Covid-19 and Value Chains: Diminishing Returns from Trade Policy

The COVID-19 pandemic will be a history-altering event. But where will it take us? In “On the Horizon,” a new CSIS series, our scholars offer their insights into the fundamental changes we might anticipate for our future social and economic world.

The immediate impact of the Covid-19 pandemic on trade is apparent. Economic slowdown has reduced import demand, and trade flows are collapsing. As a policy matter, supply disruption and shortages of medical supplies and equipment have placed a spotlight on whether production networks are sufficiently resilient. What happens once the public health emergency passes? Voters, firms, and governments are very likely to recalibrate their expectations and risk tolerance across the economy.

From the late 1980s until 2007, “globalization” accelerated trade flows and raised living standards. Rapid gains in information and communications technology (along with other innovations) reduced barriers to the movement of goods, people, knowledge, ideas, and culture. Simultaneously, many governments owned up to the failure of autarky and central planning and moved toward the open, rules-based model of the General Agreement on Tariffs and Trade and, later, the World Trade Organization (WTO). Regional arrangements like the EU single market, NAFTA, and dozens of bilateral agreements simplified cross-border flows, enhancing specialization within production networks. For the most part, it worked. Trade as a share of world output grew from the mid-teens in 1989 to 28 percent by 2007, and the income gains from trade made market-opening initiatives reasonably popular. This era came to a halt with the 2008-09 financial crisis. Since that time, initiatives at the WTO as well as regional cooperation have slowed to a crawl. By 2017, a decade after “peak trade,” trade as a share of world output had fallen to around 22 percent. While trade liberalization may have once been seen as a “good deal” for many, the aftereffects of the global downturn led to skepticism and stasis.

Production networks continue to adapt, with or without a policy agenda. People in emerging markets are now consumers as well as producers. Finished products are more knowledge-intensive while production methods are increasingly sophisticated. Regional value chains serve the new global middle class better than long-haul global chains, and trade in services outpaces goods trade. Meanwhile, the policy agenda bogged down. “Cycle time” for market-opening agreements stretched to the point of obsolescence (prime examples being the WTO Doha Round, launched in 2001, or the Transatlantic Trade and Investment Partnership, begun in 2010). As a matter of practical politics, trade liberalization seemed to reach the point of diminishing returns: deals became smaller, and benefits became harder to find. This opened the door for trade protection and further “de-globalization.”

In the midst of the Covid-19 crisis, central bankers and finance ministries will be expected to provide coordinated action, injecting liquidity and delivering stimulus. Freer trade in critical medical equipment and supplies could alleviate shortages, but the G20 trade ministers statement focused mainly on avoiding new restrictions. This underperformance stems in part from the limits of trade tools themselves but also because the habits of bargaining are more polished than the patience for coordinating. In the meantime, the medical professionals and producers here and abroad are responding with ingenuity to improve testing, diagnosis, and treatment while government and businesses work to address the very real economic challenges.

What happens to global production networks once the threat to human health from Covid-19 passes? First, expect supply chain resilience, always an important design feature, to receive greater focus and priority. Second, companies will reevaluate sole-source suppliers while governments and health care institutions will reassess stockpiling and sourcing, since a crisis tends to reshape views of what is “adequate.” Third, government officials are likely to expand the idea of “essential” products from defense articles to medicines and medical equipment and attempt to shorten the list of “reliable sources” (as termed in the Defense Production Act). Fourth, regulation, especially approval regimes for medical devices, equipment, and medicines, are likely to be evaluated with respect to speed and risk management.

On a less optimistic note, the impulse to demand local production of all drugs or medical equipment, if not moderated by expertise and careful planning, could well do more harm than good. During the crisis, elected leaders have been at their best when relying on public health experts to guide their decisionmaking. Following the crisis, officials should look to a different but equally important set of experts—those in the business of production networks—to ensure the response yields the desired outcome and not a host of unintended side effects.

I am convinced the U.S. response to this crisis will exemplify strength, ingenuity, compassion, and resilience. Our longstanding confidence in open markets should be a reminder that what we do at home is magnified by the efforts of people around the world—from a vaccine developed in Israel to test methods from a Swiss company to an anti-viral drug from Japan. In the final analysis, advanced production networks are built on vast amounts of know-how from actors throughout the value chain, accrued bit by bit like coral reefs. We benefit from them only by respecting the way they are constructed.

Scott Miller is senior adviser with the Abshire-Inamori Leadership Academy at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Scott Miller
Senior Mentor (Non-resident), Executive Education