Written submission from Jun Du (CVT0021)

 

COVID-19, International Trade and Global Value Chains

 

This evidence is provided by Jun Du, Professor of economics in Aston University, Director of Lloyds Banking Group Centre for Business Prosperity, who is an expert on firm performance and productivity, international trade and global value chains, leading research on “Making the UK a more effective trader”.

Summary

This writing provides fresh evidence on the scale of Covid-19 impact on international trade and global value chains (GVCs). It first summarises the disruption in international trade in China where the pandemic started using the most updated monthly statistics, and its ripple effects on other countries. Building on the current knowledge of global value chains and the UK’s position in the global map, it then discusses the future of global value chains, where the UK plays an important and integrated role. 

This evidence touches upon the called inquiry in the aspects:

The key messages are:

-          China has suffered a collapse in international trade in the first two months of 2020. The recovery is further dampened by demand shocks from other countries with the contagion waves in March and April.

-          In a highly interweaved global production networks, countries’ economic fates are tied together. The UK, among other EU countries and US, is in China’s top 10 trade partners, reflecting the growing dependence on this century’s ‘Workshop of the World’.

The devastation COVID-19 has brought to the world economy has seen many commentators question whether it marks the end of globalisation as we know it. However, our research on global supply chains suggests this is unlikely, for three reasons:

-          First, the foundation of globalisation was strong before the pandemic, and the fundamental economic principles haven’t changed. The complex modern supply chains that sustain the global economy will still depend on efficiency, with firms sourcing the best inputs at the lowest cost.

-          Second, businesses will learn from this crisis and will understandably want to build resilience for future ones. Some of that may entail diversification of suppliers and customers. Indeed, in the UK we’ve studied emerging evidence that firms were already diverting some of their trade to non-EU markets due to Brexit. All recessions produce a ‘cleansing effect’ from an economic point of view – weeding out the weaker and more vulnerable companies and forcing realignments that in the end produce revitalised economies.

-          Third, it’s unlikely to ‘swap out’ China from the global economy in the foreseeable future. China has advantages over all its competitors (even low-cost economies): its unrivalled density of production networks which can’t simply be ‘shipped’ elsewhere.

-          Support businesses in the best ability to ensure them “bent” but not “broken” through this crisis.

-          Support businesses to overcome difficulties in global supply chains.

-          Resume the crucial discussions and debates on trade relationship with EU post Brexit, which will have long-term impact on the UK trade and investment.

-          Play an active leading role in enhancing global cooperation to facilitate trade of commodities and services related to national safety and security.

Context

  1. Coronavirus has caught the global economy by surprise. Global financial markets tumbled by 20-25% and price of oil dropped to an unthinkable level below $0. Flash PM survey data record a developed world downturn exceeding that seen during the global financial crisis. With more than half of the world stands still, production stops and jobs are lost. Many commentators argue that the pandemic could even speed up the unravelling of globalization process.

Our approach and source of evidence

  1. At this moment, there is very limited up-to-date and available data informing the UK firms’ international trade performance. In this evidence, we consider the impact of Covid-19 on global value chains, starting from where the pandemic initiated to where it transmitted to, the UK included. Using the most recent data, we quantify the disruption and look beyond it for implications for the UK. The evidence is also based on stylised facts, our current and previous research.

Evidence

Impact of Covid-19 on China’s trade with the world

  1. Globalization goes along with complex and interweaved links among producers in many countries known as Global Value Chains (GVC). Producers rely on highly specialized intermediate inputs, often produced by only one supplier located thousands of miles away. However, COVID-19 severely disrupted multinational activities along GVCs and undermined international logistics.
  2. China was the first country impacted by the outbreak of Covid-19 as early as in January 2020. Although the global economy was not particularly strong at the turn of the new year, many had high hope of a blossom spring with positive turn of international trade following the US-China Phase One trade deal. However, the pandemic-led unprecedented quarantine on Hubei Province and draconian restrictions most regions in China both in inter-cities and international travels have brought the Chinese economy to a virtual standstill for minimum two months.
  3. The disruptions to supply chains were acute. To understand the magnitude of the disruption, we map out China’s complete global trading network using the official Chinese Customs Statistics monthly series. We analyse how important China’s trading partners are in this network based on their eigenvector scores of centralities that measure how connected they are to other highly scored traders. A more highly score suggests a higher dependence on the trade with China.
  4. Among the top 20 trading partners in 2019, four are in Europe, alongside the USA accounting for a large proportion of trade and China’s local trade partners like Japan. [Exhibit 1] These countries had an enhanced presence in the league table in 2020, with France and Germany leading the rank and whereby highlighting a clear dependence on China’s inputs.
  5. According to Chinese Customs Statistics, value of export of China in the first two months of 2020 fall by 17.2% YoY, while import has dropped by 4% YoY. Monthly or bimonthly changes in trade values can be noisy and move along cycles of business activities. Hence, we compare the same period in 2019 and 2020 export, and find export fell by 5.2% and import by 2.7%. [Exhibit 2] On the other hand, just before the pandemic, Chinese trade demonstrated solid growth of 2.4% for exports and 7.9% for imports, following the easing of trade tensions between US and China before taking a sudden halt.
  6. Disruptions were not even, when one further looks at more detailed data on China’s trade by regions and types of products. In particular, the comparative figures of the same months in 2019 and 2020 illustrate vividly a collapse in the Chinese trade with EU and US. [Exhibit 3] Exports to EU fell by 29.9%, while imports from EU declined by 18.9%. The drop on export to US was 27% and imports from US fell by 8%. Which is unexpected given China and US have signed the Phase 1 deal on January 15, 2020. However, expected growth in trade did not materialized due to the pandemic.
  7. Insightful pictures emerge with inspections on the top ten trading commodities affected by COVID-19 disruption. [Exhibit 5] The most affected products were exports of Nuclear reactors, boilers, machinery and mechanical appliances, Electrical machinery and equipment, followed by labour intensive manufacturing goods such as Furniture and some Textile and Garments. The top imported goods disrupted include several lines of intermediate inputs such as organic chemicals and plastics and articles, which could be a result of stagnated production for exports. The highest reduction in imports was seen for precious stones and metals, luxury goods and highly elastic to fall in consumers’ disposable income in uncertain times. This also highlights the sizable and sophisticated pool of luxury shoppers in the Chinese middle class.
  8. Further, it is important to note that out of the top ten commodity categories with the highest reduction in exports and imports, four are common – Machinery, Electronics, Plastics and Organic Chemicals – reflecting the intense fragmentated production networks across borders even within a narrowly defined commodity range in global value chains.
  9. A closer look at the Chinese exports to the US shows a striking picture of huge reduction commodities in Electronic machinery and equipment and labour-intensive consumer goods such as furniture and plastics. [Exhibit 6] While the sudden shutdown of the economy has led to clear supply incapacitation in consumer goods industries, it may not be straightforward to separate the supply shock of Covid-19 from longer-term US-China trade war effect on high-tech electronic goods. The latter, since the start of 2019 Washington’s sanctions to cut China out from the US supply chains by expelling Huawei supercomputer groups and other Chinese high-tech companies.

 

Impact on the intertwined webs of GVCs

  1. As China healed and the supply-side trade shocks to most major economies soothe, an unprecedented, synchronised, broad and likely deep set of demand-side shocks are now expected to reverberate the global supply chains. China again was among the first to feel the brewing demand shock. The Chinese workers returned to work in April, but for some the work they meant to return to no longer exists. Cancellation of international orders and delayed payments led to liquidity problems and a large scale of closures of businesses that relied on global demand. During 1 February and 1 April 2020, the Chinese official statistics show that 83,000 new foreign trade enterprises in China, 24.4% lower than the same period in the previous year. During the same period, 12,000 existing foreign trade enterprises registered closure, including some once successful businesses with registered capital of as high as 10-20 billion RMB Yuan, taking Gaoyue International Trade Ltd. In Fu Jian Province. 
  2. The emerging evidence reports that the sectors in China that are most affected in the current wave of Covid-19 include raw material industries, textile and clothing manufacturing, logistics and containers and agriculture, a combination of final consumption goods as well as intermediate goods reflecting the production disruption in global markets. But just like trade liberalisation produces winners and losers, this pandemic does too. There has been a surge of demand for medical gears and equipment for example. 
  3. Globally, there is a wider discussion about the future of global value chains. On the one hand, reflections are being made about the reliance on global value chains; and there is tendency of proclaiming de-globalisation. Policymakers have already started debating whether after lockdowns the business models are going to change dramatically. European Commission President Von der Leyen called for the shortening of global supply chains because the European Union is too dependent on single suppliers. Similarly, President Macron has called for value chains of domestic firms to become more French and for strengthening French and European “economic sovereignty” by investing at home in industrial sectors in high tech and medical sectors.

 

Is this the beginning of the end of globalisation?

  1. The short answer is no. However, limited decoupling may happen and reconfiguration of global value chains is inevitable.
  2. The global supply chains built over the recent decades are very complex networks, illustrated using the most recent Global input output table in 2014. [Exhibit 7] The overwhelming sense drawn from the network view is that no sector or a country is…an island! Indeed, the formation of global value chains follows the principle of efficiency. Production fragmentation and complex supply chains are the result of businesses sourcing best possible inputs to produce at lowest cost. So long as efficiency remains the principle, global value chains will not fade away, but instead strengthen in the longer term after the initial disruption.
  3. In particular, the global supply chains facilities were in good shape prior to the Covid-19 crisis. The foundation of global value chains is still strong. Demand will dwindle in the prospective recessions, but it is not be sufficient reason to decouple from global production networks. In contrast, it is the extra reason to rely on global value chains to improve productivity. There will be cleansing effect of the crisis, likely any other crisis. The least productive firms would exit and surviving businesses will learn from this crisis and emerge stronger. For example, businesses will have discovered alternative suppliers and potential customers over this period that they had never known. They will operate more flexibly in both sourcing materials or talents and in producing and marketing, and hence be more resilient. The upshot is that business interests will dictate the strategy-making in terms of specialisation versus diversification. With overwhelming evidence, global value chains facilitate business interests by a long shot.
  4. The present worries of the over-reliance on global value chains are well justified in the case of commodities that related to national security, such as medical gears. Many countries will reflect on this crisis and re-balance between efficiency and safety. Hence, we will expect to see some decoupling of national production networks from the global value chains in these areas. However, what governments will do and what governments should do are different matters. In our view, consistent with many economists, the best strategy to deal with a crisis like Covid-19 is tight international collaboration. Nobody can predict what the next crisis will look like or where it may occur, to draw a complete list of national security-warranting commodities. The most reliable and efficient insurance by far should be to build a strong international safety net. As yet, a strong global consensus seems necessary for building this network, which is unfortunately hard to reach. But this does not mean we should lose the ambition.
  5. Therefore, the UK should play a more active role in leading international collaboration and coordination in building and shaping the future global supply chains of priority goods, building on its advanced science and technology, its central role in the exiting global networks, a high-skilled workforce and a more independent geopolitcal-position following Brexit.

 

UK in GVCs: post-Brexit and Covid-19

  1. The UK plays a central role in global value chains with many of its sectors showing continued competitiveness. The UK is unique among EU countries for consistently increasing domestic contents over time, generating increasingly higher value in global value chains. According to the calculation of eigenvector scores of centralities, majority of sectors in the UK appear to be highly important within the global production network. [Exhibit 8]
  2. At the present, the UK seems to plunge into a significant hit in its economic perspectives, especially since Brexit will make it more difficult to maintain the existing value chains with other EU countries in its near vicinity and will make it more costly to create new ones that will be located faraway. The UK small and medium- businesses have started exploring non-EU markets long before the Covid-19 and show a remarkable pattern of trade diversion responding to Brexit referendum. Covid-19 may just be another push for UK businesses to look beyond EU. However, this is a precarious moment for small businesses as the breakdown of the supply chains, the lost production capacity and liquidity problems can end the businesses prematurely. Governments need to do whatever necessary to ensure the small business sectors are not broken through the crisis.
  3. Further, the UK is the second largest service market in the world and remains the second cross-border service provider globally behind the US. The UK financial services, business services and professional services feature one-third of value-adding in manufacturing exports. These sectors contribute hugely to the overall UK competitiveness, which will face unprecedented challenges post Brexit while disintegrating the EU. The value position of the UK is set to be reassessed.
  4. The UK government has already put in significant resources in place to help businesses in this crisis and the Depart of International Trade (DIT) also has dedicated support for firms to deal with supply chain disruptions and financial supports for international traders. As it is still early days, there is no evidence to evaluate the scale or scope of the supports offered and their effectiveness. The key departments of international trade both at central and local governments should survey specifically businesses, especially small businesses, to obtain updated accounts of the challenges and opportunities in the current stage of international trade from the operational level of businesses. Update-to-date information provision and transparency about the situation businesses are in is crucial and should be provided timely to the public.
  5. Covid-19 brings real challenges to businesses and governments. However, governments need to think beyond Covid-19 crisis and focus on the long-term challenges brought by Brexit.

EXHIBITS

Exhibit 1

Note: This table shows the ranking based on the Eigenvalue Centrality of China’s trading partners based on HS2 products traded internationally in 2019 and Jan-Feb 2020.

Exhibit 2

Note: This figure shows dynamics of bimonthly export and import of China measured in billions of USD in Jan-Feb, 2019 – Jan-Feb, 2020.

Source: General Administration of Customs of People’s Republic of China (GACC)

Exhibit 3

Export and Import of China with the world, % change, between Jan-Feb of 2019 and 2020

Note: This figure shows percentage change in export and import of China in Jan-Feb, 2020 by regions of the world as compared to the same period of 2019. EU is also included in the broader region of Europe.

Source: General Administration of Customs of People’s Republic of China (GACC)

 

Exhibit 4

Source: General Administration of Customs of People’s Republic of China (GACC)

Exhibit 5


Source: General Administration of Customs of People’s Republic of China (GACC)

 

Exhibit 6

 

 

 

 

 

 

 

Exhibit 7

Note: GVCs network which represents the links between 56 sectors in each country with other sectors in the world.

Source: World Input-Output Database (WIOD), 2014. Based on author’s calculation.

Exhibit 8

Note: GVCs networks of UK financial sectors (sector 41).

Source: General Administration of Customs of People’s Republic of China (GACC)