• 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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Geopolitical uncertainty and economics: Deep impact?

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One recurring theme in the media is the relationship between geopolitics and economic variables. But not only in the media: economists are also increasingly aware of the importance of geopolitical risks in accurately gauging economic prospects. But although geopolitics may be in vogue, their relationship has hardly been quantified. This article provides a preliminary examination of the issue.

To accurately measure global geopolitical uncertainty we have created an index that takes into account both political uncertainty at a global level and the trend in conflicts, also at a global level.1 To begin our analysis, it is useful to look at the degree of correlation between our geopolitical uncertainty index and various indexes for economic activity. First of all, we have analysed the relationship between this index and the global PMI business sentiment index. As can be seen in the first chart, the relationship between them is clearly negative: the higher the geopolitical uncertainty index, the lower the business sentiment index. Another indication of the close relationship between both indexes is that an increase in the uncertainty index of a magnitude equivalent of that to November 2016, after Donald Trump’s unexpected victory, goes hand in hand with a 4-point reduction in the PMI index. To provide a clear idea of this magnitude, the central 50% of observations of the PMi index are located within a range of 5 points.

Another way of analysing the relationship between geopolitical uncertainty and economic activity is to directly observe the correlation between geopolitical uncertainty and world GDP growth. In this case, an increase in uncertainty equivalent to that of Q4 2016 tends to be associated with a decrease in world GDP growth of 0.3 pp in the same quarter.

Finally, another way of quantifying t the relationship between the geopolitical risk index and economic activity indicators is to compare it with the correlation observed with indicators that are similar but from other areas. One good benchmark is the financial volatility index, the VIX, as it is commonly agreed that increases in the VIX tend to have a considerable effect on economic activity. An increase of the same magnitude in either index tends to be associated with a similar decrease in world GDP growth. Specifically, if we apply a shock to the VIX index equivalent to the one occurring in the geopolitical risk index in Q4 2016, the reduction in world GDP growth would be approximately 0.4 pp.2

Such findings are useful for a preliminary analysis of the relationship between geopolitics and the economy but they only measure correlations. In other words, they show how economic and geopolitical variables move in synch but do not indicate the cause of this effect
(Does geopolitical uncertainty increase purely due to geopolitical reasons or are such changes caused by other variables? ). To carry out a more sophisticated analysis, we have used a statistical technique3 that quantifies the impact of an exogenous uncertainty shock caused by geopolitical reasons, on the economy over time. As can be seen in the second chart, it is estimated that a shock of uncertainty, of a magnitude such as that occurring in Q4 2016, significantly reduces world growth by almost 1 pp between six months and one year after it occurs.

To properly understand how global geopolitical uncertainty operates, one important question is whether its impact is similar in both advanced and emerging countries. As can be seen in the third chart, on the whole emerging countries withstand geopolitical uncertainty much worse than advanced economies. Specifically, at the peak of the geopolitical shock (three quarters after it occurred), the reduction in GDP growth in the emerging economies is 1.45 greater than in the advanced. The effect on emerging countries also lasts longer than in the advanced. This asymmetry observed between the advanced and emerging blocs might be due to the fact that advanced countries have a more mature and well-established institutional system which provides them with a larger buffer to tackle geopolitical uncertainty. On the other hand, many emerging countries are still immersed in consolidating their institutional environment, making them more fragile and consequently more sensitive to geopolitical ups and downs. Emerging countries should therefore be more concerned about avoiding tensions that could generate geopolitical uncertainty.

Finally, we have also analysed the importance of geopolitical factors for world growth over time. We study the relative weight of global geopolitical factors,4 of macrofinancial factors5 and of financial volatility (VIX) to explain the variation in GDP growth at a global level. The sample was divided into three periods: 2000 to 2007 (previous expansionary cycle), 2008 to 2012 (economic crisis) and 2012 to 2017 (recovery).

The findings are remarkable. Geopolitical factors are now less important compared with the expansionary cycle prior to the economic crisis of 2008 and 2009 but are still significant. Between 2000 and 2007, geopolitical factors carried a weight of 49% in the explained variance in global growth. Between 2008 and 2012, their relative weight was only 13% (macrofinancial conditions explained 62%, reflecting the impact of the financial crisis) while between 2013 and 2017, their relative weight was a significant 30% (volatility and macrofinancial conditions explained 41% and 29%, respectively).

The greater relevance of geopolitical factors between 2000 and 2007 might be due to the fact that geopolitical tensions were subdued (with the exception of the period 2001-2003, coinciding with the 9-11 attacks and the invasion of Afghanistan and Iraq), so geopolitics acted
as a key support for growth. On the other hand, macrofinancial factors have gained in importance since the crisis: quantitative easing programmes have helped to reduce volatility significantly6 and accommodative financial conditions have boosted economic growth. However, the importance of geopolitical factors seems to on the rise again. This trend could consolidate as financial conditions become less accommodative and if populism continues to spread.

1. Specifically, we regress the Iacovello & Caldara geopolitical risk index against the Baker, Bloom & Davis global political uncertainty index and the conflict index constructed in MR01/2018, and use the predicted value as our geopolitical uncertainty variable.
2. Specifically, we standardise the series of the geopolitical risk index and the VIX to be able to apply a shock of similar magnitude in both cases.

3. The technique used is vector autoregression (VAR). More details are provided in the notes for the second and third chart.
4. We include the global geopolitical uncertainty index, the Iacovello & Caldara risk index and the CaixaBank Research conflict index.
5. We include the Financial Conditions Index of the Federal Reserve of Chicago, the S&P 500 and the MSCI Emerging Markets index.
6. See the Focus «Financial volatility and political uncertainty: who says there is fear?» in MR09/2017.

 

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