Rising Uncertainty and the Impact on Global Trade and Global Value Chains

This paper investigates how the disruptions and shocks over the last few years have brought about high levels of uncertainty. This uncertainty has led to changing behaviours in global trade flows, trade diplomacy and may potentially impact trade agreements[1].

Rising uncertainty and what it means for global trade?

Uncertainty is at its highest since the end of the second world War. The World Uncertainty Index (WUI) which measures uncertainty across 143 countries in the world is showing that uncertainty has been higher in the last decade than in the last 60 years [2]. With uncertainty comes a change in behaviour from all stakeholders in the economy – from households that postpone non-essential consumption, governments that divert resources from investment to short term survival, and firms and investors that postpone investment decisions.

This uncertainty is also leading to a change in supply and demand dynamics. One of the biggest demand and supply changes seen since the beginning of the Ukraine/Russia conflict is that of commodities. Russia and Ukraine are large exporters of energy (oil and gas); fertilisers; grains and some metals [3]. But since the beginning of the conflict, we have seen how major western governments and companies have either exited or suspended trade with Russia.

Many global oil traders and oil companies have expressed the will to switch oil contracts away from Russia once existing ones run out. Given that there is no end to this conflict in sight, this may be the beginning of a fundamental change in the global energy trade market as the scramble for substitute supply gains momentum. [4] Italy, by example, has already signed agreements with Algeria to increase their current gas supply. They are also looking at other countries like Congo, Angola, Azerbaijan and Qatar to reduce their reliance on Russia [5].

LNG and coal would normally have been substitutes to oil and gas in a situation like this. But as reported by The World Bank, high demand for LNG and coal as substitutes are driving up their price and ironically, making crude oil still the cheapest fuel per unit of energy [6]. In response to the increased demand for LNG, the USA and North African countries are increasing their supply to Europe, thereby bringing about another change in the supply chain.

Another significant change is Russia’s increasing sales to ‘friendly’ countries. India has been buying record numbers of barrels of oil from Russia as it takes advantage of the discounted price being offered [7]. It is certainly too early to tell how the disruption of the Ukraine conflict will impact on global trade relations but even if it is temporary (as sustainable transport and logistical infrastructure needs to be in place), there is certainly a noticeable shift in immediate global demand and supply activity as far as commodities are concerned. The World Bank suggests that the shock from the conflict as well as pandemic-related impacts could alter global production and consumption patterns till 2024 and possibly beyond.

Global Value Chains and Trade Shocks

Since 2008, rising global disruptions and political tensions have seen trade relations deteriorate and with that, levels of growth in GVCs have also declined.

The impact of the Covid-19 pandemic on Global Value Chains was of historic proportions not only because of the double-sided demand and supply shock but also because GVCs had matured so much and become very intricate by then. Every country that was a part of a global value chain was impacted by Covid-19 pandemic related lockdowns, border closures and supply chain disruptions.

Figure 1: Global Value Chain participation rates, World, 1995-2020

Source: Global Value Chain Development Report; World Trade Organisation, 2021.
Notes: Trade-based GVC participation is based on the total GVC participation rate of A. Borin and M. Mancini. 2019. Measuring What Matters in Global Value Chains and Value-Added Trade. Policy Research Working Paper. No. 8804, Washington DC: World Bank.
Production-based GVC participation is based on the forward GVC participation rate of Z. Wang, S. Wei, X. Yu, and K. Zhu. 2017. Measures of Participation in Global Value Chains and Global Business Cycles. NBER Working Paper. No 23222. Cambridge, MA: National Bureau of Economic Research.

Evidence suggests that those countries who had more mature integration into value chains as well as high-income countries with mature management systems and infrastructure, were able to recover relatively faster. For lower- and middle-income countries, recovery has been slower as the impact was deeper. Countries like Bangladesh, Myanmar and Vietnam experienced loss of jobs as factories had to close due to orders being cancelled or dried up due to the length of time experienced in the lockdowns. The impact and subsequent recovery from the pandemic have therefore not been the same for all countries. [8] Research by the World Bank shows the changes in GVC participation by countries and regions in 2020 relative to the pre-covid baseline as per the figure below [9].

Figure 2: Impacts of the COVID-19 on the GVC participation by countries and regions, % change in 2020 relative to the pre-COVID baseline

Source: ENVISAGE simulations

The future of GVCs in a world with rising tension and uncertainty

Even prior to the Covid-19 pandemic there was evidence of rising protectionism. The US pulled out of the CP-TPP, renegotiated NAFTA into the USMCA, and fuelled tensions with China. Since then, and more pronounced since the Covid-19 pandemic, there have been talks of countries looking to procure inputs closer to home – a concept called ‘near-shoring’ or ‘reshoring’ [10].

The Ukraine/Russia conflict has once again highlighted the risks associated with reliance on global value chains.

Should countries start looking inwards and impose export protection measures?

It is still believed that while export protection helped certain countries during the shock of the pandemic, to continue cutting trade or ‘reshoring’ could have more devastating effects on global economies that are a part of a global value chain. World Bank research shows that implementing these practices could lead to more poverty as more factory workers (and other downstream inputs) could be put out of work [11].

Economic modelling results indicate that if major trading countries begin reshoring, global income would drop by 1.5% with losses in all regions. This amount is higher if low- and middle-income countries pursue the same route. A shift to reshoring could drive 52 million people into poverty with more than 80% of this group living in Sub-Saharan Africa[12].

Despite the increasing narrative of reshoring and procuring closer to home, given the high level of uncertainty globally, it remains consistently proven that GVCs, especially well integrated and mature ones, are resilient in the face of shock. While recent global shocks have also shown us the downsides to GVCs as they assist in the rapid spread of shocks, it is still in the interests of countries to maintain a level of integration and participation in GVCs. The IMF research concludes that trade between countries and regions with significant participation in GVCs were able to weather the shock better [12].If anything, countries, regions and value chains have been able to adjust to the changes demanded and have shown that building resilience into GVCs is the best solution to ensure continued global economic growth and prosperity.

Against this backdrop, what can governments and policy makers do to improve its response to shocks in these changing times? The priority will be to build more agility in value chains. More investment can go into growing value chains and creating the maturity levels needed to withstand shocks. What made it possible for countries like China and Vietnam to grow their economies and successfully join global value chains was capitalising on competitive advantage in certain areas (especially labour, infrastructure and economies of scale). In the case of low income and developing countries, who are harder hit by shocks and take longer to recover, investing in multiskilling its labour force and diversifying the range of products it feeds into global chains can help it withstand shocks and recover faster.

While GVCs have shown vulnerabilities, they strengthen a countries ability to compete and specialise in what they can do best, and will remain important source of global growth and prosperity.

Cherise Janari is a business executive with International Economics Consulting Ltd.

References

[1] Much has been written about the impact of the Russia/Ukrainian conflict and how this has impacted our lives with an increase in fuel, coal, food and other precious commodities – all part of our daily consumables. Also, refer to our CEO Insights ‘Russian Invasion of Ukraine creates collateral damage in Africa’. As this article is being written, Russia has stepped up its military engagement in Ukraine and has warned the West and other (specifically NATO) countries against continued supplying arms to Ukraine. Russia has accused the West of fighting a proxy war in Ukraine and history has shown us that rhetoric of this nature generally leads to increased global political tensions. Disruptions to trade and investment are just some of the bi-products of these escalations.

[2] World Uncertainty Index

[3] Oil Market and Russian Supply – Russian supplies to global energy markets – Analysis | IEA

[4] Oil Market Report – March 2022 – Analysis |IEA

[5] Italy clinches gas deal with Algeria to temper Russian reliance | Reuters

[6] Commodity Markets Outlook | worldbank.org

[7] India is snapping up cheap Russian oil, and China could be next | CNBC

[8] Reshaping Global Value Chains in Light of COVID-19 | worldbank.org

[9] Pandemic, Climate Mitigation, and Reshoring : Impacts of a Changing Global Economy on Trade, Incomes, and Poverty | worldbank.org

[10] Is a wave of supply-chain reshoring around the corner? | The Economist

[11] Stronger value chains, not reshoring, are needed after the COVID-19 shock | worldbank.org

[12] Trading for development in the age of global value chains | worldbank.org

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