Global Value Chains in the Post‐COVID World: Governance for Reliability

Abstract

The COVID-19 pandemic has delivered a profound shock to global value chains (GVCs). To date, popular and academic press has predicted significant changes in GVC configurations due to COVID-19 (FT, 2020; Panwar, 2020). It has been argued that the pandemic has illuminated pre-existing underlying fragilities of GVCs (Silverthorne, 2020), and that lead firms are likely to respond by reshoring operations, vertically integrating, and reducing the geographic footprint of their networks. We agree that GVCs may undergo certain reconfigurations in the post-pandemic world, including strategic supply chain diversification (Gereffi, 2020), greater localization of production of essential supplies, and reduction in irreversible investments abroad (Verbeke, 2020). We do not, however, foresee long-term changes to fundamental principles of GVC governance. Moreover, we argue that many changes that do occur are not pandemic-specific. Rather, COVID-19 has reinforced extant macro-level trends and tensions already affecting GVCs, such as, for example, renewed protectionism, de-Sinicization, and digitization (Kano et al., 2020; Strange, 2020). We predict that, while some structural changes to GVCs can indeed be expected, most pandemic-induced adjustments will take place in the realm of managerial/strategic governance. The pandemic prompts scholars to carefully consider the meaning of efficiency in a value chain, and the implications of this meaning for specific governance practices in a GVC. From a comparative institutional analysis perspective, a GVC represents a distinct form of governance, which is likely to emerge and thrive only if it enables superior efficiency as compared alternatives, such as full internalization or market contracting. The most efficient governance system is the one that is comparatively superior in terms of enabling the lead multinational enterprise (MNE) to economize on bounded rationality and bounded reliability of all actors involved, and to create value through entrepreneurial resource orchestration (Kano, 2018). Such conceptualization of an efficient GVC has been previously proposed by scholars espousing a comparative institutional analysis perspective; disruptions associated with COVID-19 highlight the ongoing relevance of this conceptualization, and the fundamental importance of governance arrangements that are reliable (as opposed to merely cost-effective) in the long term. Efficient responses to unpredictable supply and demand shocks require that the lead MNE economize on new bounded rationality and bounded reliability challenges and respond to the changed circumstances in an entrepreneurial way. In practical terms, this may involve securing alternative supply and distribution channels, arranging for excess inventory and/or production capacity, engaging in new partnerships, and expertly handling relevant information. These measures may sacrifice short-term profitability, but these sacrifices are necessary to ensure the GVC’s long-term survival. It should be noted that GVCs have experienced disruptions from various non-market risks in the past, including the 2008 Sichuan earthquake, the global economic recession of 2008-2009, the 2011 Tohoku earthquake and tsunami, Fukushima Daiichi nuclear disaster, as well as various economic sanctions imposed by the Chinese, Japanese, and US governments. Like COVID-19, those events represented exogenous, unpredictable, and episodic non-market risks (Oetzel and Oh, 2015). However, the COVID-19 pandemic is more intense in its impact, larger in its geographic and industry scopes, and longer in its duration. The pandemic has created unprecedented information and reliability problems associated with, inter alia, sustained uncertainty about the duration of the health crisis, lockdowns, severe trade interruptions, and home-centred policies of governments. Therefore, governance for reliability is particularly relevant in the post-COVID world. In terms of specific managerial practices in lead MNEs, governance for reliability entails routines aimed at increasing lead MNE’s economizing and value-creation capacity. First, we may see greater investment into information systems and analytics, which will allow lead MNEs to economize on bounded rationality by quickly accessing relevant information, performing scenario analysis, and designing appropriate responses to exogenous shocks. Empirical evidence shows that lead MNEs such as Nike relied on predictive analytics to adjust production and re-route distribution, and as a result managed to moderate COVID-19 disruptions to their value chains (Lund et al., 2020). Second, we will likely see an increased reliance on relational governance in GVCs, as a way to improve information flows, secure commitments, and promote entrepreneurial action (Kano, 2018; Verbeke, 2020). Lead MNEs may target partners with compatible goals and strategies, to facilitate a coherent GVC-level response to exogenous challenges. In addition, lead MNEs may focus on strengthening their connections with relevant stakeholders outside of the firms’ immediate value chains, such as home and host country regulators who possess the power to shape local, national, and international responses to external shocks. Third, lead MNEs may increasingly adopt global factory-style orchestration practices for their GVCs. A global factory is a form of GVC characterized by continuous re-evaluation of governance, whereby no fine-sliced activity is ‘above the law’, and all governance arrangements are subject to adjustment with the goal of achieving the maximum efficiency (Buckley, 2009). However, the desired outcome of such continuous adjustment is likely to shift away from attaining the least cost-alignment of activities, toward ensuring long-term reliability of extant arrangements. For example, shifting production toward lower-cost locations may become less important than diversifying for stable inputs; organizing manufacturing around Just-in-Time principles may give way to increasing production capacity, etc. We may also see greater multi-lateral collaborations and cross-industry convergence of value chains as a way to respond innovatively to supply and demand shifts. Such international collaborations are already observed in the realm of medical R&D aimed at COVID-19 response (Guimón and Narula, 2020), and may be adopted in other industries and value chain segments. The above analysis suggests several avenues for scholarly investigation. Some of these have already been flagged as important topics for future GVC research (Kano et al., 2020), and we argue that the global pandemic illuminates the urgency to address these knowledge gaps: The new information and commitment problems created by COVID-19 highlight bounded rationality and reliability challenges inherent in managing complex, geographically dispersed networks. Future research should address how lead firm managers make decisions under high uncertainty, manage relationships within and outside of the network, and implement safeguards to secure commitments at multiple levels. We need to explicate behavioural assumptions, test these assumptions, and establish links between micro-level behaviour, exogenous circumstances, and GVC-level outcomes. Much current scholarly discussion on the impact of the pandemic on GVCs focuses on the retreat of value chains from global to regional and national scopes. There are three caveats to consider within this research stream. First, the geographic make-up of most GVCs is presently regional, rather than global (Kano et al., 2020); even when the trade in final goods produced in a GVC is globally dispersed, the intra-GVC trade is far more regionalized than the label ‘global’ suggests (Baldwin and Freeman, 2020). Second, for those GVCs that indeed have a global reach, a shift toward a regional or national footprint may not be readily feasible; relocation can be particularly inefficient for GVCs that are capital-intensive, tied to specialized knowledge, or tied to natural resources (Lund et al., 2020). Third, it is important to acknowledge that reshoring and nearshoring processes were already underway pre-COVID, spurred by a number of ongoing macro-level trends; the pandemic has simply accelerated responses to these extant trends by directing managerial attention to the increased rationality and reliability problems in their GVCs. To accurately assess the impact of the pandemic on the geographic footprint of GVCs, we need to engage in rigorous GVC mapping, linking GVC units and locations with data on inputs, outputs, and flows of physical goods, knowledge, and capital (Kano et al., 2020). Such mapping should be dynamic, whereby COVID-19 serves as a natural benchmark to study the effect of external shocks on the geographic scope of GVCs. While COVID-19 has shocked the entire world of business, its impact on various actors in a GVC is likely uneven. SMEs, for example, have been hit particularly hard (Anan et al., 2020), and may be displaced by lead MNEs that become increasingly selective in their search for reliable partners. On the contrary, resilient SMEs may have new opportunities to participate in GVCs as lead firms attempt to re-orchestrate their networks. Further, GVC participation by suppliers from emerging economies is often tied to low-cost advantages of their home countries. These cost advantages may be offset by cost-increasing investments (i.e., into information technology) required to contribute value to a GVC in the post-COVID world. Emerging market MNEs (EMNEs) will need to either have higher cost advantages or develop new relevant capabilities, which is also a costly process. As such, EMNEs – and the GVCs that rely on them for cost efficiencies – may have to reassess their competitive strategies. Our broader point is that in order to understand the complex impact of the pandemic on GVCs, we should address the roles of various, heterogeneous GVC actors in responding to the disruptions. The pandemic has brought forth an important insight: a successful GVC is one that is resilient in the face of external shocks. The GVC’s sustainability over time indicates the lead MNE’s ongoing ability to economize on bounded rationality and reliability and recombine resources in an entrepreneurial way. Long-term reliability of GVC arrangements can therefore be considered the ultimate measure of GVC performance, to be elaborated in future research (Kano et al., 2020). To summarize, we argue that the underlying principles of GVC governance remain unchanged: efficient GVCs are sustainable over time, and therefore, will likely persist post-COVID. However, the pandemic shines a spotlight on reliability as a critical property of GVC governance; governance for reliability is particularly important because future global crises are inevitable (Gereffi, 2020). Specific managerial routines in lead and peripheral firms need to be adapted systematically and for the long term, in order to meet new economizing and value-creation challenges and safeguard against future disruptions. Future research should focus on governance for reliability in GVCs in light of the changing global risk environment.