

(Figure1

).Aquickreboundcanbefacilitatedbytakingex-antemeasuresbeforeashockmaterialises(i.e.bypromotingagility)andbytakingex-postmeasureswhenitmaterialises(i.e.bypromotingadaptation,).Anex-anteagilitypolicycould,forinstance,involvetheupskillingofworkersandmanagerstoallowthemtorapidlyre-organiseproductionandsupplychainsintheeventofaforeignsupplydisruption.Fiscalpolicies,e.g.throughloanguaranteesorgrants,canactasanex-postadaptationpolicybyprovidingsupporttosolventfirmsthatareexperiencingtemporaryliquidityissuesasaresultofforeignsupplydisruptions.

Figure1.Policychannels

Agilityandadaptation

(e.g.workerandmanagementskills,fiscalpolicy)

Output

Riskmitigation

(e.g.diversificationandonshoring)

Time

Source:OECDbasedonBrunnermeier(2021[5])

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Mitigatingtheriskofvaluechainshocksfromabroad

PublicpoliciescanalsoenhanceGVCresilience,byshieldingdomesticproductionfromforeignshocks(riskmitigation),acceptingloweraveragegrowthinreturn

(Figure1

).

3

Forinstance,industrialpoliciescanaffectthecostofdomesticproductionrelativetoproductionabroad.Thismaychangethebalanceofrisksbetweendomesticandforeignshocksbutmayalsoaffectoveralleconomicefficiency.TradepoliciescanaffecttherelativecostsofsuppliersfromdifferentcountriesandtherebyraiseorreducethedegreeofgeographicalconcentrationofGVCs.

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3Methodologyanddata

Baseline

ThebaselineempiricalmodelestimatestheeffectofupstreamGVCshocksondomesticoutput.Thekeyidentifyingassumptionsare(i)theexogeneityofupstreamsupplydisruptions;and(ii)alargerresponseofdomesticoutputwhenforeigninputrelianceishigh.Withrespecttoexogeneity,themodelusestheinsightthatpandemic-relatedsupplydisruptionsabroadcanbeviewedasexogenousdodomesticoutputdevelopments(BaldwinandFreeman,2021[6];Santacreu,LeiboviciandLabelle,2021[7];Thorbecke,2021[8]).

4

Withrespecttothelargerdomesticoutputresponseathigherforeigninputreliance,therationaleisthat,inautarky,foreignsupplydisruptionsshouldhavenoeffectondomesticoutput,whereas,athighrelianceofdomesticproductiononforeigninputs,theeffectshouldbelarge.

Foreigndemandandsupplyshockshitimportsandexportswithalag,e.g.shutdownsinChinalikelyhitimportsinFrancewithalagof1-2months(Lafrogne-Joussier,MartinandMejean,2021[9]).Inordertoaccountforthedelayedresponse,therelationbetweenoutputandupstreamsupplychainshocksisestimatedusingthelocalprojectionsmethod(Jordà,2005[9]).Themethodhasbeenwidelyusedasaflexiblealternativetoautoregressivedistributedlagspecifications(AuerbachandGorodnichenko,2012[10];Romeretal.,2017[11];RameyandZubairy,2018[12])andallowsdirectlyobtainingtheresponseofthedependentvariableathorizont+ktotheshockattimetbyestimatingadifferentregressionspecificationateachhorizon.Impulseresponsefunctionsarethenconstructedbyplottingtheestimatedcoefficientsas

pointestimatesandtheirstandarderrorsasconfidencebands.

Thebaselineestimatingequationisasfollows:

Equation1

yc,j,t+k?yc,j,t?1=Fuk,upc,j,t+Fxk,xc,j,t+vdynkc,j,t+ucj+ut+cc,j,t

wheresubscriptsc,j,andtdenote,respectively,country,industryandtime;yc,j,tisameasureof(log)realoutput;upc,j,tisameasureoftheupstreamforeignsupplyshock;andxc,j,tarecontrolvariablesfordomesticanddownstreamdemandshocks;dync,j,tisa(column)vectorofleadsandlagsoftheexplanatoryvariablesincludedtomakethemodeldynamicallycomplete;

5

ucjandutarecountry-industryandtimefixedeffects;Fu,k,Fd,k,Fx,kandvkareestimatedcoefficients;andcc,j,tistheerrorterm.

Equation1

isestimatedatthemonthlyfrequencyovertheperiodJanuary2020toSeptember2021.

6

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Equation2

Theupstreamsupplyshockisdefinedastheweightedaverageofallforeignsupplydisruptionsasfollows:

N

c′≠c

upc,j,t≡xx′(FIRcjc′j′,0×disTuptionj′c′t)

whereFIRcjc′j′,0(foreigninputreliance)canbeviewedasweightsmeasuringtherelianceofcountry-industrycjoninputsfromforeigncountry-industryc’j’.Foreigninputrelianceiscalculatedingrosstermsratherthanvalueaddedtermstoaccountforthefactthattheeffectofaforeignsupplydisruptionmaydependonboththesizeoftheforeignexposureandthelengthofthevaluechain(Schwellnusetal.,forthcoming[4]).disTuptionj′c′tisameasureofforeignsupplydisruptionsthatcombinesmeasuresofexogenouscountry-levelmobilityshocksandindustry-levelrequiredphysicalpresence.Thebasicideaisthatacountry-levelmobilityshockshouldreduceoutputbymoreinindustrieswithhighrequiredphysicalpresence(lowpotentialtelework),withtheeffectonupstreamindustriesabroadbeingtransmittedthroughGVCdependencies.TheconstructionoftheexplanatoryvariablesisdescribedinAnnexA1.

Thecoefficientofinterestistheelasticityofoutputwithrespecttoforeignsupply(Fu,k).Theexpecteds