By Stefano Riela

For years, globalisation made it possible to geographically distribute economic activities. In ‘normal’ times, when the fluidity of trade is guaranteed, the nationality of goods is not relevant, especially if countries involved are market economies members of free trade agreements.

With the Coronavirus, the U.S., like many other countries, found itself with a shortage of ventilators and vital personal protective equipment (PPE) for health workers. In the last weeks, we’ve discovered the weakness of the internationalised value chains due to the concentration of production (e.g. Malaysia for medical gloves, China for masks), to the size of the increase in demand (a global symmetric shock) and to the fact that manufacturing countries themselves have been affected by the pandemic, thus reducing their production capacity and raising the incentive to curb the export.

Some of the export restrictions have been lifted, because of actions taken at G20 level[1] and at European Union (EU) level[2]. But the Pandora’s Box of national protectionism has been opened. In fact, when national security and citizens’ health are at stake, States can raise barriers even in free-trade-friendly contexts such as the WTO[3] and the EU[4].

Many States are faced with an urgent question: Is it time to redesign the geography of value chains, especially for essential goods?

What is essential? 

First of all, it is important to establish what essential goods actually are. As a general rule, essential is what satisfies the physiological and safety needs of people[5] and, for a State, what is necessary to offer the related products and services, to guarantee the conditions of supply or, in any case, to be the supplier of last resort. The lack of availability of an essential product or service (e.g. food, medicines, electricity) can destabilise public order. Value chains of essential goods, like any other goods, can be very complex[6]. For example, the food industry and its trade, along with the products harvested in the fields require packaging and the production of related products and machines, with the necessary maintenance and components.

Once the essentiality of a good has been defined, it is necessary to evaluate whether there are substitutes capable of satisfying the same need in a similar way (the so-called demand-side substitutability). An essential good with a given efficiency (productivity/price ratio) can have substitutes with equal or lower efficiency (were the substitute’s efficiency is higher, the latter would be used at first). If, for example, the essential need is to protect the eyes of those who work in a hospital, the optimal product is a pair of goggles; however, a full helmet that covers the whole head and face, even if more expensive, can be a substitute as it performs the same function. In order for the two products to be considered substitutes, the difference in the efficiency must be proportional to the degree of essentiality and the financial capacity of the State that acts as a supplier of last resort. Put more simply, only a State with adequate resources and an urgent need is willing to spend more on buying a replacement for an essential good.

Along with a demand-side substitutability, there is one on the supply-side. In the event of a shortage of the essential good, producers of other goods may be able to convert the production chain to achieve the essential product. Obviously the conversion must be sufficiently timely, i.e. the availability of the essential good must not undergo a quantitative and/or qualitative alteration such as to affect the service to citizens. As in the case of demand-side substitutability, the extra costs associated with the conversion are ultimately borne by the State. For example, we have discovered that vacuum cleaner manufacturers can, with relative ease, produce lifesaving ventilators[7].

What is the optimal geography of a value chain? 

Of course, each country would like to be sure that essential goods are available on its territory, especially in case of emergency. However, this self-sufficiency would be neither possible (e.g. raw materials are not present equally in all countries) nor convenient.

The localisation of economic activities and free trade allows greater efficiency and it is for this reason that, from Ricardo’s theory[8] to practice, most countries are in the WTO. However, we have seen that, especially in times of emergency, countries think first about their own interests and can decide not to export the goods they deem essential.

Between the impossibility and inefficiency of the national level and the uncertainty of the global level, there is a clear role for Regional agreements, the likes of the Trans-Pacific Partnership (TPP), the European Single Market, the new NAFTA / USMCA, and the Mercosur.

Integration within regional agreements can reach levels that discourage opportunistic behaviours of individual countries. Differently from thoughtful prisoners[9], States have a long-term perspective and a strong incentive to cooperate, especially if partners have a sufficient retaliatory capacity.

Footnotes 

[1] Reuters, 30 March 2020 (link)

[2] On 16 March 2020 the European Commission published “COVID-19. Guidelines for border management measures to protect health and ensure the availability of goods and essential services”. C(2020) 1753 (link)

[3] Articles XXI and XX of the General Agreement on Tariffs and Trade (GATT).

[4] Art. 36 of the Treaty on the Functioning of the European Union (TFEU).

[5] In establishing this hierarchy, reference has been made to the so-called pyramid of needs described by Abraham Maslow in the book Motivation and Personality published in 1954.

[6] The value chains of each economic activity can be reconstructed with the tables that analyse the sectoral interdependencies of an economy as proposed by the economist Wassily Leontief (winner of the Nobel Prize in 1973) or, much more pragmatically, by asking trade associations. 

[7] The Guardian, 26 March 2020 (link).

[8] According to David Ricardo, countries should specialise in what they are best or most efficient at, and then exchange these products, for, in that case, the people of both countries will be better off.

[9] In the prisoner’s dilemma, the first step to study game theory, two individuals acting in their own self-interests do not produce the optimal outcome. 


Stefano Riela is a research fellow at the Europe Institute, University of Auckland. He is an expert in European integration and EU trade policy. 

See Also:

How did coronavirus spread across the world?