April 29, 2020
The whole idea of global value chains will be reconsidered after coronavirus
In 2015 the Cameron government struck an unprecedented deal with French and Chinese companies to build a nuclear power station at Hinkley Point in Somerset, south-west England. The deal now looks like the high point in the UK’s embrace of globalisation. Having begun more than a century ago, globalisation gathered pace in recent decades on the back of everything from freer trade to the reduced power of British trade unions.
Underlying this was the notion of the value chain, the idea that different companies add value to raw materials at each stage in the production process until they become finished goods. Generally speaking, each stage is more lucrative than the last and, in recent years, the stages have been spread across continents and countries.
So, for example, it’s more lucrative to make steel than to mine the raw ingredients and more lucrative again to use the steel to make vehicle parts. And it’s still more lucrative to sell cars. There is also much value in services located near the top of the chain, such as researching better engines or providing legal advice on supply deals for car dealerships.
The philosophy, adopted by many leading economies in Europe and Asia, involved leaving “lower” stages to developing economies and concentrating on the more valuable stages instead. Manufacturing in the UK duly declined from almost 30% of the economy in 1979 when Margaret Thatcher came to power to 10% today. The assumption was that so long as we moved up the value chain and remained able to pay for what was available, supply would never be short.
This mindset was rudely disrupted by the nationalist ructions of the Brexit vote and Donald Trump’s election in 2016. And it has been turned on its head by COVID-19. Witness the UK’s struggle in accessing basic medical equipment to deal with the pandemic. Day after day in the press briefing, ministers are on the back foot over testing, personal protective equipment (PPE) and ventilators.
The equipment scramble
The UK lost valuable time early in the outbreak by not placing orders for necessary equipment – but it is the longer-term trends and international responses that really explain the failure. The lack of domestic manufacturing in the UK has meant no first-buyer privileges for the government to leverage. The UK’s health secretary, Matt Hancock, alluded to this when he said the UK did not go into the crisis with a huge diagnostics industry that could be scaled up.
The Germans could call on Swiss global diagnostics giant Roche, which has a heavy presence in Germany; while South Korea had smaller pharmaceutical producers such as Kogene Biotech. This helps explain why both countries have managed to test widely: Germany at around 25,000 tests per one million people, South Korea at nearly 12,000. Meanwhile the UK is still below 10,000 per million after battling to catch up. The UK is likely to miss its target of 100,000 daily tests by the end of April, having conducted fewer than 30,000 on Monday April 27.
The UK is also not part of global supply chains for the basic components of the tests – reagents and nasal swabs – both of which are in short supply. The world’s largest supplier of nasal swabs is Copan of Lombardy, an early victim of the virus.
At the start of the crisis, Germany could place orders for 10,000 ventilators with domestic medical supply company Draegerwerk, one of the world’s three largest ventilator makers. The UK government had to rely on Dyson, Babcock, Airbus and Formula 1, none of whom were in this space already.
It is similar with masks. China made 50% of the world’s masks before the crisis, and has expanded production 12-fold just to meet domestic demand. The UK lacks the manufacturing capabilities to upscale in this way and has been unable to rely on the global market to provide the masks it needs.
While Burberry, Royal Mint and Rolls-Royce are producing gowns, and Ineos, Diageo and Unilever are making hand-hygiene products, the UK’s capacity for such flexibility is limited relative to Germany or South Korea. As Hancock again conceded, the UK “went into this crisis without a large-scale domestic PPE manufacturing industry to draw on” and “several countries have placed export bans on the sale of PPE”.
As countries close their borders and turn production inwards, multinational firms that were part of global supply chains cannot export freely. China was not authorising mask exports at one stage – and even the output in China of the American conglomerate 3M cannot be exported back to its home country.
This scenario is repeating worldwide. The US invoked the Defense Production Act to force American companies to prioritise US orders, preventing 3M from supplying premium masks to Canada and Latin America.
In incidents reminiscent of fiction rather than international trade, the US intercepted a shipment of masks bound for France and medical equipment bound for Germany – “modern piracy”, as the Berlin state interior minister Andreas Geisel called it. Meanwhile, France and Germany have prevented masks and gloves from being shipped to Italy and Spain.
Faith no more
The UK’s strategy of concentrating on R&D and innovation, as well as services in which it is reckoned to have a comparative advantage such as law, finance and advertising, was part of this wider focus on globalisation that was highly successful in peacetime. The shortcomings have certainly been highlighted in 2020.
Some economists suggest that the only way out of this impasse is further global cooperation and moving away from the highly destructive nationalism that has taken over international medical equipment markets. Clearly, global cooperation will be essential to avoid regressing into protectionism.
Yet governments are realising that global production carries profound risks in a crisis. The German health minister Jens Spahn has said that his country needs to reduce reliance on international production, while the UK government seems to be realising this too. In future, countries will probably decide on key strategic industries in which they need to be self-sufficient. This may well increase costs for consumers – but they may be willing to pay the price. When the dust settles on COVID-19, our whole approach to global trade looks likely to be reconsidered.