Foreign Direct Investment and Supply Chains in a Risky World

Yves here. It is useful to have Joseph Joyce summarize and draw some conclusions from recent reports from the McKinsey Global Institute and the United Nations Conference on Trade and Development on the future for supply chains and foreign direct investment given increased nationalism and Covid. One thing to note in particular with McKinesy is that while it regularly marshals useful data, one needs to look carefully at how it reaches its conclusions. Its taxonomy for types of shocks, for instance, seems pretty dodgy. Since when did anyone foresee the 2008 crisis? Even those like your humble blogger and economists like Steve Keen and Michael Hudson saw that there would be financial crises in many countries, I cannot recall anyone anticipating the global financial system having a near death experience.

By Joseph Joyce, a Professor of Economics at Wellesley College, where he holds the M. Margaret Ball Chair of International Relations. He served as the first Faculty Director of the Madeleine Korbel Albright Institute for Global Affairs. Originally published at Angry Bear

The pandemic has shown that global supply chains are vulnerable to shocks. Output contracted as factories were closed in China and the impact was transmitted to firms further along the chains and the distributors of the final goods. Foreign direct investment had already slowed in the aftermath of the global financial crisis of 2008-09, and there were questions about its future (see here). How will multinational firms respond to the new shock?

The McKinsey Global Institute seeks to answer this question in a new report, Risk, Resilience and Rebalancing In Global Value Chains. The authors point out that the pandemic is only one of a range of shocks that can disrupt production. They distinguish between catastrophes that are foreseeable (such as financial crises) and those unanticipated (acts of terrorism), as well as disruptions that take place on a smaller scale. The latter can also be divided between those that are foreseeable (climate change) and those that are unanticipated (cyberattacks).

The report then measures the exposure of different business sectors to the various shocks. Those that are heavily traded are more vulnerable. These include communication equipment, computers and electronics, and semiconductors and components, all industries that are seen as promoting growth. Apparel is another sector that is vulnerable to risks, such as the pandemic and climate change.

These risks will motivate firms to reconfigure their supply chains. The political fissure between China and the U.S., as well as government policies to ensure self-sufficiency in some sectors, will also induce firms to reorganize production. The report’s authors estimated that 16% to 26% of current exports could be shifted. They find that “ .  .  .  the value chains with the largest potential to move production to new geographies are petroleum, apparel, and pharmaceuticals.” In some cases governments may need to provide financial support to induce firms to relocate to domestic economies where the governments seek domestic self-sufficiency.