The COVID-19 crisis may result in a reconfiguration of international trade and investments. In a context of strong disruptions in global value chains (GVCs), reshoring strategies have been developed at the national or territorial level, as a way of reducing dependence on third countries or as a means of preserving sovereignty in strategic areas and supporting local employment. However, the rationale for de-globalisation overlooks the multiple dynamics at play in globalisation and the potential for local SMEs to access strategic resources and markets through internationalisation, or to benefit from positive spillovers in GVCs or by operating with multinationals, or at some close distance from them. The third chapter explores the scope and forms of a restructuring of GVCs, and discusses the core role of SMEs in place-based approaches to new industrial and internationalisation policies.
OECD SME and Entrepreneurship Outlook 2021
3. Globalisation versus relocalisation: The core role of SMEs in rising place-based industrial policies
Abstract
Highlights
Potential reconfigurations in global value chains (GVCs) provide opportunities for reinforced small- and medium-sized enterprise (SME) integration in international markets and networks
The expansion of GVCs had already slowed down prior to COVID-19, in part reflecting trade tensions and policy uncertainty (OECD, 2018[1]; 2020[2]) but also the erosion of comparative advantages around labour, driven by technological advancements in digitalisation, robotics and automation (De Backer and Flaig, 2017[3]). Changes in consumer preferences for more responsible and sustainable business conduct, and locally made products (OECD, 2020) have also played a role in this slowdown. The pandemic has accelerated these trends.
By disrupting supply chains, the pandemic has revealed vulnerabilities and raised concerns about resilience. Lockdowns imposed across the globe illustrated risks in value chains, particularly highly fragmented and longer chains. Compared to larger firms, some SMEs have been particularly exposed as their ability to find new intermediate suppliers or to diversify and integrate value chains less exposed to lockdowns is typically more limited.
The shockwave has been harder in value chains where inputs were difficult to substitute, hence making specialisation (one of the key competitive advantages of SMEs) a source of vulnerability. Supply chain disruptions also led to global product shortages, generating fierce competition, with smaller firms with lower negotiating power at a disadvantage. In addition, in industries relying on extensive networks of small suppliers and service providers (e.g. automotive or aerospace sectors), the impact on demand has been severe.
COVID-19 and “resilience” have reignited the debate about industrial sovereignty. Some countries are now developing reshoring strategies at the national or territorial level, as a way of reducing dependence in strategic areas but also as instruments to support local employment (Charbit and Gatignol, 2021[4]). Many governments are now rethinking industrial policies with resilience in mind and looking to protect strategic SMEs and industries, e.g. from predatory practices, takeovers or distortions in competition, etc.
Many governments are aiming to reinforce the positioning of their SMEs in GVCs, by: keeping trade channels open and reducing costs in trading; intensifying export guarantees and export support measures for SMEs; reinforcing SME international business linkages; and reinforcing aftercare and facilitation services to retain and attract foreign direct investment (FDI). Agencies and institutions involved in export and investment promotion are also transforming their operations, to better support their users during COVID-19 (EU/OECD, 2021[5]).
Potential restructuring of GVCs can take many forms that are difficult to anticipate. Building resilience requires some degree of supplier redundancy, possibly a diversification in sourcing and production locations. This diversification may involve divestments from some locations but expansions in others, which presents both challenges and opportunities for SMEs.
Even temporary restructuring in GVCs may have longer-term impacts. Whilst GVCs that have been temporarily disturbed may see a return to the network dynamics that preceded the crisis, there is no guarantee that this will happen, as it may be difficult for many SMEs to rebuild connections that are critical to source assets (OECD, 2019[6]).
At the same time, there are limits to GVC restructuring. Cross-country and cross-region heterogeneity in endowment and capacity remain and so too does the economic rationale for interconnectedness. Simulations suggest that the economic case for reshoring GVCs (and indeed the reshoring case for resilience) is weak (OECD, 2021[7]; Cadestin et al., 2019[8]).
Introduction
SMEs are less often engaged in international activities but those that are show greater performance. SMEs remain predominantly local actors embedded in nearby markets and ecosystems. Domestic markets are the prime space where they do business. Across the OECD, SMEs account for 39% of export value-added and 46% of import value-added. This country average , however, hides large cross-country disparities: in Mexico or France, SMEs represent respectively 5%-8% and 17%-25% of export-import value-added, as compared to 69%-75% and 73%-75% in Estonia and Latvia (OECD, 2021[9]). The relatively low contribution of SMEs to overall exports reflects their lower contribution to industry, in particular to mining and manufacturing where economies of scale play an important role.
The fragmentation of production worldwide along GVCs create new market conditions (Box 3.1), enabling greater specialisation and for smaller actors to enter international markets where they can benefit from knowledge and technology spill-overs and raise their innovation capacity. Evidence suggests that looking only at direct exports by SMEs under-represents the actual engagement of small firms in a country’s exports. Alternately, when the role of SMEs as suppliers of inputs to larger direct exporters is taken into account, their importance as exporters increases considerably (OECD, 2019[6]). This is particularly true in sectors where GVCs play a critical role in sourcing and supporting production, e.g. transport equipment. This indirect mode of internationalisation provides SMEs access to new sources of growth without incurring trade-related costs.
Box 3.1. Market conditions, SME performance and strategies
Market conditions are critical for SMEs and entrepreneurs to do business and to recover after the radical disruptions the pandemic brought in supply chains, international trade and investments, and domestic demand. Market conditions determine the optimal size of firms, whether businesses invest, innovate, scale up or down and create jobs, or whether entrepreneurs enter or exit the market. Firms can adapt to market conditions through a range of strategies but smaller ones have typically more limited options than larger ones that benefit from (size-enhanced) economies of scale. Smaller firms mainly rely on product differentiation (e.g. product innovation), network effects (e.g. standardisation, inter-firm co‑operation or the use of digital platforms) and agglomeration effects (spatial concentration) for competing. Market conditions are set at the national, international, regional or local levels.
Source: OECD (2019[6]), OECD SME and Entrepreneurship Outlook 2019, https://dx.doi.org/10.1787/34907e9c-en.
SMEs, including non-exporters, can benefit from cheaper or more sophisticated imported products and services, or the technology embodied in imported capital products (López González, 2016[10]; López González and Jouanjean, 2017[11]). Firms that use more imports are in fact more productive and better able to face the costs of exporting (Bas and Strauss-Kahn, 2015[12]; 2014[13]). Closer global integration has implications for firms that operate in local markets as well, through increased competition, which can have disruptive effects on local economies and requires enhancing market knowledge and the competitiveness of small businesses.
International investments can also have positive spill-overs on domestic SMEs through various diffusion channels (Crespo, Fontoura and Proenca, 2009[14]; Keller and Yeaple, 2009[15]; Criscuolo and Timmis, 2017[16]; Lejarraga et al., 2016[17]; OECD, 2019[18]; 2020[19]; OECD/UNIDO, 2019[20]). These channels include value chain linkages when SMEs serve as local suppliers or buyers, strategic partnerships with foreign investors, the mobility of foreign firm employees to local SMEs, or competition and imitation effects. The magnitude of FDI spill-overs depends on the FDI qualities that the country attracts, the absorptive capacity of local SMEs and some structural factors such as local economic geography and the regulatory and institutional framework. A greenfield investment, for example, is likely to involve the implementation of new technology in the host country and be accompanied by a direct transfer of knowledge and technology from the parent firm to the new affiliate (Farole and Winkler, 2014[21]). Benefits in terms of productivity incur to local SMEs (in the same region), especially if the FDI is made in a different sector (Lembcke and Wildnerova, 2020[22]). This points to the existence of agglomeration economies and knowledge spill-overs that easily cross sectoral boundaries.
Overall, the benefits from GVC participation depend on the sector, the position of the SME within global production networks and the nature of inter-firm linkages, i.e. the mode of governance of the GVC which is typically dictated by the multinational leading the chain (Gereffi, Humphrey and Sturgeon, 2005[23]). Firms and industries positioned at the centre of complex production networks have access to a greater variety of foreign inputs and potentially a broader range of technologies, compared to those at the periphery. Smaller firms display faster productivity growth in those sectors that have become more central to global production, from those on the periphery, and also in sectors with stronger linkages to more productive foreign buyers/suppliers (Criscuolo and Timmis, 2018[24]).
In sectors where quality (e.g. pharmaceuticals) and a commercial presence (e.g. marketing, advertising, financial services) are important, the establishment of a subsidiary will allow multinationals (MNEs) to secure high levels of quality in production and direct access to clients in the domestic market.
In industries of standardised and simple products for which little formal co‑operation between GVC participants is required (e.g. agricultural commodities), arm’s length market transactions are MNE preferred strategies (UNCTAD, 2013[25]; Gereffi and Fernandez-Stark, 2016[26]). MNEs do not exert any influence in the supply chain and suppliers, many of them SMEs, learn from the demands placed upon them and from market feedback.
In knowledge-intensive sectors (e.g. information technology [IT] hardware, automotive industry), contractual partnerships seem to matter the most (Andrenelli et al., 2019[27]). MNEs exert some influence over their partners, through contract agreements, or more implicitly via their bargaining power (UNCTAD, 2011[28]). In the car industry, on average, around three-quarters of all first-tier suppliers in a manufacturer’s global production chain operate through contractual partnerships, of which over three‑quarters are with foreign-owned enterprises (Lejarraga et al., 2016[17]).
Prior to COVID-19, the expansion of GVCs and the global fragmentation of production have already slowed down
Prior to COVID-19, market conditions for SMEs and entrepreneurs had improved with a stronger growth outlook since the 2008-09 crisis. Improved digital infrastructure and reduced transaction costs in trading across borders had helped SMEs access international markets. The digital platforms have contributed to SMEs sourcing and selling abroad more easily, by connecting them to suppliers and customers and creating network effects for their users (OECD, 2021[29]). Explicit barriers to trade and investments have been reduced as well, making it easier for smaller actors to operate on a global scale.
But there were signs that the growth expansion had peaked. Economic growth had slowed and confidence and investments were at risk (OECD, 2018[30]; 2018[31]; 2019[6]). GVCs had lost momentum, due to trade tensions and a slowdown in FDI (OECD, 2018[1]). The sourcing decisions of firms were affected by higher trade costs and rising policy uncertainty.
There was evidence of a decline in the global fragmentation of production since 2011 (Figure 3.1). For each dollar of output in the world, there has been less trade in intermediate goods and services, highlighting that firms were reducing their use of foreign inputs. Indicators measuring the length of value chains confirm that GVCs have become shorter, but only the international part of value chains (Miroudot and Nordström, 2019[32]).
Figure 3.1. GVCs had already lost momentum prior to COVID-19
Note: This indicator takes into account all trade flows of intermediates inputs used in any stage of the value chain and expresses their overall value as a share of the final output. Calculated for the world, it measures the overall level of fragmentation of production.
Source: OECD TiVA database 2016, OECD TiVA 2018, OECD Economic Outlooks, Comtrade, IMF.
FDI was below historical records, despite improvements in 2019. Global FDI flows at USD 1 426 billion in 2019 increased by 12% in the year but remained below levels recorded between 2010 and 2017 when COVID-19 hit (OECD, 2020[2]). The rebound in 2019 was partly due to a return to positive outward FDI flows from the Netherlands and from the United States (US). However, against this more positive background, FDI equity inflows dropped by 37% in the OECD area, their lowest level since 2005, continuing a downward trend that started in 2016. Equity capital1 is of particular interest because it is often associated with new investments, such as greenfield and/or mergers and acquisitions.
A number of trends were at play that already questioned the rationale for maintaining long value chains (De Backer and Flaig, 2017[3]). New business models require more responsiveness to end-user demand and greater proximity to the market (OECD, 2019[6]). Digitalisation and the servicification of manufacturing (i.e. the fact that manufacturing firms increasingly use and produce services that they combine with the goods they sell) allow firms to rely less on offshoring (OECD, 2020[33]). 3D printing can for instance reduce the cost rationale for offshoring as parts are printed locally. The use of big data increases MNE capacity to optimise local presence and wider use of on-demand contracting workers has facilitated reshoring by reducing the need for staff physical presence. Greater attention is also given to protecting data and innovation assets and locating them in jurisdictions where the rule of law prevails and laws are enforced.
Concerns have arisen about supply chain resilience and the traceability of products along (too?) long value chains. In fact, companies were already rethinking their supply chains in response to demands by consumers for more sustainable and inclusive production methods, as well as locally made products and services (OECD, 2020). Effects on the small- and medium-sized enterprise and entrepreneurship (SME&E) sector may be two-fold. For those SME&Es that are already integrated into long GVCs that are going through a reshuffling, this may mean a loss of market outcomes and lesser opportunities to benefit from knowledge and technology spill-overs from the value chains or trade finance. For local SME&Es that could engage in new supply chain relationships or strategic partnership with MNEs, or that could supply some domestically-based segments of the value chain, it may mean in turn greater market outcomes and opportunities for spill-overs and financing. It may also be possible that some SME&Es lose the position in one segment of a GVC but be able to reposition themselves in another one.
The COVID-19 crisis has deeply disrupted GVCs with differentiated impacts across firms, industries and places
Stringent restrictions to the movement of people and goods have disrupted international and regional supply chains. Pandemic outbreaks can produce strains in supply chains, as transportation systems and the chains themselves are disrupted, which could create domino effects that ripple back and forward to upstream producers and downstream clients, causing a crisis of supply and demand, especially in highly integrated sectors (OECD, 2021[7]; 2020[33]; US Congressional Budget Office, 2006[34]). However, as compared to similar episodes in the past, such as the severe acute respiratory syndrome (SARS) outbreak in 2003, the global economy has become more interconnected, favouring chain reactions along supply chains (Box 3.2).
Box 3.2. Chains reactions along supply chains: The case of China
The COVID-19 health crisis, which began in China, has triggered a series of chain reactions as it spread to Asia, Europe and the rest of the world, provoking major disruptions in supply chains.
China plays a far greater role in global output, trade, tourism and commodity markets than a decade ago (OECD, 2020[35]). The country is now a key world producer of intermediate goods, particularly in computers, electronics, pharmaceuticals and transport equipment, and a primary source of demand for many commodities, such as oil and copper, as well as for high-end user products, such as luxury goods or cars (CNN, 2020[36]). In addition, Chinese tourists worldwide account for around one-tenth of all cross-border visitors and one-quarter or more of all visitors in Japan, Korea and some smaller Asian economies (OECD, 2020[35]).
Containment efforts in China involved quarantines and widespread restrictions on labour mobility and travel, resulting in unplanned delays in restarting factories after the Lunar New Year holiday and sharp cutbacks in many service sector activities. Output contractions in China have been felt around the world, through disrupted supply chains. Depressed demand in China has affected local and international markets as well.
In the automotive industry, Chinese automotive sales declined in the first months of 2020, the production of automotive parts from China-based suppliers dropped and a number of world automobile producers (General Motors, Renault, Toyota, Volkswagen) suspended production while others closed their Chinese plants (CNN, 2020[37]; 2020[38]; Reuters, 2020[39]; The Guardian, 2020[40]).
In the retail trade industry, global brands that count on the Chinese market for a sizeable share of their sales have been braced for a significant hit.
In the healthcare industry, while the global demand for face masks skyrockets, disrupted supplies of pharmaceuticals, medical equipment and biotechnological devices threaten growth prospects (The Guardian, 2020[40]; Forbes, 2020[41]).
Source: OECD (2020[35]), OECD Economic Outlook, Interim Report March 2020, https://dx.doi.org/10.1787/7969896b-en; Reuters (2020[39]), “Bosch CEO warns coronavirus could hit global auto supply chains”, https://www.reuters.com/article/us-china-health-bosch-virus-idUSKBN1ZS10H (accessed on 10 March 2020); The Guardian (2020[40]), “How coronavirus is affecting the global economy”, https://www.theguardian.com/world/2020/feb/05/coronavirus-global-economy (accessed on 11 March 2020); Forbes (2020[41]), “Impact of the coronavirus on business”, https://www.forbes.com/sites/sarwantsingh/2020/03/02/impact-of-the-coronavirus-on-business/#7dd853624414 (accessed on 10 March 2020); CNN (2020[36]), “The coronavirus is already hurting the world economy. Here’s why it could get really scary”, https://edition.cnn.com/2020/02/08/business/coronavirus-global-economy/index.html (accessed on 3 October 2020); CNN (2020[37]), “China’s car sales plunged 18% in January. The coronavirus could make things even worse”, https://edition.cnn.com/2020/02/13/business/china-car-industry-coronavirus/index.html (accessed on 10 March 2020); CNN (2020[38]), “You can’t make a car with 99% of the parts. Coronavirus could wreck the global auto industry”, https://edition.cnn.com/2020/02/09/business/china-coronavirus-global-auto-industry-impact/index.html (accessed on 10 March 2020).
Global trade collapsed in the first half of 2020 and rebounded in the second half of the year. Global industrial production has continued to strengthen in recent months and global merchandise trade has now surpassed pre-pandemic levels (Figure 3.2), helped by the strong demand for IT equipment (e.g. teleworking-related goods) and medical supplies (e.g. masks and personal protective equipment) (OECD, 2021[42]). The recovery in industrial production in China has also boosted demand for raw materials in commodity-exporting economies, particularly metals (OECD, 2020[43]). Cross-border services trade (e.g. tourism) remains weak.
Figure 3.2. Global trade and activity are slowly recovering
Note: The retail sales measure uses monthly household consumption for the US and the monthly synthetic consumption indicator for Japan. The 11-country activity indicator uses gross domestic product (GDP) or economy-wide output data for Argentina, Brazil, Canada, Chile, Colombia, Finland, Japan, Korea, Mexico, Norway, Sweden and the United Kingdom (UK). Data in Panel B are PPP-weighted aggregates.
Source: OECD (2021[42]), OECD Economic Outlook, Interim Report March 2021, https://doi.org/10.1787/34bfd999-en. Based on OECD Economic Outlook 109 database; CPB Netherlands Bureau for Economic Policy Analysis, Institute of Shipping Economics and Logistics (ISL), Leibniz-Institut für Wirtschaftsforschung (RWI), International Air Transport Association (IATA) and OECD calculations.
FDI flows receded sharply but the drop may have slowed. According to OECD official statistics, global FDI flows decreased by 38% in 2020 as compared to 2019. The COVID-19 pandemic accelerated a steady decline and contributed to sinking global FDI flows to their lowest levels in absolute terms since 2005 and, in relative terms to GDP, their lowest levels since 1999 (Figure 3.3) (OECD, 2021[44]). Yet, the drop may have slowed down. The rebound of cross-border mergers and acquisitions activity, which started in the second half of the year and continued through the first quarter of 2021 in advanced economies, could boost FDI total flows in 2021, unless new and large divestments persist in 2021. In addition, recent data on FDI transactions signal a global drop in announced greenfield investments that is affecting emerging markets and developing economies disproportionately, as the decline in capital expenditures affects manufacturing and extractive activities primarily. On the contrary, the largest boost in greenfield investment was observed in biotechnology and communications, where capital expenditures nearly doubled since 2019.
Figure 3.3. International investments by multinationals have plummeted
Source: OECD (2021[44]), FDI in Figures, April 2021, http://www.oecd.org/investment/investment-policy/FDI-in-Figures-October-2020.pdf. Based on OECD International Direct Investment Statistics Database.
Market and supply chains disruptions have a severe but unequal impact across firms. SMEs often have a more limited number of suppliers. In some cases, this may have sheltered them from the shock. At the beginning of the outbreak in China, this appeared to be the case with German SMEs operating more in regional supply chains and therefore less affected by developments in Asia. In other cases, SMEs may have relied heavily on a few suppliers, which were located in COVID-19 clusters or in places under strict and long lockdowns, which could have contributed to further increase their vulnerability. The propagation is also stronger in value chains where inputs are specific and difficult to substitute (OECD, 2020[33]), hence where specialisation (one of the key competitive advantages of SMEs) can become a source of vulnerability.
Supply chain disruptions led to global shortages of products, especially in highly integrated sectors. Since the mid-2000s, the centrality of China as the main manufacturing hub in several sectors has grown significantly, both as a source and as a destination (Box 3.3). In the computers and electronics manufacturing industry, the network has shifted from Korea and the US towards China. The German and US motor vehicle industries remain two of the most central manufacturing hubs globally. In the service sector, France, Germany, the UK and the US are key hubs. The US, in particular, is the most central provider of business services, i.e. financial and insurance services, legal and accounting services, wholesale and retail trade, and research and development (R&D).
The market of semiconductors and its small suppliers have been under stress over the year. The semiconductor value chain is complex and global in scope (OECD, 2019[45]). The production is one of the most R&D-intensive and spans across different companies around the world achieving a number of specialised tasks. The largest semiconductor vendors are predominantly based in Japan, Korea, the US and Europe but many outsource capital-intensive manufacturing and assembly-testing activities to specialised firms located elsewhere (e.g. in China, Chinese Taipei and Singapore). Although the industry is generally characterised by large economies of scale and significant market concentration, smaller companies are able to specialise upstream in high-value segments for the computer-assisted design of semiconductors.
Fierce competition for missing parts could evict smaller actors. The shortfall of semiconductors has driven the prices of a range of high-tech applications up (e.g. mobile phones, computers, or video game consoles) and increasing intermediary costs in a range of downstream industries, such as IT and security infrastructure, electronic appliances, automotive or aerospace. Automotive manufacturers are expected to lose billions of dollars this year due to the global shortage of semiconductor chips and fierce competition for critical parts (Reuters, 2021[46]; 2020[47]; 2021[48]).
In addition to difficulties in sourcing intermediaries, the automotive and aerospace sectors have faced mounting difficulties in finding market outcomes, with the risk of giants dragging down their ecosystems of suppliers with them. The length of the GVC increases the vulnerability of the chain, as it induces a higher risk of chain reactions and increases the risk of default among a larger community of intermediary suppliers (Figure 3.1). The automotive and aerospace sectors typically operate with longer value chains.
According to the International Organization of Motor Vehicle Manufacturers (OICA), the number of car sales/registration for the first 9 months of 2020 was more than 20% down compared to 2019, with, however, good prospects of recovery (OICA, 2020[49]). The giants of the automotive industry suffered historical losses for 2020 (L'Usine Nouvelle, 2021[50]). In early 2020, the abrupt stop of production rippled through the industry, effectively closing down the entire supply chain (Klein, Høj and Machlica, 2021[51]). The lifting of restrictions at a different speed across sectors and countries have resulted in input shortages in the sector’s complex value chains. At the same time, a demand shock markedly reduced production across all assemblers. Persisting low demand, especially in times that are more favourable for precautionary savings than durable goods purchase and repeated outbreaks could lead subcontractors to stop activities due to insolvency or bankruptcy.
Travel bans worldwide and a decline in global traffic and transportation have prompted international carriers to suspend flights and freights (Reuters, 2020[52]), in turn affecting aircraft demand. Many global airlines are under stress, some recording massive losses for 2020 (for example over EUR 7 billion losses for Air France-KLM) (Euronews, 2021[53]), some having folded, even at early times in the pandemic (for example UK-based FlyBe) (BBC, 2020[54]). In addition, due to lower aircraft utilisation, the sale of aftermarket parts and services could also remain below-trend, especially if airlines delay discretionary maintenance or upgrades to reduce costs (Deloitte, 2021[55]).
Box 3.3. The centrality of GVCs
Some countries and industries are very central in GVC networks when they are highly connected with other major hubs (OECD, 2021[7]). Conversely, they are peripheral when they reveal weaker trade linkages. The three largest actors, China, Germany and the US dominate GVC exchanges, in both manufacturing and services sectors.
Figure 3.4. Top ten most central hubs in GVCs
Note: Total centrality is computed as an average of forward and backward centrality. Forward centrality captures the importance of a country – or a sector – as a seller of value-added in intermediates for the production of exports of a specific partner. Backward centrality measures the importance of a country – or a sector – as a buyer of value-added in intermediates for the production of its own exports. The manufacturing sector excludes construction while the service sector excludes electricity, gas and water supply services.
Source: OECD (2021[7]), “Global value chains: Efficiency and risks in the context of COVID-19”, https://doi.org/10.1787/67c75fdc-en. OECD calculations based on OECD (2018[56]), Inter-Country Input-Output (ICIO) Database, http://www.oecd.org/sti/ind/inter-country-input-output-tables.htm.
Box 3.4. The length of GVCs
The length of GVCs is highly variable across sectors. It can be measured as per the number of intermediate inputs used to produce a final good or service (Figure 3.5). Some industries show a higher degree of fragmentation, such as television and communication equipment, motor vehicles, basic metals, textiles, leather and footwear and electrical machinery. Services have on average shorter value chains but some such as construction, hotels and restaurants, R&D or transport and storage are also found with relatively long value chains.
Figure 3.5. Large variations in the length of GVCs across sectors
Note: The index of the number of production stages is proposed by Fally (2012[57]) and calculated using an inter-country inter-industry framework, The minimum value of the index is 1 when no intermediate inputs are used to produce a final good or service. Its value increases when inputs from the same industry or other industries are used. The Inter-Country Input-Output (ICIO) matrix provides the values of all inputs used by one industry in a given country. The ICIO model links internationally input-output tables from 58 countries and accounts for more than 95% of world output. See De Backer and Miroudot for more details on methodology.
Source: De Backer, K. and S. Miroudot (2013[58]), “Mapping Global Value Chains”, http://dx.doi.org/10.1787/5k3v1trgnbr4-en. Authors’ calculations based on the OECD ICIO model, May 2013 release.
Market disruptions have also altered agglomeration and network dynamics, which are key for SMEs to achieve external economies of scale. Spatial concentration may have turned into a weakness, at least temporarily. The regional and local impact of the crisis has been highly asymmetric within countries (OECD, 2020[59]) and it appears to depend on the region’s exposure to tradeable sectors and GVCs. The crisis has temporarily turned these sources of productivity into sources of vulnerabilities (Tsvetkova et al., 2020[60]). Network dynamics are also been disturbed, without any certainty about if or when they could be restored. SMEs tend to be particularly dependent on business networks, sometimes with larger operators (e.g. MNEs) to source technologies, business services and knowledge assets that are critical to their performance (OECD, 2019[6]). Over the longer term, it may be difficult for many of them to rebuild connections once they are disrupted and former partners have set up new alliances and contracts.
The crisis may prompt multinationals to engage in massive divestment plans to prepare for the post-crisis world. Divestments are frequent corporate strategies. Firms routinely invest and expand their operations, as well as downsize and sell their business activities at home and abroad. In fact, about one in five foreign affiliates is divested every five years (Borga and Sztajerowska, 2021[61]). Divestment enables MNEs to optimise their business portfolios by shifting resources from less productive to more productive activities. A recent survey of large multinationals2 shows that a majority of them intends to pursue or accelerate divestment plans as a result of the crisis, as they consider having held on to assets for too long (EY, 2020[62]). Companies will reshape their portfolio which includes refocusing on core businesses and investing in new technologies that can support their future business models.
The restructuring of GVCs could take many forms that are difficult to anticipate. Some firms may rethink the spread of their activities and shorten the distance between suppliers and clients. Others may seek to diversify their supplier and partner networks in order to boost their resilience and reduce exposure to location-specific shocks. This diversification may involve divestments from some locations but expansions in others. MNEs may also make more intense use of e-solutions to dematerialise and automate processes and to reduce reliance on unmovable assets and long-term contracts (OECD, 2021[44]). Finally, while it remains difficult to seize the full impact of ethical consumerism (e.g. localism, sustainable products) on future GVCs, it is likely that consumers will look more favourably to companies that have sought to take a responsible business conduct (RBC) approach and adopt a corporate social purpose, also altering the investment priorities of MNEs.
All this may mean less FDI and cross-border trade in the long run but could also lead to market consolidation, for instance in the e-commerce and digital space. There were already signs of market concentration, in particular but not only in digitally dependent sectors (Furman and Orszag, 2015[63]; Grullon, Larkin and Michaely, 2017[64]), suggesting a reallocation of business activity, assets and profits towards “superstar” firms (Autor et al., 2017[65]). Similarly, the global and massive shift of business operations and sales online since the beginning of the pandemic have reinforced the market power of large digital platforms (OECD, 2021[29]). Altogether, this may tighten competition conditions for smaller players.
Building resilience requires some degree of supplier redundancy and extensive networks, possibly a diversification of location, which could be out of the reach of small businesses. After the Great East Japan Earthquake, firms with extensive networks of suppliers made a faster recovery (Todo, Nakajima and Matous, 2015[66]). Because of their complex supply networks, these firms were initially more affected but these networks became their advantage in the recovery phase. In the wake of the disaster, manufacturers have actually diversified their suppliers and moved away from the “keiretsu” model of long-term relationships with first-tier suppliers (Matous and Todo, 2017[67]). Similarly, foreign-owned affiliates, including SME investors, show often greater resilience during crises thanks to their linkages with and access to the financial resources of their parent companies (Alfaro and Chen, 2012[68]; Desai, Fritz Foley and Forbes, 2008[69]). In addition, delayed reinvestments of earnings of foreign firms often materialise after crisis peaks (OECD, 2020[70]).
Against this backdrop, SMEs are likely to be at a disadvantage. SMEs, including affiliates of foreign MNEs, are typically less well prepared to adjust their operations and move towards the automation of some occupations. Those SMEs participating in GVCs can be even more vulnerable as they often endure most of the difficulties of large MNEs and are exposed to the supply chain management decisions made by MNEs that lead GVCs (OECD, 2020[71]). It may be difficult for many to shift if MNE internationalisation priorities shift.
COVID-19 has reignited the debate about supply chain risks and industrial sovereignty
The crisis has illustrated the vulnerabilities of industries and places to disruptions in GVCs, calling for policy action to search for new sources of growth and resilience. The policy discussion around supply chain resilience and industrial sovereignty starts from the viewpoint that there is a need to rethink GVCs to make them more resilient, for example by diversifying the supplier base or by reshoring some strategic activities. Some observers assert that renationalising GVCs could insulate countries from the economic consequences of the pandemic (OECD, 2020[33]).
At the same time, there are some limits to the way GVCs could effectively be restructured. The terms and conditions of GVC integration are defined by structural factors, such as industrial structure and specialisation, technological advantages, skills composition, the absorptive capacity of domestic SMEs and their ability to build arm-length relationships with MNEs, the performance of national and regional innovation systems, etc., with a strong legacy of past economic and policy choices. These structural factors are overall difficult to reverse or alter in the short term. For instance, technology lock-ins can raise barriers to extensive industrial reshuffling. Looking at patent data and revealed technological advantages in three technological areas, i.e. information and communication technology (ICT), health- and environment-related technologies, it appears clear that not all countries have the same technological assets and capacity (Figure 3.6) (OECD, 2017[72]). China and Korea show a clear technological advantage in ICT, while Ireland, Israel and New Zealand lead patenting in the health field, and Denmark has an edge on green tech. In addition, frontier R&D increasingly requires large investments and the accumulation of knowledge, technology and data, in proportions that often exceed the capacity of a single country and a fortiori a single region. This heterogeneity in endowment and capacity, as well as inertia in technological and industrial patterns, are major impediments to a radical transformation of GVCs. This also means that there is no one-size-fits-all approach to managing supply chain risk.
In addition, there is still a strong economic rationale to maintain GVCs and economies’ interconnectedness. Recent analytical work indicates that the contraction of GDP would have been worse with renationalised GVCs, as government lockdowns also affect the supply of domestic inputs (Bonadio et al., 2020[73]). A counterfactual scenario based on the OECD’s global trade model shed light on the consequences of relocalisation on economic efficiency and stability (OECD, 2021[7]). In this scenario, countries are less exposed to foreign shocks but they are also less efficient (lower levels of economic activity and lower incomes) and less able to cushion shocks through trade, the latter effects being stronger than the former. Modelling results suggest therefore that the economic case for reshoring GVCs is indeed weak.
MNE affiliates generate important indirect effects, depending on how strongly integrated they are into domestic economies. The assertion that foreign affiliates operate in an isolated manner in host countries and source all intermediate goods and services from within their MNE network does not seem to be supported by the data (Cadestin et al., 2019[8]). Instead, foreign affiliates contract and co-operate increasingly with domestic suppliers, including SMEs. The evidence prior to the COVID-19 pandemic demonstrates the importance of foreign affiliates in domestic value chains, not only as customers for locally produced inputs, tradeable as well as non-tradeable, but also as suppliers of final and intermediate products sold and used within the domestic economy. A simulation of “what if international investment were no longer present in the global economy”, resulting in the removal of all foreign affiliates across all industries and countries, suggests that world GDP would decrease by 20.5%, i.e. one-fifth of world GDP (Figure 3.7 based on 2014 data). At the industry level, manufacturing sectors would be the most affected (-40%), especially those highly integrated into GVCs, but services would not be spared (over -30%), including knowledge-intensive services such as computer and information services, or finance and insurance. The same stands for smaller countries or highly integrated countries such as Ireland, Luxembourg or East European countries. In comparison, large countries such as Japan or the US would incur fewer substantial losses.
Figure 3.6. Not all countries have the same assets and capacity to reverse old industrial patterns
Note: The revealed technological advantage (RTA) index is calculated as the share of patents of an economy in a particular technology area relative to the share of total patents belonging to the economy. When the index is above 1, the country has an RTA in the field. Data refer to IP5 families, by filing date, according to the inventors’ residence using fractional counts. IP5 patent families are patents filed in at least two offices worldwide, including one of the five largest IP offices: the European Patent Office, the Japan Patent Office, the Korean Intellectual Property Office, the US Patent and Trademark Office and the National Intellectual Property Administration of People’s Republic of China. Only economies with more than 250 patent families in the periods considered are included.
Source: OECD based on OECD (2017[72]), OECD Science, Technology and Industry Scoreboard 2017: The Digital Transformation, https://doi.org/10.1787/9789264268821‑en, OECD (2017[74]), OECD Science, Technology and Innovation Scoreboard, https://www.oecd.org/innovation/scoreboard.htm and OECD (2017[75]), STI Micro-data Lab: Intellectual Property Database, http://oe.cd/ipstats.
Figure 3.7. A world without foreign affiliates: How much would countries lose?
Source: Cadestin, C. et al. (2019[8]), “Multinational enterprises in domestic value chains”, https://doi.org/10.1787/9abfa931-en. OECD calculations based on the OECD (2018[76]), OECD Analytical AMNE Database, oe.cd/amne.
Strong integration of MNEs in domestic value chains could secure future investments and local SMEs are not just poised to benefit but act as strategic magnets. A strong MNE presence could make the host economy more vulnerable in case of disinvestment. However, it is likely that ceteris paribus foreign affiliates may be less likely to leave because of their strong customer and/or supplier relationships (Cadestin et al., 2019[8]). The domestic SMEs have therefore a key role to play in building the business networks that could help attract and maintain international investments locally.
It is against this background that the policy debate about new industrial policies is taking place (Box 3.5). Whereas industrial policies have long been the policy “that should not be named”, developments in both the policy theory and practice over the past decade suggest that it is possible to find a theoretical rationale for a government role in the area (Warwick, 2013[77]). There is now a growing consensus that the risks associated with selective industrial policy (“picking winners”) and the influence of vested interests could be minimised (OECD, 2016[78]).
Box 3.5. The rise of new industrial policies and the central role of SMEs
A regain of interest in industrial and manufacturing policies followed the 2008-09 crisis, as policymakers aimed to find new sources of growth, address the structural productivity slowdown and the growing competition in GVC segments of higher value-added, and seize the potential of emerging technologies to drive the next production revolution (OECD, 2016[78]; 2017[79]).
New industrial policies are articulated around the following axis of policy action:
Reinforcing business linkages through cluster policies and place-based approaches involving local SMEs.
Attracting foreign MNEs and strengthening the role of domestic SMEs in GVCs through a range of investment promotion policies, SME policies, innovation policies and regional development policies, aiming to enable FDI spill-overs to domestic SMEs and to attract and retain MNEs.
Encouraging technology development at the upstream stage as opposed to the downstream stage, focusing on generic technologies with the view to not impeding competition and infringing state aid rules (European Union [EU], World Trade Organization).
Encouraging entrepreneurship through access to appropriate sources of finance and the development of supportive local entrepreneurial ecosystems.
Improving framework conditions through the enforcement of competition rules, trade openness, the protection of data and intellectual property rights, or the training and retraining of workers.
Optimising the policy mix for innovation by better combining supply-side (innovation creation) and demand-side (innovation diffusion) measures. Demand-side initiatives, such as public procurement, standards or lead market initiatives, are considered effective mechanisms to create a market in areas where it is needed to meet environmental and societal challenges.
Governments are taking steps to reinforce their industrial profile and the positioning of their SMEs in GVCs, through full-fledged industrial policies or a panache of related initiatives (Box 3.5). While the regain of governments’ interest in industrial policies is not new, the current crisis may accelerate the development of policy agenda in the area. For instance:
The European Commission (EC) revised its industrial strategy in March 2020 with a view to addressing the twin challenges of the green and digital transformations (EC, 2020[80]). The new European Industrial Strategy highlights the importance of research and innovation in providing the technological foundation to transform and strengthen industrial value chains, helping to turn sustainability and digital challenges into business opportunities. Common industrial technology roadmaps are a key tool to achieve this objective. The European Skills Agenda pursues a shift in upskilling (improving existing skills) and reskilling (training in new skills) of the industrial workforce. In addition, many of the future programmes, such as Horizon Europe (R&D and innovation), the Digital Europe Programme (digitalisation) and InvestEU (strategic investments and financing), will help step up the competitiveness of the EU industry.
With the view of developing the automotive industry and increasing the competitive production and R&D-based exports in the electronics sector, Turkey has opened its R&D and Innovation and Product & Development Programme to SMEs for the first time. Applications are still ongoing at the time of drafting.
The following analysis focuses on FDI and export policies, competition policies and public procurement (Pillar 2 of the analytical framework of SME&E performance). Country examples are drawn from extensive monitoring of country policy responses to COVID‑19 (OECD, 2021[81]) or otherwise stated.
Governments provide support to SMEs to find (alternative) markets abroad and diversify integration patterns in GVCs (Box 4.6):
Countries, OECD and non-OECD members alike, have intensified export guarantees and support measures for SMEs, including extra financial support, market intelligence services or match-making assistance, etc.
Some countries aim to reinforce the international business linkages of SMEs, also involving MNEs.
Others are reinforcing aftercare and facilitation services to retain FDI (see also Table 3.1).
Some governments are implementing measures to maintain trade channels open and reduce costs in trading abroad, such as by reducing customs duties or streamlining custom procedures.
Box 3.6. Trends in FDI and export policies in a time of COVID-19: Some country examples
Finding (alternative) markets abroad and diversifying integration patterns in GVCs
Flanders (Belgium) has opened up existing financial instruments for SMEs – such as the SME growth subsidy – to help them find alternative markets, particularly where supply chains are impacted (Flanders Innovation & Entrepreneursip Agency, 2020[82]).
Denmark (EKF Export Credit Agency) launched two initiatives in March 2020 to assist Danish exporters, by providing them liquidities and by extending the reinsurance capacity of private trade credit insurance companies in order to cover both large companies and SMEs (EKF, 2020[83]).
Indonesia aims to boost SME exports through virtual business match-making events.
Italy’s export credit agency (SACE) has announced a EUR 4 billion package to support export activity and help SMEs address cash flow needs and diversify export markets. In addition, the Italian agency for the promotion of business internationalisation (ICE) has cancelled the costs already incurred by companies for participation in fairs and events, also proposing alternative visibility solutions.
Korea will extend the maturity of trade insurance and guarantees within a ceiling of KRW 30 trillion. Also, emergency liquidity worth KRW 5 trillion is made available to local companies in order to expand overseas activities.
Slovenia offers aid for internationalisation and measures to diversify export and import markets.
In South Africa, the Business Growth or Resilience Facility aims to enable continued participation of micro, small- and medium-sized enterprises (MSMEs) in supply value chains, in particular those that manufacture (locally) or supply various products that are in demand, emanating from the current shortages due to the COVID-19 pandemic.
In Spain, the government approved an extension of the insurance coverage of the export insurance programme with an additional budget of EUR 2 billion (USD 2.4 billion) in March 2020.
Switzerland offers compensation for reduced exports promotion activities of CHF 4.5 million.
Reinforcing the international business linkages of SMEs, involving MNEs
China is encouraging large enterprises to co‑operate with SMEs, by increasing their support in supply chains, in the form of loan recovery, raw material supply and project outsourcing.
New Zealand extended its NZTE Regional Business Partner network to include SMEs since June 2020 as part of the Trade Recovery Strategy. This mainly includes advice on how to navigate the policy landscape and access public support, as well as market intelligence to help SMEs diversify export and import markets (New Zealand Foreign Affairs and Trade, 2020[84]).
Reinforcing aftercare and facilitation services to retain FDI
Finland (Business Finland) has refocused activities towards aftercare services instead of attracting new clients in FDI (EU/OECD, 2021[5]).
Lithuania (Invest Lithuania) has shifted activities to focus on its engagement with existing customers, conducting a pulse-check survey to understand how companies respond to the COVID-19 crisis, providing information about government programmes and available financial support (with translation into English and a dedicated webpage) as well as support with ongoing investments (EU/OECD, 2021[5]).
Maintaining trade channels open and reducing costs in trading abroad
Argentina abolished the obligation of paying export taxes for MSMEs in August 2020.
Australia committed AUD 241.9 million (USD 183.8 million) to the Australian International Freight Assistance Mechanism to support international freight routes and flights, to maintain over 90 000 tonnes of exports to 65 international destinations between April and October (Australian Government, 2020[85]).
Source: Flanders Innovation & Entrepreneursip Agency (2020[82]), SME Growth Subsidy, https://www.vlaio.be/nl/media/549; EKF (2020[83]), “EKF to help Danish exporters impacted by coronavirus (COVID-19)”, https://www.ekf.dk/en/about-ekf/ekf-s-organisation/news/2020/ekf-to-help-danish-exporters-impacted-by-coronavirus-covid-19; New Zealand Foreign Affairs and Trade (2020[84]), New Zealand’s COVID-19 Trade Recovery Strategy; EU/OECD (2021[5]), EU/OECD Survey on Policies Enabling FDI Spillovers to Domestic SMEs; Australian Government (2020[85]), International Freight Assistance Mechanism, https://www.austrade.gov.au/news/news/international-freight-assistance-mechanism.
Others have initiated action for reshoring strategic activities. Reshoring policies are territorial attractiveness policies targeting either national companies that have offshored part or all of their production or foreign companies with an interest in locating their activities in the territory as well as existing local companies aiming to support import substitution (Charbit and Gatignol, 2021[4]).
Japan has earmarked JPN 10.2 trillion (1.9% of GDP) for the reshoring of factories, among others objectives.
Korea has earmarked KRW 1.5 trillion (USD 1.4 billion) in that view. Government agencies are tasked to identify product segments of strategic importance and support is made available to SMEs and start-ups in order to encourage them to produce these products and bring their production facilities back to Korea (Korea JoonAng Daily, 2020[86]).
Agencies and institutions involved in export and international investment promotion are also transforming their own operations. Preliminary findings from an EU/OECD survey on policies enabling FDI diffusion to SMEs show that, often, national institutions and agencies had to change objectives and rearrange workstreams, instruments and budgets due to COVID-19 (Table 3.1). To note, some digitalise their activities, e.g. by organising site visits, meetings or events online, adopting customer relationship management system and marketing automation tools (Lithuania) or launching online platforms for sharing information (Bulgaria).
Governments aim to protect their strategic SMEs and industries, for example from predatory practices, takeovers or distortions in competition etc. (Box 3.7).
Box 3.7. Policy initiatives to protect strategic assets and firms: Some country examples
Germany has set up an Economy Stabilisation Fund (Wirtschaftsstabilisierungsfonds), aiming to ring-fence businesses seen as of critical importance for the German economy. The fund comprises a EUR 600 billion support package, of which EUR 100 billion are earmarked for direct equity participation in businesses of strategic importance for the German economy (including critical SMEs).
India, as part of its INR 20 trillion (USD 266 billion) support package for SMEs and microenterprises, is now excluding global tenders from government procurement of up to INR 2 billion in order to protect firms from foreign competition.
Italy announced it intends to strengthen and extend its takeover shield for SMEs. The scope of application of the “Golden Power” Law, i.e. the capacity of the Italian government to prohibit or impose restrictions or conditions on foreign investments in industries that are deemed strategic for the country, is extended to sectors such as energy, transport, water and health, or food safety.
Poland aims to prevent hostile takeovers of Polish companies by foreign enterprises from outside of the EU. Transactions will be audited by the Office for Competition and Consumer Protection (UOKiK).
The EC provided guidelines in March 2020 to protect European strategic assets and technologies and ensure a strong EU-wide approach to foreign investment screening in a time of economic vulnerability. The aim is to preserve EU companies and critical assets, notably in areas such as health, medical research, biotechnology and infrastructures that are essential for security and public order, without undermining the EU’s openness to foreign investment.
Public procurement has become more than ever an instrument to provide SMEs with market prospects and direct funding.
In Belgium, the Federal Plan for Social and Economic Protection includes public procurement measures that aim at supporting SMEs by not imposing late penalties to contracting SMEs affected by the COVID-19 crisis and speeding up payment periods (Belgium.be, 2020[87]).
In the Slovak Republic, the Public Procurement Office issued the first guidance to support the participation of SMEs in tenders and guide contracting authorities on how to prepare conditions to achieve it (OECD, 2020[88]).
Israel has also put in place similar measures, encouraging local authorities to buy from local SMEs (KPMG, 2020[89]).
Table 3.1. National institutions had to rearrange workstreams, instruments and budgets
Adjustments in national institutions’ policy mix and arrangements in response to COVID-19, selected countries, national-level institutions for investment promotion, SME policies and innovation policies
Note: Changes in objectives include, for example, focus on emergency planning and crisis recovery, and enhanced focus on FDI retention instead of attraction. Changes in policy workstreams include, for example, new initiatives put in place and a shift in sectoral and value chain focus of existing programmes (e.g. towards sectors that were most affected or where more supply opportunities emerged). Changes in target groups include, for example, new or enhanced emphasis on SMEs and businesses in the most affected sectors. Changes in budget include, for example, reallocation of funds to new priorities and increases/cuts in the annual budget. Changes in the timeframe of implementation include, for example, extended deadlines for specific policy initiatives.
Source: Based on preliminary institutions’ responses to EU/OECD (2021[5]), EU/OECD Survey on Policies Enabling FDI Spillovers to Domestic SMEs.
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