Is there a role for policy?
Global Value Chains (GVCs) are extremely complex to the point that “supply chain visibility becomes supply chain opaqueness,” argue Baldwin and Freeman. Much like Elliott et al., they argue that this lack of information can lead firms to misjudge how risky their network is. The authors suggest that such information problems are a justification for policy intervention and propose the risk-versus-reward framework from portfolio theory as a good way to evaluate whether anti-risk policy is justified:
The trade-off between the risk that comes with GSCs (vertical axis) and the rewards (horizontal axis) is illustrated in Figure 1 (inspired by optimal portfolio analysis). Risk is assumed to increase as manufacturers concentrate production of a particular input in the single cheapest location. Diversification of sources reduces risk but at a diminishing rate. The indifference curve shapes reflect that firms and society both would prefer less risk for any given level of reward, but the public cares relatively more about risk. This divergence, assumed here for illustration’s sake, is clear in sectors such as banking where, in the past, government provided guarantees when the risk went wrong, and in food production where atomistic producers underinvest in anti-famines actions. Its applicability to any particular GSC is an empirical matter, but it is easy to imagine that medical supplies share features of the public-private wedge in food production, as might other ‘strategic’ inputs such as semiconductors. The situation depicted has the public desiring a lower level of risk, point S, than the private sector, point P. This wedge between the public and private evaluation for risk is a clear market failure that could justify policy interventions.
Risks and Global Supply Chains: What We Know and What We Need to Know
Authors: Richard Baldwin, Rebecca Freeman
From: Graduate Institute – Geneva, Bank of England
