The greening of global value chains

Clogged ports, long shipping delays, and skyrocketing transportation costs are all evidence of the havoc Covid-19 is continuing to wreak with global value chains (GVCs). Firms are reconsidering where to locate (or relocate) production, whether and how much redundancy their operations need, and which inventories to hold as a buffer against future shocks. The effects are rippling through the global economy, creating additional uncertainty and slowing the recovery. Moreover, with policymakers currently in Glasgow for the United Nations Climate Change Conference (COP26), there is increasing pressure to decarbonise production and transportation along GVCs.

How quickly this happens is of great importance. GVCs account for half of the global exports, and emerging and developing economies' share of these production networks has increased significantly since the 2008 global financial crisis. For example, a low- or middle-income economy no longer needs to produce a whole car to enter the global automobile supply chain; it is enough to specialise in one small component.

Against this backdrop, a recent report from the Asian Infrastructure Investment Bank examines the pandemic's impact on GVCs and shows how they can now become tools for achieving the 2015 Paris climate agreement's goal of limiting global warming to 1.5º Celsius, relative to preindustrial levels.

TBS Illustration

The evidence from previous crises that significantly disrupted key supply chains (such as the 1999 Jiji earthquake and the 2011 Fukushima nuclear disaster) suggests that strong efficiency pressures and heavy dependence on personal trust in supplier relationships favour a return to the status quo ante. If this pattern holds, then current pandemic-induced GVC disruptions and dislocations will prove temporary and resolve themselves as the world normalises. But this time may be different, because Covid-19 has hit the global economic system much more broadly and lasted much longer than most previous shocks.

The pandemic's current impact stems less from the initial shutdown in China in early 2020 – from which the Chinese economy and GVCs recovered remarkably quickly – and more from the rapid increase in demand triggered by massive government stimulus and the unleashing of accumulated savings. The asynchronous opening of economies has also amplified the supply disruptions. It may take years to determine the effect of the Covid-19 crisis on GVCs. The pandemic could spark a fundamental rethink of how to organise them and where to locate production. Resilience, or the capacity to bounce back from shocks, has become a buzzword in this discussion. At the same time, geopolitical concerns are creating pressures for economies to reduce their supply dependence on individual countries while decoupling is already underway in important high-tech industries.

Recent energy-price spikes are a reminder that GVCs face an even greater challenge as the world seeks to accelerate the transition to net-zero carbon dioxide emissions. With production geographically dispersed and intermediate products shipped back and forth across borders and over long distances, pressure to decarbonise GVCs is mounting. At the same time, emerging and developing economies themselves must meet their nationally determined contributions under the Paris agreement. 

But the drive to decarbonise GVCs also represents a great opportunity to accelerate the net-zero transition. Because such production networks rely on their lead firms' capacity to increase efficiency throughout the supply chain, these companies can play an important role in pushing the net-zero agenda across borders and sectors. Many of them have already committed to becoming carbon neutral by 2050 and central banks are putting pressure on these firms' creditors to reduce climate risk in their loan portfolios. 

Likewise, countries that want to attract and retain GVC investments will have an additional incentive to offer green infrastructure, including access to renewable energy, emissions-free multimodal transportation systems, and high-speed broadband. Going green can thus become a competitive advantage for emerging and developing economies seeking to join global production systems and fulfill their Paris commitments. Increased interest from governments can in turn encourage lead firms to engage in joint decarbonisation investments. 

To realise the full potential of this virtuous circle of decarbonisation pressures on GVC lead firms and host countries, transparency and traceability must increase at every level of production and in all aspects of the value chain. Without careful measurement of carbon footprints and consistent implementation of international standards, market forces and regulators cannot play their vital roles. 

The multilateral development banks can facilitate sustainable investments along value chains, incorporating the best technologies and standards while helping to ensure transparency and traceability with respect to CO2 emissions. They can also assist private-sector investors in managing policy risks, which often discourage infrastructure investment. Without private and institutional capital, emerging and developing economies will not close the infrastructure gap with developed countries.

The pandemic has highlighted the importance of GVCs for the world economy, particularly in helping emerging and developing economies climb the value-added ladder and bridge the prosperity gap. But the crisis has also put the spotlight on the potential role GVCs can play in accelerating the net-zero transition across countries and sectors. As the world leaders currently in Glasgow are fully aware, we will need every available tool to ensure a sustainable future.

Erik Berglof is Chief Economist of the Asian Infrastructure Investment Bank.

Disclaimer: This article first appeared on Project Syndicate, and is published by special syndication arrangement.