Russian Invasion of Ukraine: Global Implications

The tricky restructuring of global supply chains

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much

Mains level : Paper 3- New phase of globalisation and challenges ahead

Context

After the go-go 1990s and 2000s the pace of economic integration stalled in the 2010s, as firms grappled with the aftershocks of a financial crisis, a populist revolt against open borders and President Donald Trump’s trade war.

Background of globalisation

  • After the Berlin Wall fell in 1989, main theme of globalisation was efficiency.
  • Companies located production where costs were lowest, while investors deployed capital where returns were highest.
  • Governments aspired to treat firms equally, regardless of their nationality, and to strike trade deals with democracies and autocracies alike.
  • Low prices: All this kept prices low for consumers and helped lift 1bn people out of extreme poverty as the emerging world, including China, industrialised.

 

Recent worries with globalisation

  • Volatile capital flows destabilised financial markets. Many blue-collar workers in rich countries lost out.
  • Recently, two other worries have loomed large.
  • Cost in case of disruption is high: First, some lean supply chains are not as good value as they appear: mostly they keep costs low, but when they break, the bill can be crippling.
  • Covid-19 was a shock, but wars, extreme weather or another virus could easily disrupt supply chains in the next decade.
  • Dependencies on autocracies have increased: The second problem is that the single-minded pursuit of cost advantage has led to a dependency on autocracies that abuse human rights and use trade as a means of coercion.
  • Hopes that economic integration would lead to reform—what the Germans call “change through trade”—have been dashed: autocracies account for a third of world gdp.

The fragile state of the international trade and beginning of new phase in globalisation

  • The pandemic and war in Ukraine have triggered a once-in-a-generation reimagining of global capitalism in boardrooms and governments.
  • Supply chain resilience: The supply chains are being transformed, from the $9trn in inventories, stockpiled as insurance against shortages and inflation, to the fight for workers as global firms shift from China into Vietnam.
  • Preferring security over efficiency: This new kind of globalisation is about security, not efficiency: it prioritises doing business with people you can rely on, in countries your government is friendly with.
  • One indication that companies are shifting from efficiency to resilience is the vast build-up in precautionary inventories: for the biggest 3,000 firms globally these have risen from 6% to 9% of world gdp since 2016.
  • Many firms are adopting dual sourcing and longer-term contracts.
  • Investment pattern is inverted: The pattern of multinational investment has been inverted: 69% is from local subsidiaries reinvesting locally, rather than parent firms sending capital across borders.
  • Strategic autonomy: The industries under most pressure are already reinventing their business models, encouraged by governments that from Europe to India are keen on “strategic autonomy”.
  • Moving towards vertical integration: The car industry is copying Elon Musk’s Tesla by moving towards vertical integration, in which you control everything from nickel mining to chip design.
  • Long-term supply deals: In energy, the West is seeking long-term supply deals from allies rather than relying on spot markets dominated by rivals.

Challenges

  • Protectionism: The danger is that a reasonable pursuit of security will morph into rampant protectionism, jobs schemes and hundreds of billions of dollars of industrial subsidies.
  • Long-run inefficiencies: The long-run inefficiency from indiscriminately replicating supply chains would be enormous.
  • Were you to duplicate a quarter of all multinational activity, the extra annual operating and financial costs involved could exceed 2% of world gdp.

Way forward

  • Restraint: Because of the above challenges, restraint is crucial.
  • Diversification: Governments and firms must remember that resilience comes from diversification, not concentration at home.
  • Diversify in the areas controlled by autocracies: The choke-points autocracies control amount to only about a tenth of global trade, based on their exports of goods in which they have a leading market share of over 10% and for which it is hard to find substitutes.
  • The answer is to require firms to diversify their suppliers in these areas, and let the market adapt. 

Conclusion

Will today’s governments be up to the task? Myopia and insularity abound. But if you are a consumer of global goods and ideas—that is to say, a citizen of the world—you should hope globalisation’s next phase involves the maximum possible degree of openness.

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