Przemysław Kowalski
OECD Trade and Agriculture Directorate
Andrea Andrenelli
OECD Trade and Agriculture Directorate
Economic Security in a Changing World
Economic efficiency gains associated with international supply chains continue to be widely acknowledged. Yet there is also debate about whether the greater fragmentation of production in supply chains contributed to the spread and amplification of recent negative economic shocks (such as the COVID-19 pandemic or Russia’s invasion of Ukraine) or whether it was an attenuating factor in reducing the impact of those shocks. Against this background, growing geopolitical tensions, expanded intervention by governments in the economy, and intensifying international competition for natural resources, have all led to a greater focus by the public and policymakers on the potentially negative implications of trade interdependencies.
The perceived likelihood of politicisation or weaponisation of trade interdependencies is triggering interest in identifying areas of vulnerability. These potential “trade dependencies” can be broadly defined as commercial links that could cause high economic or societal damage in case of unexpected disruptions, and that could be used as a tool of coercion, compromising national security and disrupting strategic activities.
Following a discussion of how supply chain interdependence has influenced the efficiency of production, and the transmission and management of shocks in the global economy, the remainder of this chapter discusses trade and supply-chain specific economic security risks. It then discuses key challenges of measuring trade dependencies more broadly and presents selected results of recent OECD analysis attempting to quantify elements of the historical evolution and economic significance of trade dependencies using different data and empirical methodologies.
The emergence of international supply chains has been transformative. The falling costs of long-distance communication and data transfer, which accelerated in the early 1990s, created new business opportunities and boosted productivity through finer specialisation at the task or specialised input level (Baldwin, 2011[1]). Supply chains have also created new opportunities for less developed countries to grow and create jobs by participating in trade and production of advanced products by providing specialised inputs. Organising production in supply chains also made different production locations and national economies more interdependent. It is now common for the different stages of a production process of a good or service (e.g. design, production, marketing, manufacturing, assembly and distribution) to be carried out in parallel or sequentially in several geographical locations. Profit-seeking multinational enterprises are the key actors managing these activities and they make strategic decisions about locations of different specialised activities and their co-ordination. The interdependency which underlies these activities is therefore an integral feature of international supply chains and one of the main sources of their economic efficiency.
However, supply chain interdependencies can also have important – although not always straightforward – implications for how national economies can be affected by – and how they can respond to – unexpected external shocks or events and how they may be affected by the policies of other countries.
On the one hand, well diversified supply chain activities can support resilience to both domestic and external shocks by drawing on more varied sets of commercial partners and markets and thereby creating a wider range of options to assist in coping and recovery from disruptions. For example, in the face of some disruptions, it may be easier to change a supplier, or reconfigure or relocate just a segment of a supply chain rather than overhaul a whole industry. In this sense, global value chains (GVCs) have also opened new possibilities for diversification and improved resilience (e.g. Lafrogne-Joussier (2021[2]), Arriola et al. (2020[3])).
On the other hand, by depending more on foreign inputs and foreign demand, national economies linked through international supply chains may be more exposed to external shocks. Sometimes this exposure may be difficult to assess in advance as intricate cross-border movements of physical and intangible inputs in supply chains can create complex links between different stages of production. These multifaceted and multitiered links can nevertheless be sensitive to even small changes in regulation and trade, transport and communication costs, while not being always fully transparent or straightforward to track for lead firms. To the extent they involve trade in specialised differentiated inputs, they may also be associated with significant lock-in effects for buyers and sellers and thus may constrain the possibility to switch to an alternative party (Antras and Staiger, 2012[4]). They also often span across countries characterised by different levels of development, institutions, and political systems, which may make the containment of shocks and co-ordination of responses more difficult.
The emergence of international supply chains has also changed the nature of trade and trade-related policy making. Relative to the pre-supply chain era, trade policies have been focused less on negotiating access to foreign markets for final products (lowering of barriers to accessing foreign markets) and more on having access to competitive high-quality inputs and on lowering various types of trade costs to ensure a smooth multidirectional exchange of intermediate products and services (lowering of own and foreign trade costs) (Baldwin, 2011[1]). Decisions about a geographical location of specific supply chain segments are highly sensitive not only to international trade costs but also to various domestic costs which are influenced by regulation (e.g. permits), business environment (e.g. taxation) and quality of infrastructure (e.g. energy availability and costs, ports, roads and connectivity). In this sense, the fragmentation of supply chains has expanded the range of what are, in principle, domestic policy interventions, but which nevertheless have significant international spillover effects (see also Staiger (2022[5])).
Supply chain linkages are rarely characterised by perfect competition. The differences in market and bargaining powers of different supply chain actors and the often-unequal distribution of gains from supply chain participation across the different supply chain segments, have also prompted policymakers to try to improve the position of national firms and to create conditions to attract the most lucrative supply chain segments to their countries, in particular through industrial policy. For example, governments have tried to lower the costs of upstream inputs and to boost profitability of domestic firms via other forms of government support. These measures have aimed at attracting domestic and foreign investment in preferred downstream activities, as well as enlarging influence in specific upstream and downstream segments of supply chains to gain access to superior capital and technology or to gain a strategic or economically preferred supply chain position. Even if not always well defined,1 moving up or upgrading of the value chain position has been a frequently declared policy objective in the 2010s, particularly in developing and emerging economies. Then, the policy debate focused on how to best maximise the benefits from supply chain participation.
One of the factors that has contributed to a greater focus on possible negative aspects of interconnectedness and propagation of shocks in international supply chains is a perceived increase in geopolitical, policy and economic uncertainty. While measurement of these phenomena is complex, and results are not always straightforward to interpret, a few recent studies and measurement initiatives have gathered evidence for increased uncertainty. The methodology developed initially by Baker, Bloom and Davis (2016[6]) showed that global economic policy uncertainty increased markedly in the aftermath of the 9/11 terrorist attacks in 2001, during and in the aftermath of the 2008-09 global financial crisis (GFC), during the COVID-19 pandemic, and after Russia’s large-scale invasion of Ukraine in 2022. According to this index, in the last four years, policy uncertainty was on average significantly higher than in any previous period since the end of 1990s. Caldara and Iacoviello (2022[7]) measured the perception of risk related to wars, terrorism and tensions among states and political actors, and similarly showed an increase in geopolitical risk following the 9/11 terrorist attacks in 2001 and another significant increase in the aftermath of large-scale Russia’s invasion of Ukraine in February 2022.2
This new environment is forcing a reassessment of economic policy assumptions and consideration of new trade-offs. Policymakers are confronted by a landscape characterised by rising geopolitical tensions; heightened national security concerns, notably in relation to digital technologies; strategic competition and the quest for leadership on new technologies, notably for the green and digital transitions; reassessment of the role of global supply chains in ensuring access to essential goods and services, including for those same transitions; and the weaponisation of trade interdependencies in instances of economic coercion. These forces come at a juncture where both the GFC and the COVID-19 pandemic had already seen governments playing a greater role in the economy in several countries, and where there is a growing discussion of how the “rules of the road” (including WTO rules) for an integrated global economy can most effectively function across countries with very different economic systems.
Against this background, the concept of “economic security” has been gaining prominence among policymakers. While economic security entails a range of issues that go beyond the trade and investment policy community, it is a concept that deeply engages the trade policy community, as international economic linkages are both an enabler of economic security (for example, in enabling diversification of supply and demand) and a source of risks to that security.
A key issue in discussions on economic security is security of supply of critical goods and services. This is part of a wider agenda of ensuring the resilience of global supply chains, which requires an understanding of the nature and extent of vulnerabilities (notably in relation to concentration). Vulnerabilities can be used by third parties to interrupt the supply of critical goods and services and can also be used to coerce vulnerable parties into policy changes.3 Beyond critical goods and services, certain dependencies upon certain countries can become vulnerabilities under geopolitical tensions, or where countries or regions are at a risk of conflict.
This changing landscape has triggered reflections on possible policy responses to economic security concerns. While the debate on the best policy responses continues, diversification of supply appears to be seen as one of the most effective policies to reduce risks arising from the geopolitical environment. Co‑operation between trusted partners is important and can help reduce risks. This can be seen both as a means for trade to provide mutual benefit to trusted partners, as well as to reduce the risk of supply disruption from partners perceived as less reliable. In a wider debate on ensuring resilience, a range of other approaches has been put forward, from greater transparency on supply chains to assisting with risk identification and management, including through public-private dialogue; through to efforts to diversify supply across companies and countries; to the creation of domestic production capacity.
Certain technologies or products are also seen as being strategically important representing an additional argument for co-operation among trusted partners to ensure resilient production and trade of these sensitive products. This can involve ensuring the supply of critical inputs, such as critical raw materials, by tackling export restrictions or reaching supply deals with trusted partners (see Special Focus 2). In other cases, it may mean paying additional attention to the sources and range of suppliers for products not seen as sensitive themselves, but which may be essential inputs into critical infrastructure.
There is also the debate over whether some goods and services are so important or sensitive strategically, technologically or because they may have military applications, that countries want to ensure supply through domestic production. While this is not realistically an option for all or even many countries depending on the good or service concerned, where this is possible it can raise issues for integrated global markets. For example, building domestic production capacity (notably where it represents a decision that companies would not have taken on their own commercially) can involve government support, raising issues related to the impact on other countries (including in terms of attracting investment that might have otherwise gone elsewhere) and on competition in global markets.
In this wider landscape, policymakers are dealing with difficult decisions, which require new data and analysis (such as on trade dependencies and vulnerabilities). With an increasing number of these decisions to be made, evidence-based policymaking remains important.
Notwithstanding the increased interest in identifying trade vulnerabilities, it is difficult to identify objective analytical criteria that would enable a clear separation of those trade links that may be sources of concern from those that are advantageous. This is in part related to the fact that the concerns that lie behind the debate on trade dependencies are often non-economic and that what is considered to be of concern from the point of view of, for example, protection of the environment, social sustainability or national security, can be country specific. Thus, it is not immediately obvious what role economic analysis could play in addressing such concerns.
From an economic point of view, however, there are concerns that policy responses which are aimed at minimising trade-related risks may unnecessarily undermine the economic benefits of international trade or have unwanted or unintended economic and non-economic effects. Economic analysis can thus be used to help draw a comprehensive picture of the economic characteristics of trade linkages which could be viewed as trade dependencies. It could also help assess the economic costs and benefits associated with different policy options for addressing trade dependency.
The emerging economic literature suggests that trade dependencies can be usefully defined as trade flows combining three characteristics: high risk of disruption, high economic (or other) importance, and constrained possibility of diversification or substitution (Figure 1.1). In a recent analysis aiming to shed empirical light on the question of trade dependency, the OECD has investigated different sources of data and key modelling frameworks to identify trade flows appearing to meet these criteria and to examine their characteristics and evolution (Arriola et al., 2024[8]).
Source: Arriola et al. (2024[8]), "Towards demystifying trade dependencies: At what point do trade linkages become a concern?", OECD Trade Policy Papers, No. 280, OECD Publishing, Paris.
Several measures of trade dependency build on the concept of trade concentration; that is, reliance on only a few suppliers for imports or only a few markets for exports of specific products. If a country’s imports or exports of a product are accounted for by only a few partners (are highly concentrated), the country may struggle to find alternatives in the face of disruptions in foreign supply or demand.4 The evolution of global trade data at a detailed product level in the period 1997-2021 has been studied through the lens of trade shares and trade concentrations.5 Trade concentration matters for economic security as shown econometrically, for example, in the context of the COVID-19 pandemic foreign supply disruptions by Schwellnus et al. (2023[9]), who found that foreign supply disruptions have larger adverse effects in sectors where industry and geographic suppliers are highly concentrated. While the measures – or combinations of measures – as well as the specific quantitative thresholds used to delineate normal and concerning degrees of trade concentration often differ from one study to another, the trade concentration approach has been used frequently to quantify trade dependency or vulnerability in the recent literature (Bonneau and Nakaa, 2020[10]; European Commission, 2022[11]; Vicard and Wibaux, 2023[12]; Berthou, Haramboure and Samek, 2024[13]).
Imports of specific products have become on average more concentrated across trading partners between 2008-10, i.e. at the time of the global financial crisis, and 2014-16, i.e. during the period before the first US-China trade tensions episode (Figure 1.2). In part, this likely reflects finer levels of specialisation in international supply chains which proliferated during this period. The trend is also consistent with the perception of an increase in vulnerabilities to unexpected shocks transmitted through international trade and supply chains. In addition, global exports of products are on average more concentrated than global imports, while national imports of products are more concentrated than national exports, which might explain the focus in public debate on supply or import dependencies.
However, the data also show that the current levels of trade concentration of global exports and imports are, overall, not alarming and that large, if not dominant, portions of trade are relatively well diversified. For example, for global exports of products, which are on average more concentrated across exporting countries than global imports are across importing countries, only about 30% of products record relatively high levels of concentration, while exports of the remaining products are relatively well diversified. This suggests that large portions of international markets are characterised by a reasonable degree of competition, and that specific exporters and importers have limited control over total supply or price formation.
This is not to say that the levels of concentration seen for some products in some countries are not of concern, but rather that, for many products, international markets in fact offer good options for diversification. Products with some of the highest levels of global export concentration include, for example, a range of industrial raw materials (e.g. tin, lead, copper and wood, see also the Special Focus on critical raw materials) and a range of products of light manufacturing (e.g. textiles and footwear or headgear) and products of the agri-food industries (e.g. fibres, coffee, tea and fishery products). Products with some of the highest levels of global export diversification include several advanced manufacturing industries (e.g. aluminium, iron and steel, base metals and machinery manufacturing) notwithstanding the perception that they are vulnerable.
Overall, the uneven – and sometimes counterintuitive – patterns of global export concentration across products highlight the multiple factors which drive concentration of trade in international supply chains. These include availability of natural endowments, patterns of comparative advantage, and economies of scale, but also trade and industrial policies which influence relative costs of production in different locations.
Interestingly, concentrations of national trade tend to be higher than concentrations of global trade which means that countries typically source their imports from – and ship their exports to – fewer partners than is in principle globally possible. This likely reflects a combination of natural factors, such as the role of geography and trade costs, particularly in the context of international supply chains which tend to be concentrated regionally, as well as countries’ preferences and policies. The latter have been revealed for example in the expansion of regional and preferential trade agreements which by design tend to lower trade costs and give other advantages to selected trade partners, contributing thereby to trade concentration. Strategic economic policies of importers and exporters could also have played a role.
On the export side, the overall rise in national import concentrations of other nations has coincided with raising shares of China as a source of imports (Figure 1.2, Panel B).
A. Average country-level concentration of exports and imports across all HS6 products
B. Contributions of China and other countries to the average country-level import concentration
Note: In Panel A, the average country-level concentration of imports and exports is obtained by calculating, first, for each HS6 product and, for exports (imports), each exporting (importing) country an index of concentration (HHI) across all importers (exporters) from (to) that country, and second by calculating a weighted average across all relevant product lists, with weights equal to the value of exports (imports) in that product across all partners. ‘1996-98’, ‘2002-04’, etc., denote the averages for the three-year periods 1996, 1997 and 1999; 2002, 2003 and 2004; and so on. Panel B shows the decomposition by selected exporters of the above values of the HHI index for imports of all products. For more information on methodology see Arriola et al. (2024[8]).
Source: OECD calculations using the BACI data.
Defining the extent to which countries rely on significantly fewer suppliers (national import concentration) than is offered by the global economy (global export concentration) as significant import concentration reveals that the overall incidence of such significant concentration of national imports has been on the rise in the investigated period. This has been mainly accounted for by non-OECD economies as significant import concentration has not changed much on average for OECD countries (Figure 1.3, Panel A). This suggests that to some extent firms and consumers in OECD countries have been able to take advantage of diversification possibilities offered by international markets to diversify and reduce dependency.
A. Average number of imported HS6 products with significant import concentration per country
B. Number of imported HS6 products with significant import concentration (average for 2017-19 and 2020-22)
Note: Significant import concentration is defined in cases of bilateral import links at the product level where the value of country-level HHI for imports is more than double the value of the corresponding HHI for global exports. To further constrain the spectrum of cases of significant concentration, an additional minimum cut-off value of HHI calculated for global product-level exports was set at 0.2. This means that only products with a global exports HHI of at least 0.2 and products with country-level imports HHI of at least 0.4 were considered. The country group “others” comprises all non-OECD, non-MOE countries for which data are available in the BACI database. This focus is purely analytical and is without prejudice to the relationships between the OECD or any of its members and any of the individual countries of the major other economies (MOE) grouping. The MOE grouping includes Brazil, China, India, Indonesia, Russia and South Africa. For more information on methodology see Arriola et al. (2024[8]).
Source: OECD calculations using BACI data.
However, the differences in the levels of such significant import concentration also suggest that, even amongst OECD countries, there is untapped potential to diversify further (Figure 1.3, Panel B). For example, in the OECD countries which recorded the highest scores for significant import concentration such as Chile, Mexico and Korea, these scores are more than three times higher than in the countries with the lowest scores (Germany, France and Italy).
Which trading partners are the main counterparts in the highly concentrated trade linkages matters as geographic, economic and geopolitical risks vary across countries. Dependency on China has increased significantly across all OECD countries and regions since the late 1990s and China is now the single most important counterpart in trade dependencies of the OECD as a whole and of several OECD countries individually (Figure 1.4). Thus, there is interest in a better understanding of the reasons for the emergence of China as a source of dependencies. In particular, the contributions of natural and policy‑related factors, including policies which may have involved market distortions or targeted non‑economic objectives, need to be better understood.
At the same time, trade dependencies of OECD economies on China also need to be put in the context of China’s dependencies on OECD economies. The OECD as a group – and several OECD countries on their own – are a much more important counterparts in dependencies of China. Moreover, China’s sectoral dependencies involving OECD countries include several industries in which several OECD countries also depend on China, underscoring the mutual character of some trade interdependencies (Figure 1.5).
Average per country number of bilateral import dependencies on the United States, China, Germany and other countries (shares in labels)
Note: Other – all the other OECD and non-OECD countries covered in the BACI database. For more information on methodology see Arriola et al. (2024[8]).
Source: OECD calculations using the BACI data.
Average per country number of bilateral import dependencies of China on the United States, Germany, Japan, other OECD, MOEs and other countries (shares in labels)
Note: Other OECD are all the OECD countries except the United States, Japan and OECD countries that are EU members. The major other economies (MOE) grouping includes Brazil, China, India, Indonesia, Russia and South Africa. For more information on methodology see Arriola et al. (2024[8]).
Source: OECD calculations using the BACI data.
While product-level analysis can provide valuable insights into trade dependency, exposure of national economies to potential shocks depends on the nature of their specialisation and integration into international supply chains. These characteristics go beyond trade concentrations and bilateral trade shares. The OECD global trade model METRO can be used to unpack some of the broad relationships with a view to informing government and business efforts to enhance resilience to shocks (Arriola et al., 2020[3]).6 While the modelling relied on several assumptions which necessitate a careful approach to policy implications, a few broad findings and policy consequences can be identified.
Production disruptions in most segments of the global economy cause relatively small output responses elsewhere. This suggests that the current structure of domestic and international linkages and economic adjustment mechanisms tend to dampen the impacts of shocks rather than amplify them. That said, there are also some large outliers indicating that shocks in some segments of the global economy may have more consequential effects.
The impacts of shocks occurring in other domestic sectors tend to be larger than impacts of shocks occurring in foreign sectors. This is because in most sectors the reliance on foreign inputs and foreign markets for final products is still smaller than reliance on domestic inputs and product and factor markets. In addition, international markets offer broader adjustment and diversification options than domestic markets. Therefore, production disruptions originating in foreign vertically-linked sectors – the kind of shocks that are at the centre of the debate on propagation of shocks in international supply chains (GVC shocks hereafter in this section) – do not appear to be the main source of disruptions. While disruptions in upstream sectors in the value chain can constrain access to intermediate inputs, and output declines downstream can lower demand for inputs, most impacts are two orders of magnitude smaller than the original shocks. The dispersion of impacts is also smaller than for domestic shocks. Again, this reflects the current levels of diversification and greater possibilities for adjustment in GVCs.
A wide variety of domestic and international economic adjustment mechanisms may be at play. Price signals leading to substitution towards other suppliers or other market outlets, and responses of labour and capital markets play an important role in shaping responses to shocks. They should therefore be part of assessments of resilience to shocks and trade dependency.
The degree of factor market adjustment can affect the transmission of shocks. Impacts of shocks across national economies tend to be smaller when factors of production cannot move across sectors (short term) than when they can move freely (medium to long term). This underscores that short-lived disruptions may matter less than disruptions which last longer and allow more time for factor markets to react and pass on the impacts to other sectors. It also suggests that policies protecting employment or restricting capital movements may play an attenuating role in the face of temporary shocks.7
While most of the impacts of GVC shocks are much smaller than the initial shocks, in a small portion of cases the opposite is true, with responses being more than three times larger. In addition, a cumulation of multiple adverse shocks (as was for instance the case during the COVID-19 pandemic) can have more significant implications.
Statistics summarising responses to such highly adverse constellations of shocks suggest that some sectors and countries may be more exposed than others. Economies with strong vertical links to major foreign economies tend to be more exposed to GVC shocks, with Canada, France, Germany and the United Kingdom leading the rankings, and the United States, Brazil and China being relatively less exposed due to their greater reliance on domestic product and factor markets in most sectors. Russia and South Africa move to the top of the ranking of the most exposed countries under the assumption of immobile factors. This is because the sectors in which they tend to specialise, such as petroleum and coal, mining and chemicals, are more exposed to external shocks and have more difficulty adjusting when labour and capital cannot migrate to other sectors (Figure 1.6).
A maximum per cent combined impact of all possible 1%-shocks
Note: Value of output at the starting point of the simulation are used as weights to produce weighted averages.
Source: OECD METRO model simulations.
There is more variation in the measures of exposure across sectors than there is across countries, suggesting potential for sectoral initiatives to address exposure to shocks. Manufacturing sectors are on average much more exposed to foreign output shocks than services sectors and agriculture and food because they are more internationalised in terms of destination of output as well as sourcing of intermediate inputs. For this reason, manufacturing of electronics, non-ferrous metals, iron and steel, machinery and equipment, and chemicals appear as the most exposed. When production factors are immobile, extractive industries, as well as the manufacturing sectors linked to them (metals, iron and steel, and chemicals) move towards the top of shock exposure rankings (Figure 1.7).
There are also important differences across countries and sectors in terms of which shocks contribute the most to exposure. For example, Germany’s motor vehicles sector, while less exposed to GVC shocks than manufacturing of electronic equipment or metals,8 tends to be relatively more exposed than that of the United States, and a bigger portion of this exposure can be attributed to shocks originating in China.
Services sectors, which in some countries employ large shares of labour resources (e.g. hospitality and recreation, retail trade, construction or warehousing and support activities), can be sources of shocks with relatively big impacts across the global economy. However, these tend not to be transmitted through constrained access to, or demand for, intermediate inputs, but rather through domestic economy-wide impacts involving factor markets. In the medium to long run, an output reduction in those sectors tends to be associated with a release of labour and capital that finds employment in other parts of the economy, which impacts other sectors. Shocks to business services, a sector which has strong upstream and downstream linkages to manufacturing sectors, are characterised by more classical transmission of vertical foreign shocks through GVCs.
Note: Value of output at the starting point of the simulation are used as weights to produce weighted averages.
Source: OECD METRO model simulations.
The discussion in the preceding sections demonstrates that some trade linkages appear relatively highly concentrated and that this may increase the probability of economic or other damage in the context of large, unexpected shocks or trade-related economic coercion. This confirms the merit in monitoring measures of trade concentration and anticipating impacts of possible shocks and disruptions. However, this might also suggest a greater scope for policymakers to induce trade diversification to de-risk certain trade linkages.
Most recently, concerns about trade dependencies and exposure to shocks, the growing role of strategic economic policies and raising geopolitical tensions have indeed resulted in a new wave of calls for deglobalisation, friendshoring, nearshoring, creation of trading blocks or re‑localisation (e.g. Arriola et al. (2020[3]), Crowe and Rawdanowicz (2023[14])). Calls for economic security and strategic autonomy, and the associated pleas to limit dependency on foreign economies, are putting open markets and the rules‑based trading system under pressure. At the same time, the calls to enhance economic security may also reflect a response to (sometimes very real) weaponisation of trade dependencies and other coercive practices, which undermine the rules-based trading system in the first place. There are also concerns that some of the policy responses which aim to minimise trade risks and improve supply chain resilience may not be well designed and may in fact unnecessarily undermine the benefits of international trade. Thus, the debate on de-risking international trade and supply chains needs to carefully consider the possible costs and benefits of different policy choices.
Until recently, there was no clear evidence of a major reorganisation of international supply chains towards reshoring or geoeconomic fragmentation. That said, the plateauing of the world trade-to-GDP ratio observed already since the 2008-09 GFC indicates a slowdown in economic globalisation. There are also signs that some of the newly implemented or considered policy responses are reshaping the regulatory landscape of supply chains and becoming key drivers of potentially long-term strategic decisions of firms. This can be seen, for example, in results of recent surveys on resilience-improving strategies of businesses (e.g., Accenture (2023[15]) and EconPol (2024[16])) and the reorientation of bilateral trade between China, and the United States and the European Union, as well as in the growing importance of third economies (OECD, 2024[17]).The emerging empirical evidence demonstrates a relatively high degree of trade interdependence. To the extent that fragmentation could involve undoing international supply chains, break the supply of critical raw materials and endanger technology transfers and the division of labour across countries at different levels of development, the economic costs of significant trade fragmentation are potentially high.
Model-based estimates of possible fragmentation scenarios can be informative but depend ultimately on assumptions about the extent and nature of fragmentation, ranging from scenarios of small increases in trade policy barriers, through discriminatory regional integration, to the formation of more or less autarchic geopolitical trading blocs. Model-based analyses of the costs of fragmentation have proliferated in the aftermath of the COVID-19 pandemic and, even more so, Russia’s invasion of Ukraine. A summary of studies of trade fragmentation in the aftermath of Russia’s invasion by IMF (2023[18]) concluded that the costs from the trade and technology diffusion channels range from close to zero to 12% of a country’s or region’s GDP.9 They also suggest that developing and emerging market economies would lose the most (although, again, the estimated costs depend very much on uncertain assumptions).
An OECD METRO model-based analysis, motivated by the early COVID-19 supply chain disruptions and strong calls for re-localisation of supply chains at the time, compared simulated impacts on economic efficiency and the extent of international transmission of country-specific trade cost shocks under different assumptions about countries’ openness and integration into GVCs. It showed that the policies that may result in more localised value chains are likely to be costly in terms of efficiency and do not necessarily offer more stability in the face of shocks (Arriola et al., 2020[3]) (Figure 1.8). The localised economies regime, which assumed an implementation of a suite of hypothetical and stylised re-localisation policy responses where all countries decided to reduce their connectedness via GVCs through a combination of higher import tariffs, subsidies to domestic production and putting additional constraints on sourcing possibilities in GVCs, was estimated to decrease global trade by more than 18% and global real GDP by more than 5% relative to the interconnected regime, with individual countries losing between 1.1 and 12.2% of GDP depending on the extent and nature of their GVC integration. In addition, when the effects of a stylised set of “supply chain” shocks were modelled,10 contrary to some of the claims in the general debate on risks in GVCs, in the localised regime, shocks did not result in a significant increase in the stability of GDP, production and consumption relative to the interconnected regime. In fact, for more than half of the economies, the stability of GDP decreased in the localised regime. This is because openness and geographical diversification of the sources of inputs and destinations of output in GVCs can offer possibilities of adjustment to disruptions.
Simulated impact on GDP of selected OECD and MOE economies of a supply chain localisation scenario
Note: All changes in variables are relative to the level of the interconnected regime base scenario, which is set to equal 100. Blue dots show the base in the given regime relative to the interconnected base and whiskers show average deviations for negative and positive trade cost shocks
Source: Arriola et al. (2020[3]), “Efficiency and risks in global value chains in the context of COVID-19”, OECD Economics Department Working Papers, No. 1637, OECD Publishing, Paris, https://doi.org/10.1787/3e4b7ecf-en.
A recent OECD study (Arriola et al., 2024[8]) of the economy-wide dimensions of trade dependencies considered possible economic implications of a hypothetical and highly stylised scenario that partially reduced trade between the OECD and major non-OECD economies (MOEs).11 The scenario assumed that all goods and services trade flows between each of the OECD countries and each of the MOEs are reduced by 10% (hereafter a trade reduction shock or a trade shock). All other trade flows were assumed to remain directly unaffected, but they could be affected indirectly, for example through interruption of indirect links involving OECD-MOE trade if such links exist, or through redirection of trade and other economic adjustments.
This scenario was analysed using the OECD Inter‑Country Input‑Output tables (ICIO) and Input-Output analysis methods12 and the OECD’s CGE trade model METRO. Albeit allowing for different levels of country and industry detail and putting different emphases on various economic adjustment mechanisms, both the ICIO and the CGE approaches allow for assessment of economy‑wide implications of trade dependencies. They also take a broader supply chain perspective and capture not only those trade dependencies that are due to direct import-export relationships but also those that may result from indirect trade links (e.g. when a product exported from one country to another embeds a component produced in a third country). Importantly, these methodologies enable analysis of direct and indirect dependencies in the services sectors.
Overall, the results of this analysis (Arriola et al., 2024[8]) confirm a high degree of trade interdependence of the two groups of countries (and especially between OECD countries and China) and illustrate some of the economic costs that may be involved in the currently debated strategies of de-risking supply chains:
Most OECD and MOE countries lose in the trade reduction scenario; that said there is significant inter-country variation and the estimated impacts depend on the modelling approach used. Depending on the modelling framework used and country considered GDP declines range from nil to about 1.7%.
OECD countries and sectors with stronger trade linkages with MOEs rather than with other OECD economies fare worse, while stronger linkages within the OECD help mitigate the impacts of the trade shock. The OECD countries in the Asia Pacific, in particular Korea and Australia, are affected the most while the OECD countries in Europe are affected moderately and those in North America remain largely unaffected.
Across all OECD regions, the main driver of these GDP reductions is the decrease in trade with China, even though some OECD countries also have noticeable exposures to other MOEs. This is not surprising, given that China accounts for almost two-thirds of the MOEs’ overall trade with the OECD.
The considered trade shock is found to impact the GDP of some MOE countries even more than for OECD countries. This is because the export and import links disrupted in this scenario represent a larger share of the economy in MOEs.
In any given country, not all sectors of the economy are exposed to the considered trade shock to the same degree.13 The list of the most impacted industries varies from one country to another, but it is reasonably common to find the highest levels of exposure in the primary sector and, more specifically, in the mining and quarrying cluster. This is because the trade shock constrains several important flows of mineral resources between OECD and MOEs.
Results of recent exploratory OECD empirical analyses attempting to quantify the historical evolution and economic significance of trade dependencies illustrate some of the concerns that lie beneath the debate on trade. Global production of at least some products has become increasingly concentrated, and increasingly clustered around some countries and regions. Therefore, shocks related to climate change, changes in economic policy or geopolitical conflicts, arguably may have a higher potential to disrupt commercial links and cause economic or societal damage. Concentration can also give rise to concerns about policy-induced issues with security of supply, such as economic coercion.
While the growing concentration of trade may be shaped by market economic factors, such as natural endowments, comparative advantage, economies of scale, or GVC fragmentation, it may also have been influenced by non-market policies and notably by government support. There is thus interest in a better understanding of the reasons for the growth of concentration. In particular, the contributions of natural and policy-related factors, including policies which may have involved market distortions or targeted non‑economic objectives, need to be better understood.
While trade concentration has grown on average, large – if not dominant – portions of global and national trade remain relatively well diversified overall. As suggested by the concentration profile of global trade flows, international product markets also are generally characterised by a reasonable degree of competition and limited control over supply or price formation of specific importers or exporters. Moreover, it is difficult to distinguish those concentrated trade links that could cause problems from advantageous trade linkages. There are legitimate concerns that policy responses which aim to minimise trade risks and improve supply chain resilience may not be well designed and may unnecessarily undermine the benefits of international trade.
In this context, the current debate on de-risking international trade needs to consider carefully the possible costs and benefits of different policy choices. The different methodologies used to produce evidence all demonstrate a relatively high degree of trade interdependency between the OECD and MOE countries (and especially between OECD countries and China) as well as potentially high economic costs of significant trade fragmentation.
References
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← 1. In policy debates, “moving up the value chain” has been often understood as – either commercially-driven or government-induced – transition to activities characterised by relatively “high value added” (for example at product design and marketing stages rather than assembly or manufacturing stages) or even as the need to capture a growing share of domestic value added in exports. This view of upgrading, however, misses the point that the volume of the activity also matters and if a country or a firm has an advantage of performing assembly or manufacturing at scale, it may obtain more economic benefits from focusing on these supply chain activities (Kowalski et al., 2015[19]).
← 2. Considered from a longer historical perspective, the level of geopolitical risk in the early 2020s, as measured by this methodology, was higher than that in the late 1990s. However, it was still markedly lower than during previous episodes of geopolitical tensions, for example around the Gulf War, Korean War and, particularly, World War I and World War II (Caldara and Iacoviello, 2022[7]).
← 3. There have been cases where trade interdependencies have been exploited for the purposes of interfering with the legitimate sovereign policy choices of another country. While there is no internationally agreed definition, such instances have been characterised as “economic coercion” (OECD, 2024[17]).
← 4. The analysis covers all countries which report internationally comparable trade data but in examining the nature and evolution of trade dependencies it focuses on OECD and major other economies (NOEs), where the latter grouping is composed of Brazil, China, India, Indonesia, Russia and South Africa.
← 5. Products are here defined at the Harmonised System 6-digit (HS6) level of product aggregation.
← 6. This work analysed simulated responses of output of national economic sectors to production shocks occurring in other domestic and foreign sectors connected vertically through supply chains and horizontally through competition in product markets. In addition to assessing the overall magnitude and nature of shock transmission, the analysis identified countries and broad sectors which may be particularly vulnerable to shocks or could be a more significant source of risk.
← 7. That said, the differences in impacts under different factor mobility assumptions vary across sectors and depend also on whether the impacted sector has a significant weight in domestic labour and capital markets.
← 8. For instance, the country’s exposure to GVC shocks in the electronics industry is approximately twice as high. For more on industry and country exposure see Arriola, Kowalski and Tongeren (Arriola et al., 2024[8]).
← 9. There are also the migration and cross-border capital flows and financial integration channels which are less explored.
← 10. The spectrum of shocks included equally probable and spatially uncorrelated increases and decreases in the cost of bilateral trade (for both imports and exports) between each country or region included in the model and all its trading partners.
← 11. The MOE grouping includes Brazil, China, India, Indonesia, Russia and South Africa. This focus is purely analytical and is without prejudice to the relationships between the OECD or any of its members and any of the individual countries of the MOE grouping.
← 12. The principal method used in this analysis is called “hypothetical extraction” (Miller and Blair, 2022[20]). The hypothetical extraction method evaluates the economic significance of certain economic connections by calculating what would happen if those connections were removed or reduced while preserving the rest of the global trade and economic activity structure. For more details, see (Arriola et al., 2024[8]).
← 13. In several cases, the sectors identified as the most heavily dependent on OECD-MOE trade represent only small shares of their country’s economy. On the other hand, the list of highly impacted industries also includes those of great significance from both a domestic and a global point of view.