By Liz Lorincz, Director, Global Trade Consulting
The human toll wrought by the COVID-19 pandemic will be, without question, what people around the world will recall most when looking back at 2020 a generation from now.
For those involved in global trade, however, 2020 has the potential to be of separate and distinct significance, albeit one of far less gravity. It will be the year in which global firms re-evaluate the length, composition and nature of global value chains (GVCs).
GVCs are the ecosystem of interconnected energy producers, manufacturers, suppliers, buyers and sellers spread out across multiple geographies. They have grown extensively since the early 1990s when the liberalization of trade and the advent of advanced communications technology allowed businesses to spread out in search of new markets, new cost efficiencies and new services from around the world. They have been instrumental in enhancing firms’ productivity, making them more competitive, but also delineating where certain work will be performed (e.g. high-skilled vs. low-skilled). In recent years, however, changes in the trade environment, such as the rise of protectionist policies, the growing complexity of regulatory policies and the interspersion of political agendas within trade agreements – as well as growing environmental volatility and political instability – have forced many firms to scale back the scope of their GVCs.
Re-evaluating GVCs in the wake of COVID-19
The outbreak of COVID-19, which forced a shutdown of production in China that lasted for weeks and nearly paralyzed global trade, has given the impetus to re-evaluate GVCs a significant jolt forward. Firms with a high concentration of production in China first found themselves unable to generate sufficient supply to meet demand and later were left with little choice but to wait patiently for a backlog of supply to find its way to intended markets as trucks, ports and ships gradually resumed operations. The pandemic exposed the vulnerability of supply chains that are highly dependent on offshore production.
This was an “aha” moment for the globalization movement. A recent report from the McKinsey Global Institute estimates 16-26% of global trade, valued at $2.9-4.6 trillion, could shift in some form in the medium term, be it through reshoring, nearshoring or the diversification of offshoring. The same report shows production diversification varies significantly by industry with the tech sector demonstrating the highest degree of dispersion across geographies while aerospace and automotive and industrial machinery have witnessed a concentration of production within fewer locales. Those firms with GVCs highly exposed to disruption can expect to lose as much as 42% of one year’s EBITDA over the course of a decade.
For many firms, the choice to locate production in a particular company is often rooted in a broad range of factors, including labor and production costs, regulatory burden, tax policy, infrastructure and time in transit to end markets. GVCs that are being reconfigured through a strategic and measured evaluation process are likely to be transformed gradually with an eye to creating sustainable and holistic change while using broad-ranging criteria to determine whether or not (and how) production should be moved.
In other cases, firms are making shifts in their GVCs in response to immediate needs. For example, many firms have already moved, or are planning to move, production out of China to neighboring markets to guard against future production shutdowns or to circumvent U.S. tariffs. These are understandable changes, but careful planning is critical. Geographic proximity and low-cost labor should not be isolated criteria for such decisions. Other factors, such as the scarcity of available labor in Vietnam and labor skill level should be equally critical factors, as should inadequate road and port infrastructure. This is not to say a move to Vietnam from China won’t make sense for a business with a high concentration of production in China. It very well may. But it won’t make sense for every business.
The tariff factor
One of the considerations often overlooked in assessing the resilience of GVCs is that of trade policy and relations. The aforementioned example of Vietnam is a case in point. The Southeast Asian nation has been the biggest beneficiary of Washington’s ongoing row with Beijing, capturing approximately 40% of production leaving China, most of which is uncoincidentally U.S. bound. Yet as Vietnam’s exports to the U.S. have spiked over the past two years, so has the U.S. Department of Commerce’s awareness of America’s growing trade imbalance with Vietnam.
In 2020, the U.S. moved to impose countervailing duties on Vietnamese car and truck tires and launched a Section 301 investigation into currency manipulation. Even before the conclusion of the investigation, U.S. labor groups are already requesting a tariff of 8.4% be imposed on Vietnamese goods to counteract the effects of the alleged currency manipulation. That’s a far cry from the 25% tariffs being imposed on China-origin goods, but when coupled with other factors, it could negate the business case for moving production out of China and into Vietnam.
Conversely, for Canadian businesses looking to guard against future disruption to production in China, Vietnam is very viable alternative. Both Canada and Vietnam are members of the Comprehensive & Progressive Agreement for Trans-Pacific Partnership (CPTPP), a free-trade agreement involving 11 Pacific Rim countries. Therefore, the threat of future trade barriers is extremely limited. For Canadian businesses, strategic placement in GVCs is of particular importance as more than half of the country’s imports are intermediate goods designed for use in additional or final production, and eight percent are imported strictly for direct transshipment to another country (mostly the U.S.).
Asking the right questions
Of course, it is often difficult to foresee how trade regimes and trade relationships will change over time. However, those firms actively considering a shift in their production source, or just looking to create redundancies in other locations to make their supply chains more flexible, must make trade policy considerations part of their evaluation process by asking questions, such as:
- What is the existing tariff regime in the location being considered and how does that tariff regime interact with the tariff regimes of the countries from which I will be moving product and/or to where I will be moving product?
- Is the location being considered part of a trade bloc, such as the CPTPP, RCEP, USMCA or Mercosur and, if so, how can I capitalize on that trade liberalization?
- Does the location being considered have a robust border-administration infrastructure to prevent delays at ports and land border crossings?
- How extensive is the regulatory regime in the location being considered and what are the monetary and human-resource implications of regulatory compliance?
- Is the location being considered at risk of engaging in trade conflicts with other nations and, if so, what are the potential cost and transport implications?
This is by no means a comprehensive list, but it’s a solid start for organizations that may not have previously considered trade policy and tariff regimes to be critical considerations in their decision-making process.
Given the rise of protectionism in some parts of the world and the potential for its continued expansion, trade policy will gradually become an influential element in how global value chains are composed. For business decision makers, becoming more deeply immersed in these matters will be not only helpful, but increasingly essential.
Liz Lorincz is a recognized expert in tariff classification as well as in customs valuation and rules of origin pertaining to various trade agreements. She is highly knowledgeable in all areas of commodity tax, goods and services tax, harmonized sales tax, marking rules and import and export controls.