The expansion of globalization has been stagnant recently due to the rise of protectionism worldwide, despite the significant benefits it has provided, including efficient resource allocation and technology diffusion across countries. One reason for the rise of protectionism is that many people fear negative economic shocks spread through global corporate networks. For example, the global financial crisis propagated rapidly from the United States to the rest of the world through the network of financial institutions.

Another prominent example is propagation of shocks through global supply chains, the network supplier-client relationships that spans the globe. In 2011, we observed that the Great East Japan earthquake and Thai flood lead to reduced production in factories that were not directly hit by the disasters. They were linked with suppliers and customers in the disaster areas and hit by a shortage of supply and demand. The indirect effect of natural disasters on production can be large. It is estimated to be 100 times as large as the direct effect in the case of the Great East Japan earthquake.

However, we should not focus only on the negative side of global supply chains, as they can be a channel to support damaged firms in the wake of natural disasters. In fact, it is well known that after the Great East Japan earthquake, manufacturers often supported their suppliers and customers during recovery. For example, automobile makers, such as Toyota and Honda dispatched their workers for 80,000 man-days to Renesas Electronics, a supplier of microcomputers for automobiles that was heavily damaged by the earthquake. An analysis based on firm-level data has confirmed that firms in the damaged areas recovered earlier if they were connected with firms outside the damaged areas through supply chains.

Moreover, the positive effects of post-disaster policies can propagate through supply chains so that their total effect can be augmented. My background paper with Yuzuka Kashiwagi for the Asian Development Outlook 2019 examines the effect of subsidies to small- and medium-sized enterprises (SMEs) after the Great East Japan earthquake. According to its estimates, the post-earthquake subsidies improved the sales and employment of small-sized recipient firms (with 5 or fewer workers in the service sector or 20 or fewer in the manufacturing) by 7-8%. Moreover, firms that were not directly damaged by the earthquake but were linked with the small recipient firms through supply chains also improved their sales by 7-9%.

The indirect effect of the policy is substantial. Although the amount of subsidies provided to small firms in 2011 and 2012 was 31.8 billion yen, their indirect effect on sales of non-recipients linked with the recipients amounts to 299 billion yen, as compared with their direct effect on the recipients of 57.8 billion yen. Thus, the rate of return on the subsidies is more than 1,000%.

  Global supply chains could play an unexpected role in disaster recovery

It is clear from this evidence that effects of post-disaster policies can propagate through supply chains. Therefore, policy makers should consider effectively employing policies to restore supply chains immediately after disasters to minimize their negative effect on the whole economy.

Besides policies, propagation of negative disaster shocks through supply chains can be mitigated by diversifying suppliers and clients. We have already seen that firms could recover earlier after the Great East Japan earthquake if they were linked with firms outside the disaster areas, rather than closed within the areas. One of my studies with Yuzuka Kashiwagi also finds that negative shocks by Hurricane Sandy that hit the United States east coast in 2012 propagated within the US but not beyond through supply chains. Moreover, the negative effect did not reach US firms that were linked with directly damaged firms as well as foreign firms. In other words, propagation of negative shocks through supply chains can be mitigated if firms are well internationalized. This is probably because internationalized firms have greater information and managerial resources obtained from their diverse partners and thus can substitute damaged partners for new ones more easily than domestically-constrained firms. 

These implications can be applicable to all types of countries, including emerging and developing countries, as global supply chains have expanded throughout the world economy. Thus, people in emerging and developing countries should not worry too much about the negative side of global supply chains. At the same time, however, policy makers should implement policies to facilitate the resilience of supply chains. This can be done by, for example, supporting firms’ recovery immediately after major disasters and promoting diversification of partners of local firms, including linking with foreign partners.

This blog post is based on research from the April 2019 Asian Development Outlook.