Global value chains (GVCs) have already come under pressure as a viable model for the organization of international production since the outbreak of the COVID-19 epidemic in China, and even more so since the virus turned into a global pandemic. Some analysts expect a major reshuffling of the global production network as a result of the pandemic, which was already triggered by the US-China trade war (CNBC, 2020).
UNIDO’s data on world manufacturing production
UNIDO’s data showed a consistent decline in production growth, indicating an overall economic slowdown already before the outbreak of the COVID-19 crisis. Manufacturing output growth fell below the landmark of 1 per cent and remained at 0.7 per cent in the fourth quarter of 2019 (UNIDO, 2019).
In the fourth quarter of 2019, only three industries registered a positive year-over-year growth rate in all country groups, namely basic pharmaceutical products, beverages and food products. While these three industries represent essential basic consumer goods and are likely to continue to perform well over the coming months, other manufacturing industries are expected to suffer a severe blow due to the coronavirus outbreak and the resulting economic implications. Consequently, world GDP growth can be expected to decline in the coming months.
Global GDP growth, 1995–2020. Source: UNCTAD calculations based on IMF, WEO, October 2019
Three main channels of the global economy will be disrupted: demand, supply, and finance
On the demand side, a combination of reduced income and fear of contagion will result in lower private spending. Although some of these effects might be offset by increased government spending, the COVID-19 shock’s net demand effect is expected to be negative in the short run.
This could be amplified by negative supply side effects, attributable to a sudden halt in manufacturing activities in the most affected regions and the resulting bottlenecks in global value chains. If left unaddressed, such disruptions will in turn trigger widespread factory closures due to the lack of intermediary inputs, even in areas less affected by the virus.
Lastly, increased risk aversion and a flight-to-liquidity in the face of uncertainty caused by the COVID-19 shock, the financial markets stress will weigh heavily on the global economy. Further fluctuations are expected in the foreign exchange market.
Substantial increase in unemployment
A substantial increase in global unemployment seems almost certain. The ILO expects the pandemic to disproportionally affect not only those workers with underlying health conditions, but also young people who are more vulnerable to decreased labour demand, women, who are over-represented in those sectors that are likely to be affected most (such as services or in occupations on the front lines of the pandemic, e.g. nurses), as well as unprotected workers in the so-called ‘gig economy’ and migrants. (ILO, 2020).
Capital flight
The pandemic has already triggered capital flight and a sharp reversal of international investment in emerging markets. Whereas a group of 24 emerging markets including China, India, South Africa and Brazil, had a net inflow of investments of US$79bn in 2019, US$70bn in investments had already exited those countries in the last two months alone according to the Institute of International Finance (New York Times, 2020). With this in mind, the decision by the G20 governments to “do whatever it takes” to minimize the social and economic fallout due to the coronavirus – and most importantly, to ensure cross-border flows of vital medical supplies, agricultural products and other goods and services – was welcomed (The Guardian, 2020).
Possibility of insolvency and default
This capital flight has reignited fears that countries such as Argentina, Turkey or South Africa, could be sliding toward insolvency and default soon. This could be further accelerated by currency depreciations in these countries. The Argentine peso continued to devalue and decreased by another 6 per cent against the dollar this year alone. Similarly, the Turkish lira has dropped by 10 per cent since January due to investors pulling out money and Turkish companies facing bankruptcy.
While these are only two examples, the situation is becoming equally dire in many other low- and middle-income countries and requires urgent attention from policymakers and the international community.
Significant contraction of FDI
The effect of the pandemic is similarly dramatic when we look at foreign direct investment (FDI). On26 March, UNCTAD estimated a collapse of global FDI by – 30 per cent to – 40 per cent during 2020–2021, much more than the previous projections of -5 per cent to -15 per cent two weeks earlier.
While those countries most severely affected by COVID-19 will be hardest hit, other countries are also likely to feel the virus’s full impact as supply chain disruptions on investment prospects. Over two-thirds of the 100 multinational companies tracked by UNCTAD have issued statements on the effects the virus has had on their business. Many are reducing capital expenditure in affected areas, and to date, 41 have issued profit alerts. Lower profits translate into lower reinvested earnings, a major component of FDI.
A wider sample of the top 5,000 listed companies shows that the earnings forecasts for the fiscal year 2020 have been revised down by an average of 30 per cent. The hardest hit sectors are the energy and basic materials industries (-208 per cent for energy, with an additional shock caused by the recent drop in oil prices), airlines (-116 per cent) and the automotive industry (-47 per cent).
Trouble in global value chains and supply chain contagion
As outlined by Richard Baldwin and Eiichi Tomiura in their essay published on 6 March 2020, the hardest hit countries account for the majority of global GDP, manufacturing production and exports. Furthermore, the mitigation policies introduced will result in a global slowdown in aggregate demand. Global supply chains have fundamentally changed how supply shocks propagate. As industrial parts and components are increasingly traded, a supply shock in a globally integrated economy is likely to create ‘supply chain contagion’ via the trade in intermediate goods.
Baldwin and Tomiura develop different supply chain scenarios based on the WTO’s GlobalValue Chain Development Report 2019 and by citing case studies from The Economist. They also use data from the OECD Trade in Value Added database to quantify the importance of inter-linkages for different countries. The authors find a mixed picture for trade in services, as some industries such as tourism and air travel will be hit hard, while others, such as ICT and medical services, will not be as affected.
Impact on production and trade
According to reports by academics and practitioners on the impacts of the coronavirus, the virus implies both a demand and a supply shock.
The supply shock
From the supply side perspective, production is affected, on the one hand, because of reductions in labour supply as a consequence of the number of workers infected, thus reducing the number of people available to work, and because value chains are disrupted, on the other. Countries that rely on equipment and components from regions affected by the virus may experience disruptions in the production process.
The demand shock
Demand for manufactured goods could reduce as a consequence of the pandemic. This usually occurs for two reasons:
First, the propensity to consume decreases as workers who are required to stay at home in support of “social distancing” measures tend to prioritize saving over spending.
Second, firms that are experiencing disruptions in the production process may decrease their consumption of intermediate goods.
Supply and demand shocks can manifest in different ways across countries and different industries. The differences between various regions could be as follows:
- Economies like China, Europe and the United States are mostly affected by direct impacts on their population’s health condition;
- The majority of developing countries are mostly affected, for the moment, by indirect impacts relating to their level of inter-linkages with countries affected by the coronavirus, i.e. their demand for goods or the supply of goods and services. However, as COVID-19 further spreads to developing countries, the direct impacts on those countries are likely to increase.
- It is plausible to assume that resource-rich developing countries will be also affected by a reduction in commodity prices (e.g. copper, oil) driven by reduced international demand for such goods, and that developed countries will experience a drop in the production of transformed manufactured goods.
Impact on manufacturing industries
The coronavirus is now rapidly spreading around the world. Anecdotal evidence is reporting losses for the manufacturing sector beyond China, namely also for many rich developed countries. According to IBIS World, relevant impacts are being registered in many countries such as Australia, Canada, Germany, New Zealand and the United States. Recurrent losses in these countries are reported in the domestic market, particularly in the food industry due to the closure of pubs, restaurants and other caterers.
Heavy losses are being registered on the international markets in the automotive industry (a huge decrease in sales of 82 per cent in Germany), and in high-tech industries such as computers and electronics, the traditional champions of revealed comparative advantage in rich countries.
Managing COVID-19: How industrial policy can mitigate the impact of the pandemic
What began as a health emergency is now rapidly threatening to turn into a global economic crisis. Policy actions and coordination will be crucial in mitigating the impacts of the emergency on industry.
As the number of confirmed COVID-19 cases continues to rise, UN Secretary General António Guterres has warned that this pandemic is the biggest challenge the world has faced since World War II. What began as a health emergency is now rapidly threatening to turn into a global economic crisis. Containment measures have shaken the foundations of the three main pillars of the global economy: demand, supply, and finance. Timely and coordinated action is crucial to contain the spread of the virus, to minimize the short-term impacts on the economy and to create conditions to redress global economic activity. A comprehensive evaluation of measures to significantly slow down infection rates is necessary to reduce the risk of exacerbating the ensuing economic downturn. Some of these issues are addressed here with a focus on industrial development in both developed and developing countries.
This opinion piece is part of a series of articles by UNIDO’s Department of Policy Research and Statistics
Industry is affected by supply- and demand-side effects
It is too early for statistical data to fully capture the impact of the COVID-19 crisis on global demand and supply. Emerging evidence from China and a select number of developed countries suggest a drop in demand, proxied by the considerable decline in energy consumption and transport use, real estate-related commercial activity and other indicators of consumer behaviour.1 Social distancing measures mean reduced commercial activity. A combination of lower incomes and the fear of contagion have resulted in lower private spending, which an increase in government spending can only partly compensate for.
On the supply side, with factories either closed or operating well below capacity and large numbers of employees prevented from working, less output is being produced. Production is further hampered by the lack of intermediate supplies. The disruption of trade and its impact on international production networks and global value chains will need to be evaluated, but will likely be very pronounced. Governments around the world are introducing debt relief measures and offering businesses deferral programmes. It remains to be seen how many firms—especially SMEs—will succeed in absorbing the de facto accrued losses and survive the pandemic fairly unscathed.
The impacts differ across countries
The impact of this crisis and countries’ ability to cope with it varies considerably. While some countries are better prepared to cope with the pandemic and its impacts, others are struggling to deal with either the COVID-19 outbreak or its impacts or with both; others yet will find it hard to apply any COVID containing measures or rely on the donor community. The scope of the pandemic’s impact is not confined to the national level; differences in impact will be observed across industries, firms and households alike. At the national level, several pre-emptive policy measures may help save lives, provide support for businesses to stay afloat, protect employment and gear up the economy to weather the storm.
Although such policies are directed towards a large majority, many are falling through the cracks. Such containment measures can only be effective at the individual, household, firm or even country level if sufficient savings and cash flow are available. Just like households that rely on daily wage earnings will not be able to afford to comply with social distancing measures, some countries will not be able to afford to shut down substantial parts of their economy to contain the spread of the virus. Even if this were possible, the duration of such drastic measures highly depends on how robust a country’s social welfare system is, if one exists at all. The community impacts in countries with a weak social welfare system are likely be severe, leading to deteriorating health conditions that will quickly overwhelm the already fragile health care system and bring the economy to its knees. The ability to manage both the emergency situation and the recovery phase also hinges on the individual country’s economic structure.
This pandemic will further intensify the effects of persistent inequalities2, with highly vulnerable households, businesses and countries expected to suffer the highest losses. They would certainly benefit most from organized global collective action. Progress towards achieving the SDGs will likely be postponed and any advancement made so far may very well suffer a setback. The role of industry and industrial development to contribute to the advancement of the SDGs will be seriously jeopardized. Local industries involved in boosting production of most-needed goods (e.g. food products to ensure higher degrees of food self-sufficiency, essential health care products, telecommunications technology and inputs for local manufacturing) will be the winners as they assure revenues.
Immediate reactions from the manufacturing sector
Industrial firms have responded to the spread of COVID-19 in various ways. Many are trying to solve immediate cash-flow challenges by cutting costs and seeking debt relief and compensation from their governments. Employees are being put on short-time working and are requested to take leave to reduce the wage burden. The ensuing personal income loss will lower both consumption and company revenues. Meanwhile, a number of companies are repurposing their production lines, switching to the production of urgently needed goods such as ventilators, masks and intensive care units.3 Many companies have also reorganized their businesses to make use of telecommuting and e-commerce.
It remains to be seen how many businesses will be able to absorb the shock waves; those with a higher cash flow and a more diversified investment portfolio will certainly fare better. Extensive debt guarantees and credit support programmes should cushion—at least partially—the need for liquidity, but may need to be combined with mechanisms to defer debt repayments to a later stage. Further to credit support, some governments are already considering subsidies for the most severely affected businesses.
Finally, some firms have started rethinking their business models, with supply shortages from overseas leading to an increase in procurement of inputs from local or regional businesses. The full extent of these measures will only become evident after the shocks associated with COVID-19 have settled.
How governments can help
Businesses will not be able to weather the economic downturn on their own. Policy actions and coordination will be crucial in mitigating the impacts of the crisis. Many governments have already adopted a wide array of policies, including exchange rate adjustments and balance of payments measures, monetary policies as well as fiscal measures. Solutions at the microeconomic level will also, however, be necessary, as the scale of the current supply shock—a general forced shutdown of economic activity—is unprecedented, and adequate policy responses may in part lie outside the traditional mix of interventions.4 Policy measures can be structured around four target areas:
- Measures to keep businesses afloat during COVID-19 containment efforts. Such measures include the introduction of actions to ensure liquidity for businesses to tackle immediate cash flow challenges and support business continuity. This might include subsidizing publicly-provided inputs, temporary debt relief and compensation through special credit lines and guarantees, deferral of financial obligations and, where possible, revisiting the conditions for firms to file for bankruptcy. Partial closures to accommodate fluctuations in demand may also be an option. Governments can defer the payment of taxes, duties and other government fees.
- Measures to maintain employment during COVID-19 containment efforts: These measures are aimed at supporting employee retention. For instance, public health care systems could cover the wages of workers and employees who have to quarantine. Furthermore, temporary regulations could be introduced to prevent large-scale layoffs and alternative work arrangements, including short-term leave, telecommuting and cost sharing through partial salary adjustments.
- Measures to adapt businesses during COVID-19 containment efforts: Firms can be incentivized to shift to other means of doing business, for example, by improving their web presence, advertising via social media, enhancing customer service functions via phone and online, and engaging in e-commerce. Companies should be supported in the provision of higher workplace safety standards and better protection for workers. Moreover, governments can support the private sector by increasing the procurement capacity of the health care system, its service delivery and its ability to conduct research. Funds can be established that provide grants and loans to businesses that produce the goods and services necessary to curb COVID-19 and to support the development of COVID-19-related (virtual) industrial clusters.
- Measures to reorient businesses after COVID-19 containment efforts: Governments can implement measures that prepare businesses for the new post-COVID-19 economic conditions and realities. Industrial development may follow a path of increased risk aversion to protect the basis of domestic industreis and be inclined to promote most-crucial production (including food products, health care products, telecommunications technology and inputs for local manufacturing). In the medium run, governments, particularly in developing countries, will need to promote initiatives to secure the supply of such products in view of possible disruptions in global value chains. Firms will need to invest in new business processes and in technological innovation. Governments can support these efforts by monitoring market conditions and developing indicators allowing firms to quickly identify emerging market needs and changes in consumer behaviour. Governments could also provide public funding schemes to facilitate investment in internalizing production and establishing new supplier networks.
In these unprecedented times, business continuity in industry is key, calling for a prudent response to the supply- and demand-side effects as soon as the restrictions related to COVID-19 have been lifted. To future-proof industry, governments may need to promote initiatives that ensure production stands on a more solid ground in case of supply chain disruptions. This may include reorientation towards sourcing from less distances and emphasizing domestic supply chain development.
Getting post-COVID ready
It remains to be seen how quickly economies around the world will be able to resume their operations, and what this recovery will look like. The longer the COVID-19 containment measures stay in place, the more challenging and taxing the recovery process will be, magnifying the need for public support.
In the short term, policy measures should counteract increased risk aversion and prevent flight-to-liquidity, which could exacerbate financial stress, particularly in emerging and developing markets, and thus curtailing access to the resources needed to manage the anticipated consequences of COVID-19 on the economy. On the supply side, policies should ensure continued protection of workers, a quick rebooting of domestic supply as well as restoring—and eventually reshaping—the functioning of global value chains. On the demand side, public procurement and innovation in products and processes may be necessary, including investments in new technologies.
For many developing countries, sustainable long-term recovery will require a commitment to bridge capability gaps and improve the performance of local health care systems,5 including links to local manufacturing capacities. UNIDO, together with the UN system, would have the necessary competencies to take the lead by developing an agenda for the coordination of efforts to support the most vulnerable and the most severely affected industries worldwide.
For economies to reopen as soon as the spread of COVID-19 has been contained, flexibility and close monitoring will be necessary to allow for an orderly phasing out of interventions, to incentivize business restructuring and avoid policy capture or free-riding behaviours.
The recovery from the shock of COVID-19 will likely not allow a return to pre-crisis normality. Policies to identify new alternatives for the organization of global production networks and to build, diversify and reorient productive capabilities will represent an important component of the strategies to build resilience against future disruptions.
Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).