Will the COVID‐19 Pandemic Really Change the Governance of Global Value Chains?

The COVID‐19 pandemic has given rise to various predictions on the future shape of Global Value Chains (GVCs). The pandemic is an exogenous shock of uncommon magnitude imposed on firms with international commercial linkages, including large multinational enterprises (MNEs), small and medium‐sized firms, new ventures, and their supply chain partners. Empirical research in a variety of management disciplines will investigate the pandemic's effects on these firms, as well as their strategic responses. Research will also permit assessing the continued relevance of extant international business (IB) theory, and the possible need to revisit mainstream theorizing in the post‐pandemic world.

MNEs have used GVCs for decades as a governance tool to organize IB activities, thereby involving a myriad of other types of companies. Much empirical evidence has shown that efficient governance modes in IB typically prevail over less efficient ones. But authoritative voices now claim that the pandemic will change everything in GVC design in response to the “new normal”. What does a “new normal” actually mean? The term describes a situation of radical change, consistent with a large exogenous shock experienced by firms and society at large. Such shock can be a radical change in institutions (such as the Fall of the Berlin War) or a broader‐environment related shock (such as climate change). Through many “cascading” effects”, somewhat similar to those found in ecological systems, the shock structurally changes behaviors.

UNIDO recently observed that: “In a number of developed countries, leading government politicians have called for a rethinking of their companies’ approaches to international outsourcing of production, with a view to avoiding future supply bottlenecks while increasing resilience of supply chains.” And The Economist noted: “Narendra Modi, India's prime minister, told the nation that a new era of economic self‐reliance has begun. Japan's COVID‐19 stimulus includes subsidies for firms that repatriate factories; European Union officials talk of ‘strategic autonomy’ and are creating a fund to buy stakes in firms. America is urging Intel to build plants at home.”

There will undoubtedly be long‐term impacts on established IB managerial practices, such as human resources management. The main guiding principles of GVC design, however, are less likely to change: the GVC governance system came into existence because it was better suited to serve economic efficiency and to create economic value than other types of governance, with the food industry GVC being perhaps the most impressive example. When a lead firm designs or enacts a GVC, it must assemble many economic activities that are technically or managerially linked to each other and that can benefit from joint coordination to create value. The lead firm uses both external contracts and internalization to organize fine‐sliced value chain activities. All these activities can be geographically dispersed across many countries as a function of evolving location advantages. Because of advanced, activity‐based accounting and digital tools, as well as other managerial innovations in coordination and control (such as block chains), senior managers can identify and isolate very narrow, modular activity sets to be coordinated with each other. For each activity set, they decide on internalization versus external production, and on its optimal location. They continuously reflect on what should be done inside the firm versus outside of it, and where. The outcome is a GVC with great agility to respond swiftly to exogenous shocks.

From an IB research perspective, the pandemic is likely to stimulate studies in the following four research areas that are the home of a rich literature on MNE and GVC governance. This future research will ultimately allow testing the resilience of GVCs to major exogenous disruptions.

First, investments in intelligence and contracting safeguards. The extant IB literature mostly acknowledges the increased bounded rationality and bounded reliability challenges that arise when firms operate in higher distance environments, with distance having geographic, economic, cultural and broader institutional dimensions. The question arises whether the pandemic, which has exacerbated uncertainties and volatility, will increase governance‐related investments in intelligence and safeguards to reduce bounded rationality and bounded reliability problems, and what form these investments will take. One key testable hypothesis in the realm of bounded rationality reduction is that the size and diversity of MNE top management teams, and the usage of various intra‐GVC coordination mechanisms will increase to improve the firm's information processing capacity. Another key testable hypothesis, related to safeguarding against bounded reliability, is that MNEs will further “micro‐modularize” value chains to allow easier substitution of one micro‐module by another, thereby also reducing the possible negative impact of any micro‐module in the GVC on the entire network (new geo‐redundancy).

Second, levels of irreversible investments abroad. Reducing irreversible investments abroad is the standard outcome of increased, uncontrollable risks. The pandemic has demonstrated that public policy makers can simply shut down entire sectors of the economy as well as GVCs without any advance warning and without any negotiations with the economic actors affected, using public health and national security arguments. A key testable research hypothesis is therefore the following: lead firms aiming to reduce reliability problems, will be less inclined to invest in highly specific assets abroad, when these cannot be adequately insured or otherwise protected against future discriminatory government policies targeting foreign actors.

Third, relational contracting with key partners and ex post governance. In a context of global institutional fracturing and macro‐level institutions being less reliable than expected to protect business interests, as the pandemic has shown, MNEs may naturally reduce their reliance on these institutions. They may engage in more elaborate micro‐level contracting with the critical partners in their GVC networks. The question arises how the balance between formal and relational contracting will evolve. One key testable hypothesis is that MNEs will focus more on relational contracting and on the intricate details of ex post governance when dealing with reliable GVC partners (the expected reliability may be indicated, inter alia, by the length of the relationship and the number of linkages with that partner). For example, it might be more efficient for key GVC partners to access and process information about the evolving economic prospects of a particular locale than it is for the GVC's lead firm. Even when adopting higher modularity as suggested above, the lead firm need not be more insular. Reliable, key GVC partners can be entrepreneurial too, and if sufficiently large, can even support modular structures by providing alternative supply options and innovative, risk‐reducing solutions to the lead firm.

Fourth, levels of diversification. The pandemic has clearly shown that a crisis has winners too. In past global crises, typical winners have included businesses as diverse as those trading in gold or manufacturing weapons. In this instance, the winners include on‐line retailers, manufacturers of protective equipment and health care products, and various types of digital services providers. After decades of being told to focus on their core business, lead firms in GVCs might want to diversify into activities that share similar underlying competences but are unlikely to be negatively affected by an unexpected crisis at the same time as the core business. The key testable hypothesis is that lead firms in GVCs as well as some of their partners will engage in higher product and industry diversification to reduce the possible ravaging effects of a future crisis on their core business.

Despite the great societal devastation caused, future IB research can hopefully demonstrate that the pandemic is no match for agile GVCs, and confirm the conventional triple rule of good governance: When facing large‐scale, uncontrollable risks, firms will adjust their governance systems to mitigate the novel bounded rationality and reliability challenges, and create a governance context conducive to sustained value creation. Paradoxically, in an era of declining multilateralism, agile GVCs are the best safeguard to maintaining the economic connections necessary for a thriving world economy.

Biography

Dr. Alain Verbeke is Editor‐in‐Chief of the Journal of International Business Studies. He holds the McCaig Chair in Management at the Haskayne School of Business, University of Calgary (Canada). He is the Inaugural Alan Rugman Memorial Fellow at the Henley Business School, University of Reading (UK) and an Adjunct Professor at the Solvay Business School, Vrije Universiteit Brussel (Belgium). Dr. Verbeke is a Fellow of the Academy of International Business and European International Business Academy.