• Global value chains: yesterday, today and tomorrow

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    Made in Spain, Made in the USA and even Made in China labels make less and less sense in today’s world. Since firms decided to fragment their production processes and move them to other countries, the label Made in the World probably better represents the nature of most of the manufactured goods we consume. In this article we review the past, present and future of global value chains at a time when pandemic-induced restrictions on travel and supply disruptions have brought them back into the spotlight.

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    The creation of global value chains

    he 1990s saw the beginning of a far-reaching optimisation of production processes beyond the borders of a single country. Companies decided to fragment these processes and carry them out in as many countries (in order to make the most of each country’s advantages of specialisation), giving rise to what are known as global value chains (GVCs). Several factors helped to encourage the creation of GVCs but first and foremost were the advances made in information and communication technologies (ICTs), which enabled the different production stages to be coordinated perfectly. A second factor was the reduction in trade costs, helped by the important free trade agreements reached during that decade,11 as well as by improvements in transportation, especially by air.

    In fact, GVCs have boosted international trade flows to values that were unthinkable a few decades ago: exports of goods and services as a percentage of GDP rose from around 18% in the early 1990s to levels close to 30% just before the pandemic, while the relative weight of GVCs in total trade flows went from around 40% to just over 50% in the same period (see the chart below).12 

    • 11. 1994 saw the conclusion of the largest round of multilateral trade negotiations (the Uruguay Round), in which 123 countries took part. Also in 1994, the North American Free Trade Agreement (NAFTA) was concluded. Both agreements led to a substantial reduction in tariffs worldwide: from levels of around 16% in the early 1990s to 5% today (according to World Bank data, simple averages).
    • 12. The development of GVCs was particularly dynamic between 1990 and the early 2000s, just before the outbreak of the global financial crisis. Since then, the relative importance of these chains in trade seems to have stagnated.

    The importance of global value chains in trade flows

    Last actualization: 04 May 2022 - 09:16
    The pandemic: present impact and future approaches to GVCs

    The COVID crisis has raised many doubts regarding the high degree of globalisation achieved, as well as the adequacy of GVCs. At first, in countries such as Spain, we became aware of the high external dependence (beyond the EU’s borders) of goods which, at that time, were essential.

    In a second phase, with the strong recovery in demand focusing particularly on durable goods and the disruptions in some factories due to the effects of COVID,13 we have been faced with a global supply shortage problem we had not experienced since GVCs were created. And, in this world of global manufacturing, disruption in one stage of the production chain leads to major disruptions throughout the entire process. The longer the GVC, the greater the impact (the bullwhip effect).

    Such disruptions will undoubtedly change people’s minds about GVCs. Although it is still too early to know what changes the future holds, we can suggest some strategic rethinks company directors are likely to pursue in order to increase the robustness of the production chain.

    First, the chains will probably be shorter to avoid the amplifying effect of disruptions. Secondly, they will be more redundant in key components. In other words, there will be alternatives to the production of these components. Thirdly, they will be equipped with new digital technologies that will enable them to detect chain failures early on. And, in terms of logistics, investment in inventories is likely to increase: from just in time to just in case, as stated in a recent article by the Financial Times14 (see the chart below).

    • 13. See the article «Bottlenecks: from the causes to how long they will last» in the Monthly Report of December 2021.
    • 14. See the Financial Times (December 2021). «Supply chains: companies shift from ’just in time’ to ’just in case’».

    Global value chains are likely to be shorter in order to avoid the amplifying effect of disruptions.

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    However, it should be noted that these possible strategic changes, if they occur at all, may be more gradual and less far-reaching than we might have assumed after the shock of the pandemic. One of the reasons is that such changes would entail an increase in costs, with the evident impact on prices consumers would have to pay. In a globalised world, this could mean a significant loss of competitiveness compared with other countries and/or companies. Furthermore, as Harvard professor Pol Antràs has noted, the configuration of GVCs forces companies to incur large sunk costs, which leads to them being extremely rigid regarding strategic production changes.15 

    In other words, the COVID shock will indeed bring about a change in our approach to the configuration of new GVCs and may certainly lead to some rethinking of the existing chains. But, in the latter case, this rethinking might be less radical and rapid than some are predicting.

    • 15. See Antràs, P. (2020). «De-Globalisation? Global Value Chains in the Post-COVID-19 Age». National Bureau of Economic Research, no. w28115.
    The future of GVCs: plus and minus factors

    In addition to the impact of the pandemic, other factors (mostly new technologies) have the capacity to reshape GVCs and we present a brief review (see the diagram below).16

     

    Automation and 3D printing

    Although automation is a process that has been going on for centuries, today’s robots, equipped with artificial intelligence and at a cost that has decreased substantially over the past few decades, represent a full-fledged revolution. The improved productivity of these new robots may result in some of the manufacturing processes which had been moved to emerging countries in order to take advantage of low labour costs now returning to advanced countries. In other words, we would be shifting from an offshoring to a reshoring trend, which would entail a certain reversal in the globalisation of supply chains.

    On the other hand, 3D printing is a technology that could result in GVCs becoming shorter and, along with this, to the reshoring of part of the manufacturing activity. In fact, with this technology, it is not necessary to send physical products; all that’s required are the computer files to manufacture them! However, there is still no clear evidence in this respect. In fact, a paper published by the World Bank shows a strong increase in trade flows following the adoption of 3D technology in hearing aid production, something we would not expect with a shortening of GVCs.17 Although this is a very specific case, it does reveal some interesting effects that need to be considered. In particular, the hearing aid sector adopted 3D printing for almost all its parts when this became technologically feasible (about 10 years ago) and, since then, trade flows linked to the sector have increased by 60%. The main reason for this growth is that 3D printing has led to a huge reduction in the production cost of hearing aids and an improvement in terms of quality, resulting in a sharp increase in demand for the product. And with greater demand, international trade in hearing aids has intensified.

    • 16. Based partly on Canals, C. (2020). «Revolución tecnológica y comercio internacional 4.0». Geopolítica y Comercio en tiempos de cambio. Published by CIDOB.
    • 17. See Freund, C. L, Mulabdic, A. and Ruta, M. (2020). «Is 3D Printing a Threat to Global Trade? The Trade Effects You Didn’t Hear About». World Development Report.
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    The electric car

    Another case that also warrants particular attention is that of electric cars, which have the potential to alter some of the most relevant GVCs (those of the automotive sector), as well as to considerably reduce international trade. The reason is that classic combustion-engine cars require a large variety of parts and gears that are often manufactured in different countries to maximize the competitive advantages of each location. In fact, the automotive sector is responsible for a substantial part of the world’s trade flows of intermediate goods. However, the electric car, with its much simpler mechanics (far fewer parts that are also less subject to wear and tear) could lead to a reduction in these classic intermediate flows and, consequently, to a radical change in the structure of automotive GVCs.

    The production of batteries, a key component for the new electric vehicles, will also determine the future of numerous trade flows, which in this case will focus on raw materials such as lithium, nickel and cobalt.

     

    Digital technologies and the emergence of new services

    The continuous evolution of ICT, hand in hand with 5G and blockchain technology, will continue to push down logistics costs and, with it, boost the trade flows of goods and services and participation in GVCs. For instance, 5G will support the development of the Internet of Things, which will enable faster and more secure tracking of shipments in the case of goods, and better connections in the exchange of services. Likewise, blockchain has the potential to greatly facilitate international payments.

    On the other hand, these digital technologies will also encourage the emergence of new products, especially services, whose organisation could be decentralised and located in different countries, creating new GVCs in the image and likeness of the chains already established for the production of manufactured goods.

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    History reminds us that technological development and international trade are not independent of geopolitical developments.

    Geopolitics

    Finally, it should not be forgotten that geopolitics has always played an essential role in international trade. In this respect, the USA’s intention to «decouple» from China, especially in the field of technology, could bring about a very significant change in world trade and in how GVCs are managed, especially in the technology sector. Even more so because the US is not alone in wanting to put more distance between itself and other economies. For instance, Europe also seems willing to reduce its external dependence in some technology segments, such as semiconductors, with the European Chips Act.

    In summary, although we do not expect any radical or abrupt change in the form taken by GVCs since they tend to be relatively stable over time, we might see a change in trend in the next few years due to the various 4.0 technologies. In addition to these ongoing trends, factors such as the Coronavirus crisis will further exacerbate certain technological dynamics. However, history reminds us that technological development and international trade are not independent of geopolitical developments. And in this respect, trade-technology tensions between the US and China will play a decisive role.

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The benefits and costs of globalisation

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When Marco Polo reached China in the 13th century via the Silk Road, he found a prosperous land where agriculture and industry were flourishing thanks to trade, supported in turn by a vast network of roads, bridges and canals. The per capita wealth of the Chinese far exceeded that of the Europeans, as illustrated by the fact that steel production in China was five times higher than in Europe. However, in the early 15th century, at the peak of its prosperity, the Ming dynasty made a radical change to the country’s economic policy, isolating it from the outside and, in doing so, oppressing its capacity for innovation. Four centuries later, China had been left behind, while Europe, which was more open, powerful and richer, began its colonialist phase in the Asian country.

In times like those we are living in today, in which voices have arisen in favour of greater protectionism, it is more necessary than ever to understand the benefits and costs of globalisation.

The benefits of globalisation on economic growth

The economic literature identifies several channels through which the phenomenon of globalisation affects economic growth and, therefore, our well-being. The first channel is known as knowledge spillover and refers to the benefits generated by the fact that knowledge gained in one country can be used in other countries.1 Flows which contribute to globalisation (such as trade transactions or migratory movements) allow the dissemination of new ideas. These ideas, in turn, facilitate improvements in productivity in the countries which receive these flows, as well as in other countries, leading to improvements in the overall well-being of the population. One feature that makes this channel particularly relevant is the fact that knowledge is a factor of production that can be used simultaneously by different people in different countries (it is a non-rival factor, in economic terms).

Secondly, we have the «scale effect», which is derived from the larger market which is intrinsic to a more globalised world. In particular, globalisation gives companies a bigger playing field in which to exploit their ideas. Thus, they are able to earn profits from sales abroad, in addition to those from local sales. This increased market size encourages firms to grow and to acquire greater knowledge, which increases the country’s productivity and, therefore, economic growth. This effect, however, has a direct counterpart at the local level, which is that the greater profit which companies can earn in this more globalised economy due to increased demand can be offset by the loss of market share in the face of competition from foreign companies. This gives rise to the «competition effect» of globalisation, which, contrary to the scale effect, can discourage some companies from acquiring greater knowledge. This occurs when, for example, upon losing market share and thus earning lower profits, local companies have fewer funds to invest in R&D. Similarly, at the global level, increased globalisation can also end up leading to a greater concentration of companies and, therefore, lower rates of investment.

On the other hand, a more global environment increases the variety of products available for consumers, since they now have access to foreign products, which increases their well-being («gains in variety»). Finally, economists have identified a last channel, known as «technological dissemination». The link between globalisation, technology and growth is as follows: in a globalised economy, companies are forced to use technology that is equal to or greater than that of their global competitors. Therefore, the greater competition means that only those companies that employ cutting-edge technology survive. The confluence of these elements means that new players entering a more globalised market are more technologically advanced than those in one with only local competition, resulting in better well-being in a globalised world.

Although we have identified the various channels that link globalisation and economic growth, we cannot assure that the former’s impact on the latter will always be positive. This is because, although the majority of effects are beneficial for growth, the «competition effect» is detrimental to improvements in the population’s well-being. Furthermore, the importance of this relationship must be tested: it could be the case that there is a positive and statistically significant relationship, but it is not economically significant.

Indeed, numerous empirical studies that take into account the different channels we have spelled out demonstrate that the aggregate effect on economic growth is positive and quite significant. In particular, in a baseline study using information from 150 countries, Frankel and Romer demonstrated how increases in an economy’s trade flows lead to significant increases in its real per capita income. Specifically, an increase in international trade as a percentage of GDP of 1 pp translates into a 0.9% increase in per capita income. Such an increase in Spain would represent a boost of 225 euros to GDP per capita, while in Portugal it would represent an increase of 170 euros.2 Weinstein and Broda, meanwhile, identify that the variety of imports in the US increased fourfold between 1972 and 2001, and that this greater variety led to a significant improvement in the well-being of the American people.3

The losers of globalisation in advanced countries

Despite the proven positive effects which globalisation can have on people’s well-being, it can be the case – and, in fact, it is – that this better well-being is not equitably distributed among all individuals: some not only do not benefit but actually come out worse-off. They are the losers of globalisation.

Numerous studies have analysed the harmful effects of this phenomenon. In particular, the effects of globalisation on the labour market have been the subject of extensive research, especially in relation to the adverse effects it has on certain groups of workers in developed countries.

In this case, we can also identify different channels through which they are affected. The main one is related to the increase in direct competition suffered by certain groups of workers (generally, low-skilled workers) when faced with the possibility for companies in developed countries to relocate part of their production to emerging countries (with much lower labour costs). This can result in a reduction in the demand for local workers and, therefore, their salary.

There is, however, an effect that counteracts this unfavourable situation: companies opting to offshore part of their production (either by relocating or outsourcing) are able to lower their costs and thereby increase their productivity. In this situation, the company will have greater incentives to expand, which can increase the demand for workers (both qualified and non-qualified) in the country of origin and, with it, their remuneration. Finally, this decrease in the costs borne by companies opting to offshore their production leads to a decrease in the prices of the final goods and services they produce, leading to an increase in the real wages of all local workers.

At this point, and to assess the relevance of such costs, we once again turn to what the empirical analyses show us, including those conducted by the MIT economist David Author. In one of his most notorious articles, «The China Syndrome», he warns of a significant negative impact on some groups of American workers caused by the strong rise in imports from the Asian country following its entry into the World Trade Organization in 2001.4 As such, workers in regions of the US which produced a high percentage of goods directly exposed to Chinese competition (such as electronic goods or textiles) suffered significant declines in wages and an increase in unemployment. As an example, manufacturing jobs (as a percentage of the total population) fell by 5 pp between 1991 and 2007, and their estimates indicate that greater exposure to Chinese imports was responsible for half of this deterioration. Similarly, other studies show real wage reductions of up to 12% in the face of greater exposure to international trade in the US.5

Besides labour costs, some studies have focused on the negative consequences for workers’ health. The loss of employment or a reduction of wages can lead to depression. In addition, for those workers who have not lost their jobs and have even been able to keep their remuneration intact, the new scenario of greater competition which their employers face can have a substantial impact on their working day (both in terms of tasks and in terms of timetables), leading to greater occupational stress.6

In short, globalisation is capable of improving countries’ well-being through improvements in productivity, lower prices and greater variety in the products that are available. However, it generates significant adjustment costs for those workers who suffer the most from the direct competition posed by the new flows arising in a globalised world.

Its staunch detractors have focused on highlighting these costs, while its outright defenders have sometimes only emphasised its benefits. None of them are lying, but neither are they telling the whole truth. Partial truths are of little use when faced with a phenomenon that has not stopped growing in recent decades and that affects us directly. Knowing the benefits and the costs brought about by globalisation is essential for deciding what form of globalisation we want to see from today onwards.

Clàudia Canals
CaixaBank Research

1. See Grossman, G.M. and Helpman, E. (1990), «Trade, innovation, and Growth», The American Economic Review 80, n° 2: 86-91; and also Grossman, G.M. and Helpman, E. (1991), «Trade, Knowledge Spillovers, and Growth», European Economic Review 35, n° 2-3: 517-526.

2. International trade can be estimated using the ratio of imports plus exports over GDP. See Frankel, J.A. and Romer, D.H. (1999), «Does Trade Cause Growth», American Economic Review 89, n° 3: 379-399.

3. See Broda, C. and Weinstein, D.E. (2006), «Globalization and the Gains from variety», The Quarterly Journal of Economics 121.2: 541-585.

4. See Autor, D.H., Dorn, D. and Hanson, G.H. (2013), «The China Syndrome: Local Labor Market Effects of import Competition in the United States», American Economic Review 103, n° 6: 2121-68.

5. See Ebenstein, A., Harrison, A., McMillan, M. and Phillips, S. (2014), «Estimating the impact of Trade and Offshoring on American Workers using the Current Population Surveys», The Review of Economics and Statistics 96(4).

6. See Italo, C. , Crinó, R. and Ogliari, L. (2015), «The Hidden Cost of Globalization: import Competition and Mental Distress»; as well as Autor et al. (2013), referenced in note 4.

 

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