• Global value chains: yesterday, today and tomorrow

    catalanspanish

    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.

    Plantilla

    plantilla_article_vs05

    Temática
    Pre Titulo
    Miniatura
    Área geográfica
    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.

    p21

    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.
    p22

    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.

    p23

    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.

    Monograficos
    Destacado Economia y Mercados
    Desactivado
    Destacado Analisis Sectorial
    Desactivado
    Destacado Área Geográfica
    Desactivado

EU and China: mapping out a strategic interdependence

The outbreak of the pandemic in 2020, and more recently the war in Ukraine, has accelerated the trend of decoupling between the US and China, and Europe also appears to have joined in, albeit somewhat timidly for now. We analyse the EU’s dependence on China in order to understand whether European strategic autonomy is possible, or even desirable.

Content available in
Foto de CHUTTERSNAP en Unsplash

China’s aspiration to become a global economic, military and geopolitical power has generated occasional tensions with Western countries since the early 2000s. These tensions culminated in a sharp escalation of trade restrictions with the US beginning in 2018 and a decoupling process between the two powers. The outbreak of the pandemic in 2020, and more recently the war in Ukraine, has accelerated this decoupling trend, and Europe also appears to have joined in, albeit somewhat timidly for now.

New terms are appearing in the political discourse, such as «strategic autonomy», «reshoring» and «nearshoring», in an attempt to increase supply chain resilience and guarantee security in the consumption of essential products in the face of supply shocks, whether triggered by tensions in the health, climate or geopolitical spheres. But is this much-sought-after «strategic autonomy» possible, or even desirable? To answer this question, in this article we look at the EU’s dependence on China.

The Chinese origin of European final demand: 2% made in China

Over time, China has become the main source of imports into the European bloc. In 2020, China accounted for 22% of the EU’s total gross imports of goods, compared with 12% for the US and 9% in the case of the UK. This contrasts with the situation back in the year 2000, when only 6% of European imports of goods came from China, well behind the United Kingdom’s 19%, the US’ 16% or even 8% in the case of Japan.1

The data on imports and exports in gross terms do not allow us to make an accurate assessment of the origin of the goods and services that are consumed. In this regard, the OECD’s TiVA (Trade in Value Added) database, based on international input-output tables, offers us a more detailed view of the degree of economic integration between China and the EU, allowing us to measure the actual dependencies for each country and sector. By identifying the exact origin and destination of each good and service that is traded, we can investigate the composition and the actual origin of final demand and exports.2

In aggregate terms, Chinese goods and services have accounted for 2% of European final demand in recent years (see first table). This is a similar level to that in the US, but lower than in countries such as Japan or India, which have value chains that are more closely integrated with China.

  • 1. According to data from the Observatory of Economic Complexity (OEC). Unlike the TiVA database, which we use next, these data only include trade in goods (i.e. they exclude services).
  • 2. For more details on the use of this database, also see the Focus «European dependence on Russia: a primary issue» in the MR04/2022.
Value added originating in China in final demand

Between the EU and other countries we find some common trends worth highlighting. Firstly, this dependence on China has increased significantly in the last two decades and in all sectors analysed, including both manufacturing and services. Secondly, it is clear that the Asian giant has transformed itself into a global manufacturing power, accounting for 5%-10% of the manufacturing sector’s final demand worldwide. In particular, the dominance of the Chinese value chain in the textile and electronics sectors is unquestionable, accounting for over 20% of the final demand of these sectors in the largest EU economies, 40% in the case of textiles in Japan and the US, and more than 25% in electronics in India and Russia.

Focusing on the EU in particular, the bloc’s integration with China has increased in the last decade, particularly in more advanced sectors such as electronics and machinery, but also in commercial services and in information and communication services.

This strong integration of China into European value chains is evident when analysing the growing weight of Chinese goods and services in the European export sector (see second table), mainly in technologically advanced manufacturing sectors. This indicates the penetration capacity of intermediate products produced in China in highly integrated production chains, such as electronics, machinery and transportation equipment. It is noteworthy that Spanish exports of electronics and French exports of transportation equipment incorporate a greater proportion of Chinese goods and services than the corresponding export sectors in Japan. Europe’s textile industries are also among the most highly integrated with China in the world. Moreover, in the EU-27 this integration accelerated in the last decade, contrary to what has happened in the US, for instance, where exports of electronic products now contain a smaller proportion of Chinese goods than they did a few years ago.

Value added originating in China in exports

At this point, it is also important to emphasise that at a more disaggregated level the interdependence between countries may be much greater in certain specific products. If, in addition to having a significant dependence on imports of a particular product, the exporting country also has market dominance, then the risk of disruptions in production chains is greater in the event of supply issues, whether due to logistical difficulties or diplomatic tensions.

In this regard, the EU’s dependence on China is significant in the case of certain rare raw materials (crucial for the energy transition), such as manganese or scandium, as well as in various components that are essential to the production of pharmaceutical goods, such as active agents and vitamins, and in electronic components – both final and intermediate – such as LED lamps or permanent magnets. In all these products, China has a global market share of over 50%, representing as much as 90% of global production in some cases.3

  • 3. See European Commission (2021). «Strategic dependencies and capacities», Commission Staff Working Document. See also L. Salinas Conte (2021). «The dependency on China of Spain’s supply chains», Elcano Policy Paper, Elcano Royal Institute.
A sustainable attachment?

In the last Monthly Report, we analysed the impact of the current tensions with Russia, concluding that the negative effects of the decoupling process will be particularly visible in the short term and in economies that are more dependent on fossil fuels for their energy needs. However, in the medium term, and as some countries have already demonstrated in recent years, reducing dependence on Russian commodities is not impossible, and moreover it is compatible with a quicker and more coordinated energy transition.

China, however, is much more densely interconnected with the EU, as well as with the rest of the world’s major economies. In the EU in particular, this integration has accelerated in the last decade and the Chinese value chain is key to a large number of sectors, especially in manufacturing. Furthermore, in recent years the Chinese economy has come a long way in increasing its technological specialisation (see third table), thereby reaffirming a vital role in the global trading system. As the recurring supply problems experienced during the pandemic have shown, decoupling from China would have costs for the entire economy, being insurmountable in many cases. Unlike the European Green Deal, the feasibility of achieving «strategic autonomy» in many of these sectors, through reshoring part of the value chain, is not entirely clear. If the world enters a new geopolitical era that results in a process of de-globalisation is confirmed, then the inevitable tensions between the various blocs would most likely result in more losers than winners. Furthermore, a long-lasting commercial relationship between the EU and China will increasingly need to be underpinned by strong diplomacy. Not only will the European economy depend on such a diplomatic effort, but so will domestic politics, global geopolitical stability and – because there is never a bad time to recall it – the global fight against climate change.

Economic Complexity Index (ECI)