One phenomenon hogging the headlines of Bloomberg and other global business media is the fracturing of the global value chains (GVCs). The disruptions have resulted in the worldwide shortage of “chips” and are threatening the recovery of the global economy.
Will the GVC disruptions—lockdowns, re-shoring, downsizing, closure and so on of various intertwining GVC facilities located in different Asian countries—lead to the collapse of Factory Asia? Because of the GVCs set up by the multinationals, Asia has become the uncontested industrial workshop of the world. Asia has been supplying most of the manufactured goods needed by the world, particularly by the North American and European markets.
Almost all Asian countries are now “hooked” to the GVC system. Some Asian countries such as Indonesia, Malaysia, Philippines and Thailand have been involved in the GVC system on electronics, auto parts, garments and other products since the 1970s. Today, participants in the GVC system include almost all of the South and Southeast Asian countries, with Vietnam, Cambodia, India, Bangladesh, Sri Lanka and Nepal increasingly becoming major assemblers-exporters. At the center of the GVC system in Asia is China, which has succeeded in cornering about half of the GVC investments.
From the 1970s to the turn of the millennium, the GVC system grew by leaps and bounds. The system was fairly stable. The exultant neo-liberal economists argued that there was only one way forward for developing countries: open up the national borders and join the GVC system.
But today, the GVC system is no longer as stable as before. Some GVC facilities are being closed or re-shored to the home countries of investing multinationals. The situation has been compounded by the impact of the Covid-19 epidemic. Lockdowns, logistical bottlenecks and “global distancing” have affected GVC facilities in some countries, whose outputs are supposed to be inputs to the GVC facilities of other countries. The disruptions are shaking the foundations and structures of the GVCs.
However, Covid is not the only reason why the GVCs are fracturing. There are three other major contributing factors, whose impact on GVC operations is often not immediately perceived.
First, we have the “Fourth Industrial Revolution” (FIR).
Industry 4.0 is enabling corporations to do more integrated production at home. In other words, the “fragmentation” or “atomization” of work in global industries, which allows the big corporations to outsource the labor-intensive phases of production to developing countries such as assembly work, is increasingly becoming irrelevant and non-profitable. In fact, the whole GVC system can be uprooted and re-shored. For example, Adidas is now manufacturing shoes in its plants in Germany and the United States with the aid of new technology.
However, the re-organization—for examples: shortening the chain, re-shoring some outsourced activities, re-designing processes, etc.—of the different GVCs due to the impact of FIR is obviously not happening in one fell swoop. Some changes can be incremental, e.g., reduction of the number of chains or production assemblies (as in the case of electronics and auto parts which are distributed by multinationals for assembly in different countries); on the other hand, some changes can be sweeping, e.g., uprooting whole GVC system and bringing it back to the home country of the multinational.
The major technology trends shaping or re-shaping international production are: robotics, AI-enabled automation, enhanced supply chain digitalization and 3D printing (additive manufacturing). The availability of cheaper industrial robots and AI-enabled automation can offset the competitive advantage of low-cost manufacturing. Digitalization and additive or 3D manufacturing make a “rebundling” of the different stages or chains of manufacturing possible; they also enable manufacturers to do “mass customization” or production based on specific demands of customers (e.g., color, design, size, etc. of rubber shoes).
The second major disruptive reason: trade rivalries.
Trade conflicts, especially the US-China trade war, are well publicized. Then US President Donald Trump openly questioned why China has been racking up huge trade surpluses at the expense of the United States. Trump raised the following complaints: US-China trade balance one-sidedly in favor of China (for example in 2018, US imported $539.5 billion of goods from China and exported $120.3 billion in return, resulting in a US trade deficit of $419.2 billion for one year alone); China robbing the US of “hundreds of billions” a year due to Chinese piracy of US ideas amounting to “intellectual property theft”; China killing 100,000 Americans a year by exporting the dangerous fentanyl drug; and China manipulating its currency in order to gain competitive advantage in trade.
The response of China to Trump’s accusations was equally angry. The Chinese government has been arguing that its behavior as a trustworthy trade partner is well established. In a white paper issued in September 2018, China’s Information Office of the State Council explained that the slowing US economy is due to bad economics, specifically US having a low savings rate and yet consuming so much. Further, China argues that the US, which dominates the monetary system of the world, has been exploiting global markets by “printing a hundred-dollar bill” that is “no more than a few cents” while other countries “have to provide real goods and services in exchange for that note”.
Trump’s trade/tariff war has been continued by President Joe Biden, who has asked American investors with manufacturing projects in China to withdraw. As a result of the trade war, a number of American, Japanese and other investors have downsized or even phased out some manufacturing facilities in China. The downside for the US side: disruptions in US businesses that are dependent on input imports from China.
But the trade wars are not limited to US and China. Japan has a well publicized “trade conflict” with South Korea, which came out in the open in 2019. Japan restricted the export of high-tech materials to South Korea. In response, South Korea scrapped a military-intelligence sharing agreement with Japan. Further, the two countries dropped each other from the list of “trusted” trade partners.
Third disruptor: climate change risks.
The third disruptor is the global climate crisis. Asia’s economy, especially the GVCs, is vulnerable to the risks associated with climate change and environmental degradation. An ADB Report (A Region at Risk, 2017) pointed out that disasters triggered by weather disturbances have a disruptive impact on supply chain networks involving different countries hosting the GVCs. This means flooding in one host country can affect the “just-in time” standard in the delivery of inputs/outputs from one GVC chain producer to another as well as the quality and quantity of inputs/outputs under an “interdependent” system of production.
Some GVCs are also re-configuring or re-arranging production in response to global warming. Easily, the most significant among these are the GVCs for the auto industry (Toyota, Mitsubishi, Ford, etc.), which have well-developed networks of production plants in Asia. As is well publicized, the shift to electric vehicles (EVs) is now sweeping America and Europe, and is slowly gaining adherents among the rich Asian consumers. The shift is leading to a consolidation and restructuring of the auto GVCs as what has been happening in North America, Latin America and Europe. These are likely to happen in Asia within the decade with the EVs becoming more and more affordable due to advances in fuel technology.
Of course, national disasters due to CC adversely affect whole economies, including the GVC production facilities they are hosting. For example, supply chain was seriously damaged in 2011 due to two major disasters: the Great East Japan Earthquake and the severe floods in Thailand.
Arrival of Covid-19 creating a ‘perfect storm’ for the GVCs
Now on top of the foregoing three disruptors, here comes Covid-19. It has ushered in a “perfect storm” for the GVCs, roiling and disrupting the GVCs worldwide.
Governments around Asia have forced governments to impose and implement debilitating lockdowns, some on a recurring basis, to prevent the spread of the virus at the community and national levels. In the process, factories have been shut down and the movement of goods and services has ground to a halt in countries where harsh lockdowns have been declared. Two industries that are badly affected are transport (land, sea and air) and logistics, both of which play a vital role in keeping GVC operations humming with minimal interruptions. With Covid-19, interruptions and disruptions have become common. Social distancing at the community and national levels has been reinforced by global distancing as countries try to close national borders to prevent the entry of suspected carriers of the virus, especially those coming from countries with very low rates of vaccination.
In the assessment of UNCTAD (2020), Covid-19 tends to accelerate certain trends affecting the shape of GVCs such as the adoption of new technologies promoting automation and robotization, both of which lead to the reduction of GVC chains and re-shoring of some outsourced production such as electronics assembly and auto parts manufacture. Protectionist tendencies, which are at the heart of trade wars, are also reinforced. Transnationalization or internationalization of production can slide into nationalization or localization. The flow of capital through foreign direct investments (FDIs) is also disrupted.
Implications for the Philippines
Covid-19 and the three disruptors (technology revolution, trade wars and climate emergency) are indeed a perfect storm subverting Factory Asia. Does this mean the end of the GVC system?
The answer is no. The GVC system will not disappear overnight, although a few will be uprooted or closed down due to re-shoring or business losses. What is clear is that the fracturing process is a continuing one and so is the re-configuration process for each GVC. Naturally, the level of participation of each Asian country in each GVC, industry by industry, is changing, also industry by industry.
What then are the implications for the Philippines of the GVC fracturing phenomenon? There are at least two:
First, it is not good for the country to be totally dependent on GVCs as the principal base for its economic development. No country, not even Japan and China, can rely solely on GVCs in the creation of jobs for its entire population. The creation of jobs under the GVC system should only be part of a bigger program of job creation involving the development of domestic industries, modernization of the agricultural sector and strengthening of ancillary service industries, including the mobilization and capitalization of savings from overseas migrant workers.
Second, the Philippines should avoid being trapped in the low and middle levels of GVC production. GVC facilities at these levels are vulnerable to technology disruptions and decisions of GVC investors to relocate elsewhere or re-shore production at home. Moreover, being trapped at these levels for a long period, as what has happened to the Philippine electronics and auto parts assemblies (1970s-present), shows the host country is failing to scale up the industrial and development ladder.
Dr. Rene E. Ofreneo is a Professor Emeritus of University of the Philippines.
For comments, please write to reneofreneo@gmail.com.