• 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 chip shortage is going nowhere fast

What’s behind the semiconductor shortage? Is it a transitory phenomenon attributable to the pandemic or does it also reflect structural factors linked to the specific characteristics of the sector?

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October 19th, 2021
Chips

The shortage of semiconductors (or chips) and the associated bottlenecks constitute one of the most significant features of the post-pandemic economy. This shortage has affected many manufacturing sectors, and the car industry in particular, which in Europe plays a major role in the economy. It has also contributed to bottlenecks that are generating inflationary pressure and could hold back economic activity. But what lies behind this phenomenon? Are these chip bottlenecks a transient phenomenon attributable to the pandemic, or do they also reflect structural factors resulting from the sector’s specific characteristics?

Macroeconomic factors

The post-pandemic economy is characterised by significant unmet demand, especially in private consumption, which is receiving an additional boost from the pent-up savings amassed during the lockdown. Also, the demand in this reopening phase is proving particularly high in the case of information and communication technology goods, driven by the rise in teleworking and remote learning (computers, tablets, etc.), and these goods require large quantities of chips. Moreover, a considerable portion of this demand has been directed towards the purchase of cars, which also need semiconductors. While some of this excess demand ought to correct itself over the coming quarters as consumption patterns normalise and pent-up savings fade, there are other more structural forces which could cause the chip shortage to persist.

Firstly, there is the technological decoupling between China and the US, which is set to continue in the coming years and is disrupting chip supply chains. Secondly, the transition towards electric cars will also increase the demand for semiconductors, as they use more chips than internal combustion vehicles. Thirdly, and perhaps most importantly, there is the idiosyncratic structure of the semiconductor industry.

What makes the semiconductor industry special?

Semiconductor firms can be divided into three groups. There are Integrated Device Manufacturers (IDMs, such as Intel, Samsung or Texas Instruments), which handle both the design and the manufacturing; so-called fabless firms, which only design their chips and outsource the production (such as Nvidia, Qualcom or AMD), and pure play foundries (such as Taiwan Semiconductor), which only manufacture other companies’ designs.

In this semiconductor value chain, the foundries are the critical point. This is firstly because the high fixed cost of manufacturing chips, especially the most advanced ones (less than 28 nm)1, makes it very financially costly to have manufacturing units sitting idle (see first chart). Moreover, this high cost means that vast investments are required, posing a formidable barrier to entry. Thirdly, the complexity of wafer manufacturing requires a high degree of specialisation and also requires the customer – in this case the designer – to provide the manufacturer with a great deal of sensitive information if they want the product to meet their specifications. As a result, the economies of scale in the industry and the flows of sensitive information between customers and manufacturers tend to encourage concentration.

  • 1. The complexity of chips is measured by how small they are, and the unit of measurement is a nanometre (nm), representing a billionth of a metre. The fewer nanometres a chip measures, the more advanced or sophisticated it is. The most advanced ones currently measure 3 nm, but those under 28 nm are already considered relatively advanced.
Expected evolution of the chip market: the dominance of advanced chips
A concentrated market

A prime example of the key role of foundries in the sector is the fact that, over the past 20 years, the foundry market has grown at an annual rate of 10% (74 billion dollars in 2020), whilst the total semiconductor market has grown by 4% (239 billion dollars in 2020). The investment bank Goldman Sachs expects the demand for advanced nodes (under 28 nm) to cause the foundry market to grow at a rate of 15% per annum through to 2023, before returning to 10% in 2024-2025. In comparison to the previous cycle, the foundry industry is now more concentrated. Taiwan Semiconductor is the biggest pure play foundry. In 2020 it accounted for 59% of the total wafer market, compared to 50% in 2010, and in the case of highly advanced chips (less than 10 nm, a 21.1-billion-dollar market) the concentration is even higher (Taiwan Semiconductor produces around 90% of the total) (see second chart). Trailing far behind, the second biggest wafer manufacturer is Samsung. On the other hand, the aforementioned technological decoupling of the US and China has severely affected the Chinese firm SMIC (Semiconductor Manufacturing International Company), since the recent US restrictions prevent it from using certain American technology.

Chip foundries: * market share
Europe, where are you going?

In this environment of structural chip shortages, the big tech giants, such as Faang (an acronym for the leading US technology companies),2 are using their greater bargaining power to meet their high demand ahead of other industries, such as the automotive industry.

Europe is seeking to bolster its own semiconductor industry and to explore the possibility of developing European chip manufacturing. The problem is that the starting point is a long way behind the technological cutting edge, especially in the manufacture of wafers. This, coupled with the aforementioned investment requirements, means that significant long-term effort involving the major European economies is required. The European dilemma is whether to seek short-term solutions to alleviate the situation in the automotive sector or to compete directly with Taiwan. Without drastic policy changes, this looks like a chimera.

 

  • 2. Namely, Facebook, Amazon, Apple, Netflix and Alphabet.
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