COVID-19 strains global value chains in more ways than we think

Ari Van Assche,
Professor of International Business,
HEC Montréal and CIRANO,

As COVID-19 sweeps the globe, its impact extends far beyond the health implications of a pandemic that has already killed more than 70,000 people. To halt the spread of the disease, countries have rightly taken extraordinary measures to flatten the curve, that is, to slow the rate of infection so that it eases the burden on local health care systems. As of early April, governments have asked half of the world’s population to stay at home to prevent the spread of the virus. Many countries have also closed their borders to non-essential traffic, leading to a precipitous drop of more than 70 percent in international flights compared to the same week a year earlier.

The business community has been quick to point out the implications of the synchronized lockdowns on global supply chain disruptions. Several COVID-19 hotspots such as China and Italy are key suppliers of parts and materials for global buyers. As production grinded to a halt in these areas, and border closures limited firms’ abilities to find suitable alternatives, it has generated supply chain shocks that have reverberated across the globe. Dangerous shortages of China-made medical equipment are the most talked about case in point.

Less attention has been paid to the implications of COVID-19 for the heart of global value chains: intangibles. Intangibles refer to the intellectual activities that go into the development of globally produced goods and services. They include the research and development that lead firms conduct to develop new goods and services. They also comprise investments by lead firms to develop brand equity and to orchestrate value chain partners. According to a recent study by scholars at the University of Groningen, intangibles account for more than 30 percent of total income that is generated in global value chains.

A distinctive feature of intangibles is that they concentrate in global cities such as New York and Paris which have large concentrations of human capital. One reason is that intangibles benefit from agglomeration economies: frequent interactions with people from similar companies generates a knowledge “buzz” that stimulates local entrepreneurship and innovation. A second reason is that global cities have a high air transport connectivity with other global cities, which facilitates access to foreign knowledge pockets. In recent work, Ekaterina Turkina (HEC Montréal) and I have shown that both the local buzz and global connectiveness strengthen a region’s innovation performance.

The COVID-19 pandemic hurts the production of intangibles by stifling both local interactions and global travel. The goals of stay-at-home orders and social distancing rules are to limit the interactions between people so that it can help stop the transmission of the coronavirus, but a downside is that it also puts a halt to both the planned and unplanned face-to-face meetings that undergird the vibrancy of local innovation ecosystems. The closing of international borders to non-essential travel limits firms’ abilities to exchange tacit knowledge with their foreign partners.

Many intangibles producers have tried to cope with the COVID-19 crisis by replacing in-person meetings with virtual conferencing, but they are imperfect substitutes at best.  Virtual interactions work well in situations that involve occasional get-togethers that are limited in time. They do not allow for the in-depth debate and discussions that are generally needed to develop ground-breaking new ideas and solutions.

The effect of COVID-19 on the development of intangibles will ultimately depend on both the duration of the health crisis and the extent to which things return to normal once the pandemic itself is behind us. A relatively short crisis with a swift relaxing of social distancing rules and an opening up of international borders will likely limit the negative impact of COVID-19 on intangibles. A protracted public health disaster that continues to limit social interactions in the medium run, then again, will require firms to adapt their business models which will put significant strain on the development of intangibles.

Government actions will have a critical influence on the global economy’s recovery path. Past experiences have shown that governments like to turn to protectionism when facing a severe economic downturn, and this time is not different. A Global Trade Alert study shows that, since the beginning of 2020, the governments of more than 50 nations have taken steps to ban or limit the export of medical equipment and medicines. Other countries have contemplated imposing retaliatory measures against these export restrictions. If COVID-19 ends up thickening barriers between countries, global value chains and the intangibles embedded in them are likely to suffer.

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