Corona crisis: Isolation of global supply chains hurts everyone

Shutterstock

Everyone loses if the international division of labor ceases to exist. This is the conclusion of a report commissioned by the IMPULS Foundation of the VDMA. Mechanical engineering in particular would suffer disproportionately from the closure of global supply chains due to its strong international integration.

A report by IfW Kiel commissioned by the IMPULS Foundation of the VDMA shows: Germany's prosperity is decisively supported by the international division of labor. If, in response to the Corona crisis, Germany makes cooperation with foreign suppliers more difficult, for example in order to make supply chains supposedly more resilient by bringing back value creation steps from abroad, this will have massive disadvantages for all involved.

Frankfurt, 2. February 2021 - "The Corona crisis has shown the vulnerability of international supply chains. Drawing the conclusion from this to bring production back to the home countries is extremely expensive and therefore the wrong way to go," says IfW President Gabriel Felbermayr. "A more targeted approach would be to improve the resilience of the economy, for example, through greater diversification in terms of suppliers, increased warehousing or even the expanded use of recycling. A very restrictive due diligence law would be rather counterproductive in this regard.“

Scenario considers effects of foreclosure
For the report commissioned by the IMPULS Foundation of the German Engineering Federation (VDMA), the researchers at IfW Kiel ran through a scenario in which the EU seals itself off more strongly through the use of so-called non-tariff trade barriers, i.e. regulations or production standards that make it more difficult for foreign suppliers to access the market, in order to achieve a relocation of foreign value-added steps. The calculation is based on the assumption that Germany or the EU doubles these barriers. According to the calculations, such a closure would lead to a decline in real income in Germany of 3.3 percent per year. Measured in terms of German GDP in 2019, income would therefore be 114 billion euros lower.

"The German economy loses out if we try to roll back globalization".

If there is a trade war and foreign countries react as expected with retaliatory measures, income will fall by as much as 6.9 percent. If Germany also seals itself off from other EU countries, GDP is permanently 9.1 percent below the level without additional trade barriers.

Income also falls in the rest of the EU and worldwide in all three cases. This is particularly pronounced in the case of retaliatory measures. Then real income in the EU (excluding Germany) is reduced by an average of 4.9 percent, worldwide by 1.5 percent.

Mechanical engineering in Germany would be significantly affected
The mechanical engineering sector in Germany obtains almost 43 percent of its primary products either directly or indirectly from abroad. Due to this strong international integration, it would suffer disproportionately from a closure, around three times more than the German economy on average. Its production falls by 14.3 percent a year if the EU closes itself off, and by 19.5 percent if foreign countries respond with retaliatory measures. This would correspond to a loss of sales of around 50 billion euros. If Germany also seals itself off unilaterally from the EU, production in the mechanical engineering sector falls by 25 percent, corresponding to a good 60 billion euros less sales.

"The German economy loses out if we try to roll back globalization," says Henrik Schunk, Chairman of the Board of Trustees of the IMPULS Foundation and Vice President of the VDMA. "Germany's business model in general and the mechanical engineering industry in particular is based on open borders, exchange and networking. These are the guarantees of success that we must preserve, for our technological leadership and global market successes."

"The VDMA is happy to contribute to the industry dialogue with the German government in this sense".

According to the IfW, a due diligence law that would impose high legal risks on companies when selecting suppliers would counteract efforts to increase supply security. "It would make it more difficult for companies to diversify their supplier network. This would make it less crisis-proof and more expensive. The law would therefore have to be designed in such a way that security and prosperity are not jeopardized," says Gabriel Felbermayr.

"Companies must only be held responsible for their own misconduct in their obligations and not for responsibilities of states and a confusing chain of suppliers over several stages.
In any case, civil liability in Germany for misconduct of independent third parties abroad must be prevented. Increased bureaucracy and national solo efforts must be avoided," says VDMA Vice President Henrik Schunk. "The VDMA is happy to contribute to the industry dialog with the German government in this sense." 

Everyone loses if the international division of labor disappears
Study author Alexander Sandkamp emphasizes: "Without the international division of labor, all trading partners end up poorer and the pie we can distribute becomes smaller. Weaker growth also affects people who receive social benefits or government transfers such as pensions, unemployment benefits or child benefits. Savings would probably also have to be made in the health care system."

To be sure, a shutdown of Germany and the EU could slightly mitigate the consequences of a production shock in supplier countries, as was caused by the Corona crisis, and the economy would possibly slump somewhat less. However, from a much lower level. As a result, even after a shock, a closed German economy would be much worse off than under free trade.

Diversification through free trade reduces economic risk
Moreover, in a regional economy there are fewer possibilities for adjustment, so that equally conceivable domestic shocks to the domestic economy have greater negative effects on welfare than in the case of international diversification through free trade. Moreover, even in a regional economy, not every good can be produced locally. Dependencies on individual intermediate products and raw materials therefore remain in a world of limited trade as well.


The full report is available at www.impuls-stiftung.de

 

Downloads