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Supply chains have come under severe pressure due to the pandemic lockdowns that closed national borders and geo-economic tensions that have altered and disrupted existing global value chains.
As Chair of the LSE Economic Diplomacy Commission, our Final Report proposed a stress testing regime that would make supply chains more resilient and increase transparency about the way that regulation applies to them. The proposed regime is similar to the globally coordinated system for regulating systemically important financial institutions (SIFIs). Like global banks, global supply chains operate across national borders. It makes international coordination of any stress testing regimes necessary so that the regulatory requirements of different countries do not conflict, distort or cause uncertainty for the multinational companies that operate supply chains.
We suggest taking lessons from the stress testing regime for banks that came about after the various financial crises of the late 20th and early 21st centuries. For advanced economies, stress testing banks became part of the fabric of how to keep financial systems resilient after severe crises, notably the 2008 US subprime crash and the 2010 euro crises. The Federal Reserve and the European Banking Authority, respectively, scrutinise the balance sheets of major American and European banks to ensure that they have sufficient capital to withstand a crash in asset markets, deep recession, and a withdrawal of liquidity.
The stress testing regimes were conducted at the national level but are based on global standards about how much capital and liquidity banks should hold. This coordination provides transparency about the resilience of significant banks that operate beyond the borders of their home countries and impact foreign markets. In this respect, global supply chains also directly affect corporate operations in markets around the world, so their resilience matters for all of the countries in which they are located.
The Basel standards that set globally agreed capital requirements for banks came about after the early 1980s financial crises in emerging markets. [...] A supply chain stress testing regime can be modelled on similar principles.
The Basel standards that set globally agreed capital requirements for banks came about after the early 1980s financial crises in emerging markets. The global body that coordinates the setting and sharing of information about these standards likewise came about after the late 1990s financial crises that swept across Asia and other emerging economies. The Financial Stability Forum that was established then later became the Financial Stability Board (FSB) after the 2008 global financial crisis. The G20 countries came together to firefight the sub-prime crisis that originated in America but soon disrupted the functioning of international financial markets. These major economies saw the merit of having a global coordinating body like the FSB so that they could agree on the regulatory standards governing their banks and share that information so that it was transparent to each other and the market.
A supply chain stress testing regime can be modelled on similar principles. At present, individual nations take unilateral actions that may impose a negative externality on other countries. The concern about what other countries might do has led to calls to re-shore supply chains. Some re-shoring is happening in any case due to technological advances such as 3D printing that means parts can be manufactured on site. But, not everything can or should be done within one country as that might even reduce resilience should a national crisis occur. In other words, diversification leads to more resilient supply chains since a disruption or shutdown in one country could instead lead a pivot to an alternative supply chain configuration incorporating different countries or regions.
Countries could come together at a new forum or potentially at the OECD that has stressed principles including transparency, which promotes market openness and increases trust that countries will not be left without key inputs. Like how the FSB is hosted by but does not report to the Bank for International Settlements (BIS) which is known as the central banks’ central bank, the OECD could serve as the base for a supply chain coordinating body. It would be where the G20 major economies come to agree which key sectors will be subject to stress testing, what standards would be applied, and how to communicate the outcomes so that countries do not distort supply chains or stockpile inefficiently.
Also on the Forum Network: The Drivers of Supply Chain Resilience by Linda Yueh
The pandemic has shown the vitality of supply chain resilience. Dr Yueh explains what trends should be considered going forward in building back supply chains around the world.
Not all supply chains provide vital inputs into the economy, such as those related to national security or health needs, for instance. These supply chains are the ones that need to be more resilient, so would be subject to stress tests. Knowing which ones will be subject to greater scrutiny would help companies plan and reduce uncertainty that can deter investment and distort efficient decision-making. A transparent regime would be an improvement on the current system where firms do not know which supply chains may be shut down due to countries imposing export bans on each other. In setting the standards and selecting the sectors, involving stakeholders such as multinational companies would be important since they have the expertise and experience to input where alternative supply chains could be located.
The recent geo-economic tensions and the global pandemic have highlighted fragilities in supply chains. A global stress testing regime would go a long way towards increasing resilience, reducing uncertainty, and maintaining the principle of open markets by identifying where governments will intervene and where they will not.