How rising conflict is reshuffling global supply chains

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This week, the world is facing the horrific toll of conflict. But as more dire headlines emerge from the Middle East and Ukraine, economists are also trying to calculate the financial cost of this geopolitical fragmentation.

Take the International Monetary Fund, for example.As the annual meeting gets underway, it has just released its latest world economic outlook, and provide the usual analysis of the future trajectories of debt, growth and inflation. A new feature of this year’s World Economic Outlook is that the word “fragmentation” is cited no fewer than 172 times; five years ago, it was mentioned just once.

Perhaps this is not surprising. Economists at the International Monetary Fund, like global investors, worry that growing conflict will harm economic growth, especially by disrupting global supply chains. “The fragmentation of countries into blocs that only trade with each other… could reduce annual global GDP by up to 7%,” the report said.

In fact, the IMF’s model of the costs of splitting the alliance is based on the voting blocs that emerged at the United Nations after Russia’s invasion of Ukraine—a world in which China and Russia were allied against the West.

Companies are nervous, too: “Prior to the Covid-19 pandemic, companies had few mentions of fragmentation-related keywords, but usage surged after Russia’s invasion of Ukraine,” the International Monetary Fund’s text mining campaign showed. This growth is particularly evident in commodities.

An interesting question raised by the World Economic Outlook is to what extent has this bellicose rhetoric actually changed Western supply chains? In other words, will geopolitical competition lead to “reshoring” and “reshoring friends”? This is a difficult question to answer accurately because supply chains are notoriously opaque. Most previous analyzes of this issue have relied on cross-border trade and foreign direct investment statistics.

These reveal some adjustments; U.S. direct investment in China has fallen from a peak of $20.9 billion in 2008 to an 18-year low of $8.2 billion in 2022. But with the EU’s trade deficit with China still at a record high and the U.S.’s deficit also hitting a record high this year — these macro-level data don’t really explain what’s happening in supply chains at the micro-level.

Therefore, in order to contribute to this debate, Bank for International Settlements A novel bottom-up exercise has just been conducted. The report used a vast global database of company financial accounts and their stated customer and supplier relationships to create two snapshots of activity in December 2021 and September 2023. The results deserve widespread attention.

This work begins by noting that global value chains “are in the midst of a far-reaching reorganization” since Russia’s invasion of Ukraine, with the subsequent debate over nearshoring and friendly-shoring “focusing attention on building shorter, more On the advantages of flexible suppliers.” relation”. The analysis then showed that multinational companies’ reliance on cross-border suppliers did fall “significantly” between 2021 and 2023: most notably, Western companies reduced one-stop sourcing from China.

But this does not mean creating a Western-only regional trade network. Instead, end users purchase basic and intermediate products from places like China through middlemen in countries such as Vietnam. The result was a “significant increase” indirect The Bank for International Settlements said cross-border connections are emerging as new corporate nodes intervene in existing supply chains.

For end-users in Asia, this is creating a fairly cohesive trading network as regional integration in Asia has increased. However, for end users in the U.S. and Europe, this means supply chains are becoming increasingly complex. It is not so much a reshoring that is occurring, but rather a reshuffling – rising levels of complexity, widening the “distance” in the supply chain (the layer between raw materials and end users).

This has three key implications.First, it means that Western businesses remain exposed to the vagaries of geopolitics; as a penetrating report Data from the Center for Economic Policy Research shows that if China stops selling basic materials to middlemen, end users will suffer losses.

Second, it creates oversight challenges for Western corporate boards and investors, since it is difficult for companies to track supplier behavior (for example, on environmental or social issues) if there are multiple stages in the supply chain.

Third, as the CEPR points out, this trend can lead to inflation. Western companies previously established one-stop U.S.-China trade links to increase efficiency and reduce costs—one of the raison d’être of globalization. If supply chains now become more multi-layered, costs will rise; as Morgan Stanley puts it, “slow globalization” is replacing globalization.

The key point, then, is that investors and the IMF should be worried about more than the specter of Cold War-era trade bans between geopolitical blocs—more subtle extensions of supply chains that will fuel inflation and potentially dampen economic growth.

Western customers are likely to believe that this is a fair price to pay for better national security and corporate resilience. fair enough. But if this trend continues, it will create a world very different from that of recent decades. Restructuring – not just reshoring – is what needs attention now.

gillian.tett@ft.com

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